INDIA BUSINESS WORLD - JULY 2006
THE MONTH THAT WAS...

RBI WARNS AGAINST TOO MUCH MONEY

THE Reserve Bank has cautioned against the higher than projected growth in money supply and bank deposit. Simply put, higher money supply growth signals inflationary potential from the demand side or what is popularly known as demand pull inflation. It is a situation of too much money chasing few goods, thereby causing a rise in the general price level in the economy.

In its annual policy statement the central bank had projected an year-on-year increase of 15% in money supply, about 16% growth in deposits and 20% growth in credit. But the trend in the first quarter of ‘06-07 indicates that money supply, deposit and credit growth are running well above the indicative projections. This according to the RBI warrants caution.

Inflation for over last two years has been largely due to supply side factors, or costpush factors like rising global crude, commodities and food prices. At least that's the perception. But inflation has also been caused by higher demand, as reflected in strong loan growth. A growth in money supply comprising total currency with the public, demand deposits and time deposits in the banking system, is triggered by the growth in reserve money - the money supplied by the central bank directly to the system and through a process of credit creation, which is a multiplier effect of movement of money essentially in form of deposits within the banking system.

Notably, this time round though the money supply growth is higher, the growth in reserve money has been lower than that in the same period a year ago. This implies that much of the growth in money supply is on account of the multiplier effect of change of hands and higher deposit creation.