The governor issued this warning to the government while presenting the Monetary and Credit policy for the second half of 1998-99 to chief executives of commercial banks on Friday.

He also said that a rising fiscal deficit will add to the already high rate of monetary growth. "The governor has made it clear that the fiscal deficit has reached breaking limit and the government has to do something about it," former chief economist at Asian Development Bank and consultant to ICICI, VV Desai said.

Jalan in his speech to the bankers said, "money supply growth attributable largely to growth in the banking sector's credit to the government is too high inrelation to the expected growth of the real sector of the economy. The rate of inflation is also higher than the initial projections. Although the price rise during the current financial year so far is largely concentrated on a few food items, there is no denying the fact that such a high rate of monetary growth is inconsistent with the objective of maintenance of general price stability. In this situation a case could be made out for monetary tightening through measures such as increasing the interest rates or a further increase in cash reserve ratio."

"He has hinted in no uncertain terms that he is holding back a hike in interest rates just to accommodate the industry," an economist in a leading international brokerage said.

Jalan has admitted that he is facing a policy dilemma -- on the one hand he feels that there is a need to reduce monetary expansion while at the same he has to nurture real growth. "These conflicting considerations viz the need to reduce monetary expansion while at the same timenurturing real growth starkly illustrate the monetary policy dilemma that the RBI faces at the present juncture," Jalan said.

The RBI governor stated that the developments in the past few months has brought out the fact that a delicate balance has to be struck between conflicting considerations in deciding on changes in monetary policy measures in the short-term. "Monetary policy has to facilitate growth while at the same time maintaining external and internal stability. In the long run, they may point in different directions," Jalan said.

However, Jalan made it clear that the RBI will continue to manage liquidity through open market operations and repo operations. "The Reserve Bank will not hesitate to resort to further monetary tightening if inflationary pressures increase or if external development so warrant," Jalan said in his policy statement.