Inflation tolerance level in India is low relative to many developing countries because of democratic pressures, said the Reserve Bank of India Governor Y V Reddy.

Headline inflation during January-March 2007 was above 6 per cent at 6.46 per cent for the week ended March 10, 2007, but the average inflation was 5.3 per cent during April 2006-March 10, 2007.

But it needs to be recognised that historically the tolerance of inflation has been low in India due to democratic pressures, Reddy said in his address at the Bank of Greece in Athens today.

In a broad sense, the objectives of monetary policy can be no different from the overall objectives of economic policy. The broad objectives of monetary policy in India have been to maintain a reasonable degree of price stability and to help accelerate the rate of economic growth, he said.

The emphasis as between the two objectives has changed from year to year, depending upon the conditions prevailing in that year and in the previous year, he said. The relative emphasis placed on price stability and economic growth is modulated according to circumstances prevailing at a particular point in time and is clearly spelt out, from time to time, in the policy statements of the RBI.

As regards the operating procedure of monetary policy in India, reliance on direct instruments has been reduced and a policy preference for indirect instruments has become the cornerstone of current monetary policy operations, Reddy said.

Liquidity management in the system is carried out through open market operations in the form of outright purchases/sales of government securities and daily reverse repo and repo operations under a liquidity adjustment facility.

The LAF has enabled the Reserve Bank to modulate short-term liquidity under varied financial market conditions, including large capital inflows. In addition, it has enabled the Reserve Bank to set, as far as possible, an informal corridor for the short-term interest rates consistent with the policy stance.

In this new operating environment, the RBI has been increasingly relying on a mix of market-based instruments and changes in reserve requirements, when necessary, for the conduct of monetary policy.

Changes in fixed reverse repo/repo rates set by the RBI from time to time for the conduct of its LAF, under which the central bank conducts daily auctions for the banks, have emerged as the main instruments for interest rate signalling in the Indian economy.

In a market-oriented economy, policy signals are transmitted through an integrated and efficient money, government securities and foreign exchange markets combined with a robust payments and settlement system.

The RBI has, therefore, been engaged in developing, widening and deepening of various markets and institutions.