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Charts & Analysis

Chart Of The Day: Reserve Money Growth And Markets

“Reserve Money” is an interest aspect of our banking system. Reserve money is eventually multiplied into “broad money supply”. Reserve money growth has been very high in the five to seven years, other than the massive dip in 2008. The most recent data puts it below the 10% level (at 9.8%).

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The concept is that if there is only bank and it has Rs. 100, then you can lend it to someone, who puts it back in the bank (imagine no one wants cash). Then the bank can lend Rs. 100 to someone else who puts it back and so on. To avoid totally overleveraging the system, there is a regulation that needs you to “allocate” reserves for every deposit you get – usually 10% or so. Meaning if you get 100 deposited, you lend out just 90, and so on. That means a bank that has Rs. 100 worth capital can lend upto Rs. 1000. The 100 is the “reserve money” and the 1000 is the “broad money”.

Reserve money grows as people start producing more, and is usually influenced by the central bank which “prints” currency and uses it to buy government bonds or dollars or such. Also, it might sell dollars or bonds, taking money “out of the system” – meaning it eats up some of the reserve money.

In India Broad money supply is about 4x the reserve money (14 trillion Rs. of reserve money, 58 trillion in broad) Reserve money growth is interesting because beyond a certain point it fuels inflation. (that certain point is impacted by the “productivity increase”, such as using Rs. X to manufacture more of product Y – if the money supply remained the same, the price of Y would fall, so you increase the reserve money to retain prices at the same level; this is all very theoretical, since in practice things work differently)

Reserve money dipped in 2008 on massive dollar selling by the RBI and you can see that it went negative for a month before going back up. Otherwise it has been above the 15% level since 2005; only recently has it started to dip.

Looking at the markets, Reserve money isn’t much of an indicator other than that it tends to lag recovery – reserve money growth can keep dipping which markets can keep going up. Check out what happened in 1996, or even in 2009 – reserve money growth was falling even as the Sensex reversed and went back up.

(I’ve marked bear regions as those that are 25% below 3 year highs, on a monthly close basis).