Money supply in India has been galloping since the implementation of nation-wide lockdown in March 2020. Year-on-year growth in outstanding broad money increased from 8.7 per cent on March 27, 2020 to 10.1 per cent by April 24, 2020. The growth advanced further to 11.7 per cent by May 22, 2020 and climbed even higher at 12.4 per cent by July 3, 2020. In absolute terms, broad money expanded by nearly Rs.7.5 trillion between March 27 and July 3, 2020. This is nearly thrice the average quarterly growth in board money of Rs.2.5 billion per quarter seen in the last five years.
Broad money is the most popular measure of money supply. It includes currency with public and bank deposits, both demand deposits and time deposits. Broad money is also referred to as M3. Here onwards, we refer to the broad money or M3 as money supply.
The rapid increase in money supply during the last three months emanated from two sources. First, surge in net foreign exchange assets of the banking sector. And second, a sharp increase net bank credit to the government, particularly by commercial banks.
Net foreign exchange assets of banking sector increased by nearly Rs.2.7 trillion between March 27 and July 3, 2020. India accumulated huge amounts of foreign exchange reserves during this period on account of shrinkage in merchandise trade deficit in the first two months and a trade surplus recorded in the last month of the quarter. A surge in net foreign direct investment (FDI) on account of Reliance’s stake sale in Jio to foreign entities also contributed to the increase in forex assets. Net foreign exchange assets of banking sector scaled to an all-time high of Rs.40.4 trillion by June 19, 2020, before inching down to Rs.40.2 trillion by the next fortnight ended July 3, 2020.
The second factor that contributed to the money supply growth - net bank credit to the government increased by nearly Rs.6.3 trillion during March 27-July 3, 2020. Of this, Rs.869 billion were lent by the Reserve Bank of India (RBI), while a much larger chunk of Rs.5.4 trillion came from commercial banks. Requirement of government expenditure, particularly by the state governments which are at the forefront of Covid-19 battle, increased dramatically post lockdown. Starved for revenues, governments resorted to higher borrowings from the market. Gross market borrowings by the Centre and the state governments through issuance of T-bills, G-secs and SDLs shot up to Rs.10 trillion during April-June 2020. Market borrowings in the preceding four June quarters had ranged between Rs.5 and 6.2 trillion.
Commercial banks lapped up a bulk of the securities issued by the governments. On a net basis, i.e. adjusting for securities held by banks that matured during this period, bank credit to the government increased by Rs.5.4 trillion during March 27-July 3, 2020. Of this, scheduled commercial banks (SCBs) accounted for Rs.4.8 trillion.
Bank credit to the commercial sector, which has the highest multiplier effect, shrank by Rs.883 billion between March 27, 2020 and July 3, 2020. The fall came in spite of the government announcing Rs.3 trillion credit guarantee fund for MSMEs under the Atma Nirbhar Bharat package. The RBI cut CRR by one percentage point to three per cent at the very beginning of the lockdown in order to make more loanable funds available to banks. Despite this, credit-deposit ratio of SCBs shrank from 76.4 per cent on March 27, 2020 to 73.1 per cent by July 3, 2020. Their investments in SLR securities, on the other hand, increased from 27.6 per cent to 30 per cent as a proportion of deposits. While economists and industry players blamed SCBs for their lazy banking, the government and banks maintained that demand for credit itself was low.
Additional money generated through increased net government spending (fiscal deficit) and higher net inflows of foreign exchange largely got parked in time deposits, which increased by Rs.6.3 trillion between March 27 and July 3, 2020. Demand deposits, on the other hand, declined by Rs.1 trillion. Net increase in total bank deposits during this period was of the order of Rs.5.1 trillion. Currency with public also increased by Rs.2.3 trillion. Weakened consumer sentiments, rising Covid-19 cases and increasing concerns about financial risk are likely have led to higher cash hoarding.
Fast frequency indicators suggest that India’s GDP must have contracted by around 23 per cent in real terms and about 21 per cent in nominal terms in the June 2020 quarter. This is despite a record increase in money supply, which means that velocity of money gobbledegook* dropped dramatically due to supply constraints, restrictions on movement and extreme uncertainty caused by the pandemic. Such sharp opposite movement in money supply and real economic growth was also witnessed in 2008-09, the year of global liquidity crisis. The disconnect between money supply and the real economy this time, however, is more amplified.
We expect fast rising Covid-19 cases, fresh lockdowns announced by state governments and continued weakness in consumer sentiments to keep velocity of money low in the September 2020 quarter too. This dampens the recovery prospects of the Indian economy.
*Velocity of money is the rate at which money is transacted for exchange of goods and services in an economy.