The Central Bank says it would target reserve money growth in 2010 at 14.5 percent in a bid to maintain inflation at around 5 to 6 percent and economic growth of around 7 percent.

The reserve money target for the year is Rs. 315.5 billion on average and would be monitored quarterly. The quarterly targets are Rs. 306.5 billion for March, Rs. 314.9 for June, Rs. 313.9 for September and Rs. 326.9 for December.

According to the Central Bank, reserve money is the currency issued by the Central Bank and commercial banks’ deposits with the Central Bank.

"This is also called base money or high-powered money, as commercial banks can create deposits based on reserve money which are components of a broader definition of money supply, through their process of creating credits and deposits."

Central Bank Governor Ajith Nivard Cabraal said these estimates were made after taking into account an expected economic growth of 7 percent with inflation at around 6 percent.

In 2009, the reserve money target was Rs. 288.1 billion, a growth of 2.8 percent, but the actual was Rs. 275.6 billion, a 0.7 percent decline, as the rate of inflation dipped to levels that were lower than expected with tight monetary policy.

The Central Bank uses tight monetary policy to curtail the growth of money supply in a bid to curtail inflation. Therefore it targets reserve money for this purpose.

Reserve money is made up of two components, net foreign assets of the Central Bank (NFA) and its net domestic assets (NDA).

The country’s balance of payments (BOP) is a component of NFA and Cabraal said NFA is expected to expand in 2010 with the BOP recording a surplus of US$ 700 million this year.

The BOP surplus is expected due to several reasons.

Transportation, Travel and Tourism and IT related industries are expected to see an increase in foreign currency inflows. Private remittances are also expected to pick up as a result of the end of the conflict and banking services expanding in the North and East.

Foreign Direct Investments (FDIs) which took a hit in 2009 because of the global financial crisis is expected to pick up, according to Cabraal, along with loan capital to the private sector and portfolio investments.

"An increase in foreign loans and grants to the government is expected with effective and early implementation of projects," Cabraal said.

Cabraal said the NDA of the Central Bank is expected to contract this year despite a 12 percent increase in provisional lending to the government.

"However a significant increase in holdings of Treasury bills by the Central Bank is not expected in 2010," Cabraal said.

He said the bank would absorb the excess rupee liquidity that would be created by expanding NFAs through foreign exchange swaps, and as Treasury bill holdings are reduced and the bank’s own securities are reduced, the Central Bank would introduce a new scheme to borrow government securities from long term investors.

"These measures would ensure that rupee liquidity levels would be maintained at levels in consistent with reserve money targets," Cabraal said.