Sources and Deployments of Money Supply in India

As I posted a while back, it is useful to look at money supply in various ways. I had looked at relationship between M1 and M3 and money multiplier.

But where does money supply come from?And where does it go? These are all important issues to understand.

First which measure of money supply RBI follows? As  I said, there are 4 measures:

  • M1: Currency with the public + Demand Deposits + Other deposits with the RBI.
  • M2: M1 + Savings deposits with Post office savings banks.
  • M3: M1+ Time deposits with the banking system
  • M4: M3 + All deposits with post office savings banks (excluding National Savings Certificates).

RBI reports both M1 and M3. As M3 is broader in scope, it is taken as measure of money supply in India. Now let us look at components and deployments of M3.

  • Components of Money Supply: If we see the components of money supply, we can see bank deposits form bulk of the money supply. Within deposits, it is time deposits which form around 3/4th of the money supply.  The share of time deposits has declined from 74.7% in Oct – Dec 09 to 74% on 9 April 2010. The share of demand deposits has risen from 11.3% in Oct – Dec 09 to 12% on 9 April 2010. The percentage contributions of each item in components of money supply do not change much in the year.

Components of Money Supply (in %)

  April 09 – June 09 July 09 – Sep 09 Oct 09 – Dec 09 Jan 10- Mar 10 As on Apr 9, 2010
Currency with the public 14.1 13.6 13.9 14.0 13.9
Demand deposits with banks 11.4 11.6 11.3 12.0 12.0
Other deposits with RBI 0.2 0.1 0.1 0.1 0.1
Time deposits with banks 74.3 74.7 74.7 74.2 74.0
Money Supply 100.0 100.0 100.0 100.0 100.0

As both demand and time deposits  form around 85% of money supply, whatever the growth in deposits, is also the growth in money supply. RBI changes both these targets together and keeps them near similar.

  • Deployments of Money Supply: There are 5 categories of money supply deployments:

1. Net bank credit to government (A): It is further divided into two categories:

  • RBI’s credit to government: RBI lends to government for short-term expenditure management.
  • Other banks’ credit to government – This represents the total of commercial and cooperative banks investments in government securities, including treasury bills.

2. Bank credit to commercial sector (B): It is also divided into two categories

  • RBI’s credit to commercial sector: This is the aggregate of RBI investments in shares, bonds of financial institutions like ARDC, DICGC, debentures of land mortgage banks, loans and advances to financial institutions like IDBI, IFCI and state financial corporations, and internal bills purchased and discounted.
  • Other banks’ credit to commercial sector: Loans given by commercial and cooperative banks to commercial sector. Also includes investments by banks in securities (shares, bonds etc) issued by commercial sector

3. Net foreign exchange assets of banking sector (C): Sum of RBI’s foreign exchange and foreign assets held by commercial and cooperative banks. The percentage of foreign assets held by banks is very small. RBI holds majority of the foreign assets as part of its forex reserve.

4. Government’s currency liabilities to the public (D): These comprise the holdings of one rupee notes, rupee coins and small coins with the public.

5. Banking sectors’ net non-monetary liabilities other than time deposits (E): This includes capital and reserves, branch adjustments, and bills payables; the liabilities are net of investments in fixed assets, and branch adjustments. This item is subtracted from the sum of the above 4 items

Let us see how the money supply adds up using these five categories.  

Deployments of Money Supply (in %)

 

Apr 09 – Jun 09

Jul 09 – Sep 09 Oct 09 – Dec 09 Jan 10- Mar10 As on Apr 9, 2010
Net bank credit to government (A) 27.6 28.3 28.4 29.1 29.3
 of which          
RBI’s net credit to government 0.9 0.6 1.1 2.3 2.3
Other banks’ credit to government 26.5 27.7 27.4 26.8 27.0
Bank credit to commercial sector (B) 61.2 60.8 60.7 61.7 61.8
Net foreign exchange assets of banking sector (C) 27.1 27.2 26.0 24.2 22.3
Government’s currency liabilities to the public (D) 0.2 0.2 0.2 0.2 0.2
Banking sectors net non-monetary liabilities other than time deposits (E) 16.1 16.5 15.3 15.3 13.6
Money Supply (A+B+C+D-E) 100 100 100.0 100.0

100

If we analyse where money supply is going, around 60% goes as credit to commercial sector. The percentage of bank credit to commercial sector declines from 61% in Apr-Jun 09 to 60.7% in Oct-Dec 09. However, it has improved steadily since then with figure increasing to 61.8% on 9 April 2010. This is in line with growth in credit which started picking up from Nov-09 onwards. With Indian economy expected to grow, the share of this category is likely to increase.

Another trend we see is the persistent increase of Net bank credit to government. Within this category, the other banks credit to government has declined but RBI’s credit to government has increased. Contribution of other Banks’ credit to government increased from 26.5% in Apr-Jul 09 to 27.7% in Jul-Sep 09. This was because of record fiscal deficit in FY 2009-10. The government had front loaded its borrowing program hence we see a rise in banks credit to government in Jul-Sep 09. The percentage then declines to 26.8% in Jan-Mar 10. As bulk of the borrowing was completed in H1 2009-10, there was not much stress on monetary sources in the second half. It has again increased to 27.0% on 9 April 2010 as again the borrowing program is front-loaded in first half of 2010-11.
RBI’s credit to government has increased from 0.6% in Jul- Sep 09 to 2.3% on 9 April 2010. Therefore, the total funds used by government have risen from 27.6% in Apr-Jun 09 to 29.3% on 9 April 2010. The government continues to use higher percentage of financial resources available in the economy in every quarter.

Therefore, it will be interesting to see the deployments of money supply between government and private sector. In 2009-10, because of the global crisis private sector was not as aggressive in credit. In 2010-11, the situation is likely to change with high growth expected in Indian economy. As government borrowing program is still large and front loaded in first half 2010-11, banking funds to private sector could be constrained.

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