Indian Economy, 5th edition (62 page)

Stock of Money

In every economy it is necessary for the central bank to know the stock (amount/level) of money available in the economy only then it can go for suitable kind of credit and monetary policy. Saying simply, credit and monetary policy of an economy is all about changing the level of money flowing in the economic system. But it can be done only when we know the real flow of money. That’s why it is necessary to first assess the level of money flowing in the economy.

Following the recommendations of the
Second Working Group on Money Supply
(SWG)
in 1977, RBI has been publishing four
monetary aggregates
(component of money)– M
1
, M
2
, M
3
and M
4
( are basically short terms for the Money-1, Money-2, Money-3 and Money-4) besides the Reserve Money. These components used to contain money of differing liquidities:

M
1
= Currency & coins with people + Demand deposits of Banks (Current & Saving Accounts) + Other deposits of the RBI.

M
2
= M
1
+ Demand deposits of the post offices (i.e. saving schemes’ money).

M
3
= M
1
+ Time/Term deposits of the Banks (i.e. the money lying in the Recurring Deposits & the
f
ixed Deposits).

M
4
= M
3
+ total deposits of the post offices (both, Demand and Term/Time Deposits).

Now the RBI has started
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publishing a set of new monetary aggregates following the recommendations of the
Working Group on Money Supply: Analytics and Methodology of Compilation
(Chairman: Dr. Y.V. Reddy) which submitted its report in June 1998. The Working Group recommended compilation of four monetary aggregates on the basis of the balance sheet of the banking sector in conformity with the norms of progressive liquidity: M
0
(monetary base), M
1
(narrow money), M
2
and M
3
(broad money). In addition to the monetary aggregates, the Working Group had recommended compilation of three liquidity aggregates namely, L
1
, L
2
and L
3
, which include select items of financial liabilities of non-depository financial corporations such as development financial institutions and non-banking financial companies accepting deposits from the public, apart from post office savings banks. The
New Monetary Aggregates
are as given below:

Reserve Money (M
0
)
= Currency in Circulation + Bankers’ deposits with the RBI + ‘Other’
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deposits with the RBI.

Narrow Money (M
1
)
= Currency with the Public + Demand Deposits with the Banking System + ‘Other’ Deposits with the RBI.

M
2
=M
1
+ Savings Deposits of Post-office Savings Banks.

Broad Money (M
3
)
= M
1
+ Time Deposits with the Banking System.

M
4
= M
3
+ All deposits with Post Office Savings Banks (excluding National Savings Certificates).

While the Working Group did not recommend any change in the definition of reserve money and M
1
, it proposed a new
intermediate monetary aggregate
to be referred to as
NM
2
comprising currency and residents’ short-term bank deposits with contractual maturity up to and including one year, which would stand in between narrow money (which includes only the non-interest-bearing monetary liabilities of the banking sector) and broad money (an all-encompassing measure that includes long-term time deposits). The new broad money aggregate (referred to as
NM
3
for the purpose of clarity) in the Monetary Survey would comprise in addition to NM
2
, long-term deposits of residents as well as call/term borrowings from non-bank sources, which have emerged as an important source of resource mobilisation for banks. The critical
difference
between M
3
and NM
3
is the treatment of non-resident repatriable fixed foreign currency liabilities of the banking system in the money supply compilation.

There are
two basic changes
in the new monetary aggregates.
First,
since the post office bank is not a part of the banking sector,
postal deposits
are no longer treated as part of money supply, as was the case in the extant M
2
and M
4
.
Second,
the residency criterion was adopted to a limited extent for compilation of monetary aggregates. The Working Group made a recommendation in favour of compilation of monetary aggregates on residency basis. Residency essentially relates to the country in which the holder has a centre of economic interest. Holdings of currency and deposits by the non-residents in the rest of the world sector, would be determined by their portfolio choice. However, these transactions form part of balance of payments (BoP). Such holdings of currency and deposits are not strictly related to the domestic demand for monetary assets. It is therefore argued that these transactions should be regarded as external liabilities to be netted from foreign currency assets of the banking system. However, in the context of developing countries such as India, which have a large number of expatriate workers who remit their savings in the form of deposits, it could be argued that these non-residents have a centre of economic interest in their country of origin. Although in a macro-economic accounting framework all non-resident deposits need to be separated from domestic deposits and treated as capital flows, the underlying economic reality may point otherwise. In the Indian context, it may not be appropriate to exclude all categories of non-resident deposits from domestic monetary aggregates as non-resident rupee deposits are essentially integrated into the domestic financial system. The new monetary aggregates, therefore, exclude only non-resident repatriable foreign currency fixed deposits from deposit liabilities and treat those as external liabilities. Accordingly, from among the various categories of non-resident deposits at present, only Foreign Currency Non-Resident Accounts (Banks) [FCNR(B)] deposits are classified as external liabilities and excluded from the domestic money stock. Since the bulk of the FCNR(B) deposits are held abroad by commercial banks, the monetary impact of changes in such deposits is captured through changes in net foreign exchange assets of the commercial banks. Thus, now the new monetary aggregates NM
2
and NM
3
as well as liquidity aggregates L
1
, L
2
, and L3 have been introduced, the components of which are elaborated as follows:

NM
1
= Currency with the Public + Demand Deposits with the Banking System + ‘Other’ Deposits with the RBI.

NM
2
= NM
1
+ Short Term Time Deposits of Residents (including and up to the contractual maturity of one year).

