A surging money supply is behind MPC’s status quo
12 Oct 2020The monetary policy committee (MPC) of the Reserve Bank of India (RBI) let the repo rate stay at 4%. Repo rate is the rate at which RBI lends to banks. A major reason is that the money supply has risen rapidly in the last few months. Mint takes a look.
The monetary policy committee (MPC) of the Reserve Bank of India (RBI) let the repo rate stay at 4%. Repo rate is the rate at which RBI lends to banks. A major reason is that the money supply has risen rapidly in the last few months. Mint takes a look.
What has happened to the money supply?
Money supply in the economy has increased over the months. We can look at money supply from the component side and the sources side. One of the ways of measuring money supply is M3, which is a sum of the currency with the public, the demand deposits with the banking system, which include current deposits and savings deposits, the time deposits with the banking system, such as fixed deposits, recurring deposits, and other deposits of RBI. The currency with the public has grown by more than 21% since June and so have bank deposits. This has led to M3 growing by over 12% since June.
Why are the sources of money supply?
The non-food credit growth of banks as of 25 September stood at a very slow 5.1%. This primarily reflects the reluctance of banks to lend and hesitance on part of both individuals and firms to borrow. However, the lenders seem to be happy to grant loans to the government. The government has in turn spent this money on policies such as the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGA). It has also put money into 20 crore female Jan Dhan accounts. These efforts by the Centre have led to an overall increase in currency with the public.
Are there any other reasons for rising money supply?
Foreign money continuously keeps coming into India, leading to an increase in demand for the rupee against the dollar. To prevent the rupee from appreciating, RBI sold rupees and bought dollars, adding to the increase in M3. Also, in order to drive down interest rates, RBI has pumped money into the financial system by buying bonds from institutions.
How is this linked to MPC not cutting rates?
There is too much money floating around in the financial system. Until now, this excess money has not really chased goods and services in the economy and has thus not led to higher inflation rates. A lower repo rate can lead to a further lowering of the interest rates. This can then result in some of the money chasing goods and services and thus cause higher inflation. There is also the danger of food inflation seeping into the overall inflation as has happened in the past. Note that inflation is already above MPC’s comfort zone.
Explain food inflation seeping into overall?
An IMF paper titled Food Inflation in India says: “Food inflation [feeds] quickly into… core inflation." This happened between 2009 and 2013. RBI expects food inflation to fall in the second half of the year. Nevertheless, it has no control over food inflation. What it has control over is the amount of money floating around in the financial system. By keeping the repo rate constant, it is trying to control the currency supply.
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