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RBI puts brakes on money supply growth

Harish Damodaran

The RBI has not resorted to either open market operations or hiking the Bank Rate, CRR or repo rate to impound excess liquidity from the system.

New Delhi , Aug. 29

THE Reserve Bank of India is yet to effect any increase in its repo rate, the Bank Rate or the cash reserve ratio (CRR) requirement for banks, as a means to combat inflation. But it has still managed to significantly curtail money supply growth.

An indication of this is that the expansion in reserve money - the base rupee liquidity that RBI creates in the economy whenever it lends to the Government against the latter's securities or mops up foreign currency from the market - has been negative at Rs 6,748 crore (minus 1.5 per cent) during the current fiscal till August 20. This is as against an increase of Rs 5,248 crore (1.4 per cent) over the same period of 2003-04.

Consequently, overall broad money (M3) growth - the total extra money available with the public, which it holds either as cash or as deposits with the banking system - during this fiscal till August 6 has been lower, at Rs 94,607 crore (4.7 per cent), compared with the corresponding 2003-04 level of Rs 95,311 crore (5.5 per cent).

This is unlike the situation last year, when both M3 as well as reserve money growth turned out to be much higher than in 2002-03, mainly due to the surge in the RBI's foreign exchange reserves.

The resulting `monetary overhang' has been seen as a factor conducive to the current inflationary pressures, which the RBI is now seeking to neutralise through monetary tightening.

The contraction in reserve money this year has happened not because of any lower foreign exchange inflows. On the contrary, the increase in the central bank's net forex assets has been much higher, at Rs 60,613 core, so far this fiscal, against Rs 34,219 crore during the same period last year.

But the huge forex build-up has been offset by a Rs 34,328 crore decline in the RBI's net outstanding credit to the Government, alongside a Rs 29,594 crore increase in its net non-monetary liabilities, courtesy depreciation of the rupee. The rupee's depreciation this year has led to an upward revaluation of the RBI's forex assets, which are valued daily on a marked-to-market basis.

The revaluation gains are booked in a Currency and Gold Revaluation Account, forming part of the RBI's non-monetary liabilities. A weak rupee, thus, translates into an increase in the central bank's non-monetary liabilities and a simultaneous contraction in reserve money. "Our revaluation accounts have enlarged by Rs 32,163 crore so far this fiscal, against a contraction of Rs 10,056 crore last year, when the rupee was appreciating vis--vis the dollar," an RBI official said.

The other restraining factor on money supply growth has been the liquidity mop-up operations under the Market Stabilisation Scheme (MSS).

During the current fiscal, the Government has already issued dated securities and Treasury bills worth about Rs 55,000 crore (outstanding stock, net of redemptions) under the MSS.

The entire MSS monies have been sequestered in a separate cash account with the RBI, which the Government cannot use for financing its expenditures.

While securities issued under the MSS do not lead to a contraction of reserve money (unlike in normal open market operations, where the central bank offloads gilts from its own portfolio), they, however, dampen broad money growth by weakening the `money multiplier'.

In fact, this year, the RBI has not resorted to either open market operations or hiking the Bank Rate, CRR or repo rate to impound excess liquidity from the system.

Instead, it has relied on the MSS route and repo auctions, where the rate has been left unchanged at 4.50 per cent even with the introduction of one-day auctions.

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