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Charts & Analysis

Chart Of The Day: Reserve Money Growth

Reserve Money is the base money of our banking system, a level before the banks come in an multiply it with credit. It consists of the money RBI prints (“currency with the public”), the reserves banks keep with the RBI (which is a factor of how much they lend out) and some riff-raff. Typically, a growth in reserve money is useful because it helps keep prices stable as productivity increases in the system. But when you have serious inflation, the money growth needs to slow to control it.

Any slowing of the reserve money will appear in inflation and broader money supply (“M3”) only with a lag.

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India’s grown money supply tremendously through 2007-08 and that continues to pose an issue today; with the brief dip in 08-09, when banks weren’t lending, the growth went back up to 20% and remains above 15% today.

In that context, though they’re not directly linked, this indicates why inflation is at 10% or more. When your base money grows 15%, and M3 (the “multiplied” money) grows 18-20%, you will need dramatic productivity benefits to match it.

An example: If Rs. 100 money supply would buy 10 mangoes at Rs. 10, and you scale the money supply to Rs. 120, then you need to somehow produce 12 mangoes – 20% more – for the price per mango to remain the same (Rs. 10). If you get productivity gains of only 10% – and are able to only produce 11 mangoes, then the per mango cost will go to nearly Rs. 11 (120 divided by 11 mangoes), an “inflation” of 10%. India’s productivity gains seem to be in the single digits – 6-8% – which means that money supply is growing much faster. It isn’t surprising then that we see inflation.

(I suggest that we sell our dollars and take the resulting rupees out of circulation – this will reduce money supply. It does cause liquidity issues, but it will address inflation better than interest rates IMHO)

  • Phani says:

    Thats exactly what bugs me… instead of raising interest rates it will be more efficient to print less rupees. So called one of the world best central banks RBI is getting stressed by Indian Software and other companies to keep the rupee pegged at 40-45Rs per dollar (and other currencies) and as a result RBI ends up printing more money than required and in India productivity is probably growing at snail pace of 4-5% or max 6% which essentially means that all the excess supply will result in Inflation. The best solution to the issue is stop printing more Rupees than required.

  • Arghya says:

    Nice article … so simply explained such a difficult concept… keep it up..
    I think RBI is exactly doing that (selling dollar …). Somewhere in TOI read that foreign $-reserve is down by ~ billion, resulting an increase in gold reserve by ~300-400 million. Insignificant changes but I think RBI is doing absolutely wonderful job. Jai Subbrao-ji ki 🙂 ……
    Anyway we should not blame only RBI for printing money. You know after all RBI has to listen to illogical political mandates. Bravo Subbarao, for brave steps to curb money supply. Yes I do support interest rate hike even at the expense of growth. I am damn sure nobody who has the luxury to read this comment on internet has any idea about the pathetic condition of the poor in such high inflation. The demon inflation should be controlled at any cost.
    Interest rate should be further increased. $-reserve decrease by 1 billion in a month, I think is at good speed. RBI must not take any drastic measure to peg the currency. Let it stabilize itself automatically and meanwhile RBI can continue it’s business of buy-low and sell-high with $.