NM
3
= NM
2
+ Long-term Time Deposits of Residents + Call/Term Funding from Financial Institutions.

L
1
= NM
3
+ All Deposits with the Post Office Savings Banks (excluding National Savings Certificates)

L
2
= L
1
+Term deposits with Term Lending Institutions and Refinancing Institutions (FIs) + Term Borrowing by FIs + Certificates of Deposit issued by FIs

L
3
= L
2
+ Public Deposits of Non-banking Financial Companies.

Data on M
0
are published by the RBI on
weekly
basis, while those for M
1
and M
3
are available on
fortnightly
basis. Among liquidity aggregates, data on L
1
and L
2
are published
monthly,
while those for L
3
are disseminated
quarterly
. The working group advised for the quarterly publication of
Financial Sector Survey
to capture the dynamic linkages between banks and rest of the organised financial sector.

Liquidity of Money

As we move from M
1
to M
4
the liquidity (inertia, stability, spendability) of the money goes on decreasing and in the opposite direction, the liquidity increases.

Narrow Money

In banking terminology, M
1
is called narrow money as it is highly liquid and banks cannot run their lending programmes with this money.

Broad Money

The money component M
3
is called broad money in the banking terminology. with this money (which lies with banks for a known period) banks run their lending programmes.

Money Supply

In general discussion we usually use money supply to mean money circulation, money flow in the economy. But in banking and typical monetary management terminology the level and supply of M
3
is known as money supply. The growth rate of broad money (M
3
) i.e.
money supply
, was not only lower than the indicative growth set by the Reserve Bank of India but also it witnessed continuous and sequential deceleration in the last 7 quarters and moderated to 11.2 per cent by December, 2012. Aggregate deposits with the banks were the major component of broad money counting for over 85 per cent remaining almost stable. The sources of broad money are net bank credit to the Government and to the commercial sector. These two together accounted for nearly 100 per cent of the broad money in 2012-13 compared to 89 percent in 2009-10.

Minimum Reserve

The RBI is required to maintain a reserve equivalent of Rs. 200 crores in gold and foreign currency with itself, of which Rs. 115 crores should be in gold. This is being followed since 1957 and is known as the Minimum Reserve System (MRS).

Reserve Money

The gross amount of the following six segments of money at any point of time is known as the Reserve Money (RM) for the economy or the government:

1.
RBI’s net credit to the Government;

2.
RBI’s net credit to the Banks;

3.
RBI’s net credit to the commercial banks;

4.
Net forex reserve with the RBI;

5.
Government’s currency liabilities to the Public;

6.
Net non-monetary liabilities of the RBI.

RM = 1 + 2 + 3 + 4 + 5 + 6

As per the
Economic Survey 2012-13,
the rate of growth of reserve money comprising currency in circulation and deposits with RBI (bankers and others) decelerated from an average of 17.6 per cent in Q1 of 2011-12 to 4.3% in Q3 of 2012-13. Almost the entire increase in the reserve money of Rs. 2381 billion between Q3 of 2011-12 and Q3 of 2012-13 consisted of increase in
currency in circulation
. As sources of reserve money, net RBI credit to Government and increase in net financial assets of RBI contributed to the growth of
base money
.

Money Multiplier

At end March 2012, the
money multiplier
(ratio of M
3
to M
0
) was 5.2, higher than end-March 2011, due to cumulative 125 basis point reduction in CRR. During 2012-13, the money multiplier generally stayed high reflecting again, the CRR cuts. As on
December 28, 2012
, the money multiplier was 5.5 compared with 5.2 on the corresponding date of the previous year
(Economic Survey 2012-13).

Credit Counselling

Advising borrowers to overcome their debt burden and improve money management skills is credit counselling. The first well-known such agency was created in the USA when credit granters created National Foundation for Credit Counselling (NFCC) in 1951.
50

India’s sovereign debt is usually rated by six major sovereign credit rating agencies (SCRAs) of the world which are –

i.
Fitch Ratings,

ii.
Moody’s Investors Service,

iii.
Standard and Poor’s (S&P),

iv.
Dominion Bond Rating Service (DBRS),

v.
Japanese Credit Rating Agency (JCRA), and

vi.
Rating and Investment Information Inc., Tokyo (R&I).

As on
January 15, 2013
most of these rating agencies have put India under ‘stable’ category in foreign and local currencies barring Fitch and S&P which have put its foreign currency in ‘negative’ category. The government is taking a number of steps to improve its interaction with the major SCRAs so that they make informed decisions as the
Economic Survey 2012-13
says.

Credit Rating

To assess the credit worthiness (credit record, integrity, capability) of a prospective (would be) borrower to meet debt obligations is credit rating. Today it is done in the cases of individuals, companies and even countries. There are some world-renowned agencies such as the Moody’s, S & P. The concept was first introduced by
John Moody
in the USA (1909). Usually equity share is not rated here. Primarily, ratings are an investor service.

Credit rating was introduced in India is 1988 by the ICICI and UTI, jointly. The major credit rating agencies of India are-

(i)
CRISIL
(Credit Rating Information of India Ltd.) was jointly
promoted
by ICICI and UTI with share capital coming from SBI, LIC, United India Insurance Company Ltd. to rate debt instrument—
debenture
. In April 2005 its 51 per cent equity was acquired by the US credit rating agency Standard & Poor (S & P)—a McGraw Hill Group of Companies.