Carry trade in simple terms means borrowing in one currency where the interest rates are low and investing this loan money in high yielding assets some where else. A classic example of this is the carry trade going on since so many years using the Japanese Yen as the borrowing currency. Interest rates in Japan have been at near zero percent since the last 7-8 years. Traders all over the globe have taken Japanese Yen loans at very low interest rates and invested the same in other potential high assets like equities, commodities, real estate, government bonds, art, gold etc all across the globe. A simple example of this can be taking a loan in Japanese Yen at say 0.50% and converting this money into US Dollars and investing it in US Treasuries yielding say 2%. Due to the difference between the interest earned (2%) and the borrowing interest rate (0.5%) the trader makes a clean profit of 1.5%. This might look like a risk free trade and the most lucrative one. But hold on. Currency exchange rates may play spoilsport in this trade which seems risk free in the first look. We will see this later how currency exchange rates play a very important role in carry trade.

The RBI announced its Second Quarter Review of Monetary Policy for the Year 2009-10 today and as expected, has left the key rates unchanged. Though the RBI kept key rates unchanged, it hiked Statutory Liquidity Ratio (SLR), the deposits that commercial banks are to park in government securities, by one percentage points to 25 per cent.

While this should have brought some cheer to the markets, they plunged deeper into the red not only because the RBI looks set to raise interest rates going forward, but also because the central bank has upwardly revised its target inflation by March 2010 end to 6.5% from 5% earlier.

The upward bias in interest rates was apparent from the RBI's move to hike the statutory liquidity ratio (SLR) to 25% from 24%. Having said that, whether interest rates in the future rise or not will depend on whether the inflation continues to rise the way it is doing now, and the economic momentum continues to pick up pace.

Remarks by Dr. D. Subbarao, Governor, Reserve Bank of India at G-30 International Banking Seminar in Istanbul on October 5, 2009 organized on the occasion of the IMF-World Bank Annual Meetings 2009.

1. From the perspective of Emerging Market Economies (EMEs) and particularly for that of India, I will highlight five concerns. These are: first, timing of exit from the accommodative monetary policy in the context of rising food price-led inflation but still weak growth; second, the possibility of another surge in capital flows, especially if we turn out to be an outlier in withdrawal of monetary stimulus; third, monetary transmission mechanism as it is evolving from the crisis period; fourth, return to fiscal consolidation and quality of fiscal adjustment; and finally, the implications of the efforts towards financial stability on financial inclusion and growth.