The central bank is unlikely to signal any ease in the monetary policy, with surplus liquidity in the system, as any lowering of interest rates at this point could hold upside risks to inflation.

The copious capital inflows have forced the RBI to mop up close to $43 billion of foreign exchange since April, and $20.5 billion since September alone, to curb the rupee appreciation, according to the data from a research report prepared by IDBI Gilts. The rupee has appreciated by over 10 per cent against the dollar since January.

The Prime Minister's Economic Advisory Council had estimated that an increase in the forex reserves of the RBI of $26 billion in 2007-08 could be consistent with the current real growth of the economy, moderate monetary expansion (17.5 per cent) and a tolerable inflation rate (4 per cent).

"In the current financial year, up to early October 2007, forex reserves have increased by over $50 billion and tackling this problem is the most crucial policy dilemma," said S S Tarapore, former deputy governor, RBI.

Of the Rs 1,75,000 crore (Rs 1750 billion) infused into the system on account of RBI's intervention in the forex market, the central bank has absorbed Rs 1,12,000 crore (Rs 1120 billion) through the issue of bonds under its Market Stabilisation Scheme (MSS) and around Rs 31,500 crore (Rs 315 billion) through the increase in cash reserve requirements, leaving Rs 30,000 crore (Rs 300 billion) of liquidity, infused via interventions in the foreign exchange market, still to be sterilised, according to the IDBI Gilts report.

The central bank has, in the last one year, raised the CRR or the portion of deposits that banks are required to park with it, by 200 basis points to 7 per cent to absorb the surplus liquidity.

The RBI, in consultation with the government, has also successively raised the MSS ceiling to Rs 2,00,000 crore (Rs 2000 billion).

The outstanding MSS as of October 26 was around Rs 1,77,000 crore (Rs 1770 billion). Out of the margin of Rs 23,000 crore (Rs 230 billion), the RBI will absorb Rs 11,000 crore (Rs 110 billion) under its MSS in the two days following the policy review.

The government, however, is not likely to hike the MSS ceiling further this year, considering the fiscal cost involved. At Rs 2,00,000 crore outstanding, the annual cost to the government is already around Rs 14,000 crore (Rs 140 billion). By raising the CRR by 50 basis points, RBI could absorb another about Rs 15,000 crore (Rs 150 billion).

However, RBI may not want to hike the CRR in the upcoming policy and it may instead await further curbs by the government on capital inflows.

Finance Minister P Chidambaram had on Friday hinted at further controls to combat capital inflows.

"Without hurting investment, we would like to take some measures to moderate inflows. Some measures have been taken by the Securities and Exchange Board of India (Sebi). We would like to wait and see what their impact is on capital inflows," said Chidambaram.

Sebi has imposed controls on the use of participatory notes for investments in equities to stem surging capital flows and make them more transparent.

These measures are, however, unlikely to have any significant impact on foreign portfolio inflows.

RBI Governor Y V Reddy, in his speech at the Peterson Institute for International Economics in Washington, earlier this month, said, "Risks from global developments continue to persist, especially in the form of inflationary pressures, re-pricing of risks by financial markets and the possibility of a downturn in some of the asset classes. Excessive leveraging has enhanced the vulnerability of the global financial system."

While there has been a slowdown in credit growth to 23 per cent year-on-year on October 12 from 29 per cent a year earlier, it is close to RBI's projected growth of 24-25 per cent for 2007-08.

With credit offtake expected to pick up in the second half of the year, RBI may not want to endanger the gains on the inflation-control front by lowering either the repo (the rate at which RBI lends to banks against government securities) or the reverse repo (the rate at which the RBI borrows from banks against government securities) rate.

The wholesale price index inflation stood at 3.3 per cent y-o-y for the week ended September 29, though the consumer price index at 7.3 per cent was seen hardening further.

The high growth in money supply, at 21.8 per cent, is still above RBI's target of 17-17.5 per cent. The concerns about overheating of the economy also persist against the backdrop of continued high growth in the gross domestic product (GDP).

According to the Central Statistical Organisation, during the first quarter of 2007-08, the real GDP grew by 9.3 per cent on the back of 9.1 per cent in the last quarter of 2006-07.

The Monetary and Credit Policy 2007-2008