In this article we will discuss about the money supply in India:- 1. Meaning of Money Supply 2. Components of Money Supply 3. Total Volume 4. System of Issue of Currency in India or Present Method of Regulating Note Issue by RBI.
Meaning of Money Supply:
The monetary system prevailing in India at present is managed and controlled by the Reserve Bank of India. The present monetary system is based on inconvertible paper currency, supplemented by coins. On the external front Indian currency ‘rupee’ is again convertible to various other currencies of the world.
Although in narrow sense, the term money supply includes only the assets having ready liquidity but in wider sense, it also includes various other assets.
Components of Money Supply:
Accordingly, in India, total money supply includes:
(a) Rupee coins and small coins.
(b) Rupee Notes or currency in circulation of different denominations and
(c) The deposits of commercial banks.
a. Rupee Coins and Small Coins:
In India, the rupee is the monetary unit of account and it is based on the decimal system. Being a token coin its face value is always higher than its content (instrinsic) value. The rupee is also printed on paper by the Ministry of Finance, Government of India. The rupee and the half-rupee coins are considered of unlimited legal tenders.
Small coins are subsidiary coins, which are consisting of 50 paisa, 25 paisa and other decimal coins. Small coins bearing the value 25 paisa and other coins of small face value are limited legal tender, which the people may refuse to accept in large volume.
b. Rupee Notes or Currency Notes in Circulation:
The rupee notes or currency notes contain the major portion of the total money supply of the country. The sole authority to print currency note rests with the Reserve Bank of India (RBI) and the notes and coins are guaranteed by the RBI Governors.
Due to limitation in its supply, these notes and coins are maintaining its value. The RBI has the authority to print and issue currency notes of different denominations right from two rupee notes to ten-thousand rupee notes.
A separate Issue Department of the RBI looks after the issue of currency, although the Issue Department previously maintained a proportional system of reserve made of gold and government securities but this system was abandoned later on.
At present the Issue Department is maintaining minimum reserve system where it maintains a minimum reserve of gold and foreign securities to the extent of Rs 200 crore of which the gold reserve should be of minimum value not less than Rs 115 crore. Total value of RBI notes circulated in India has increased from Rs 1,910 crore in 1960-61 to Rs 59,860 crore at the end of June 1991.
Again total variations of money stock or broad money (M3) consisting of currency with the public, demand deposits with banks, time deposits with banks and other deposits to RBI stood at Rs 1,54,311 crore in 1998-99 (Jan. 16 to Jan. 15).
Total money supply with the public has also increased from Rs 7,320 crore in 1970-71 to Rs 1,45,000 crore in 1993-94. The increase in money supply in the country has mostly resulted from the policy of deficit financing pursued by the Government and rise in the demand for money for increasing volume of production and trade.
The present currency note is an inconvertible paper note and the same cannot be issued by the RBI in unlimited amount. There is a limit to the power of Issue Department of RBI to issue paper currency. The entire issue of currency note is subjected to the regulations framed in the RBI Act of 1935.
Since 1856, various amendments had already been made to the RBI Act. Under the present provisions of RBI Act, the issue of additional doses of currency notes can be made by the RBI without keeping any additional reserves of gold or foreign exchange.
c. Bank Deposits:
The commercial banks are also creating money through their power to create deposits. Thus, the money supply of the country includes current deposits with banks as they can be withdrawn or transferred easily from one bank to another bank.
Commercial banks normally collect deposits from the public and while offering loans they also create credit in multiple amount of primary deposit. Thus through lending operation, there would be secondary expansion of bank deposits. Such secondary expansion of bank deposits is under full control of the RBI.
Total Volume of Money Supply:
In recent years, the volume of money supply in India has been increasing at a steady rate. Money supply with the public (M1) includes two items, i.e. currency with the public and total deposits.
Firstly, the currency with the public is consisting of currency notes, rupee coins or notes and small coins in circulation minus the amount of balances held at treasuries and commercial banks.
Secondly, total deposits include the volume of net demand deposits of banks and other deposits with RBI. In India, the total volume of money supply (M) has increased from Rs 2,870 crore in 1960-61 to Rs 92,770 crore in 1991.
Total money supply with the public has also increased from Rs 7,320 crore in 1970-71 to Rs 1,45,000 crore in 1993-94. Such increase in money supply in the country is mostly resulted from the policy of deficit financing pursued by the Government and the rise in demand for money for increasing volume of production and trade.
Money supply is also distinguished by the RBI in two different senses, i.e., money supply in narrow sense (M1) and money supply in, broad sense (M3). The narrow money M| is consisting of currency with the public plus demand deposits of the general public with the banking system and other deposits with the RBI.
The broad money (M3) is again consisting of M1 plus time deposits with banks. Thus M3 is considered as aggregate monetary resources of the public or money stock. Now a days, RBI is giving more importance to M3. Table 14.1 shows the growth of M3 in recent past.
Table 14.1 reveals that during the period from 1970-71 to 1990-91, M1 had expanded by 12.7 times whereas M3 had expanded by 24.2 times. This is mostly resulted from rapid hike in the volume of time deposits which had increased by 47 times.
Accordingly, M1 as per cent of M3 which was 67 per cent in 1970- 71, gradually declined to 35 per cent in 1990-91. During the same period time deposits as per cent of M3 has increased from 33 per cent to 65 per cent. Again in 2006-07, the M1, and M3 have increased by 16.9 per cent and 21.3 per cent respectively as compared to previous year.
In 2011-12, M1 and M3 increased by 5.98 per cent and 13.20 per cent over the previous year.
Accordingly, M1 as per cent of M3 decreased from 29.15 per cent in 2006-07 to 23.55 per cent in 2011-12. During the same period, time deposits, other deposits and currency with the public as per cent of M3 increased from 85.57 per cent to 90.41 per cent.
In recent years, total annual variations of money stock or broad money (M3) stood at Rs 8,53,630 crore in 2011-2012 (Mar. 31 to March 31) as compared to that of Rs 9,01,420 crore in 2010-11. The major component which is mostly responsible for this variation in M3 in recent years is the growth in time deposits with banks.
System of Issue of Currency in India or Present Method of Regulating Note Issue by RBI:
The Issue Department of RBI is solely entrusted with the job of issuing currency notes of different denominations from two rupee onwards. The one-rupee note or coin is again issued by the Ministry of Finance, Government of India.
As per banking principle there are four methods of note issue.
(a) Maximum fiduciary system,
(b) Fixed fiduciary system,
(c) Proportional reserve system, and
(d) Minimum reserve system. Initially, the proportional reserve system was adopted in India.
Later on, India adopted the minimum reserve system and is still continuing with this system of note issue. The entire issue of currency notes is subjected to the regulations framed in the RBI Act, 1935.
As per section 33 (2) of the RBI Act, 1935, the Issue Department has to maintain proportional reserves equal to the minimum of 40 per cent in gold and sterling securities where the value of gold bullion should not be less than Rs 40 crore. This Act was amended in 1948 for accommodating foreign securities in place of sterling securities.
Accordingly, as per the proportional reserve system the RBI had to maintain reserves equal to 40 per cent in gold and foreign currencies. The rest 60 per, cent was maintained by one rupee notes or rupee coins and government securities.
With the growing demand for currency notes and the security of gold reserves, the proportional system proved to be very much inelastic and inflexible. Thus this proportional reserve system was abolished in 1956 and the RBI Act 1935 was again amended in 1957 so as to adopt minimum reserve system of note issue.
As per minimum reserve system, for issuing any amount of notes, the Issue Department has to maintain an overall minimum reserve of Rs 200 crore of which the gold reserve should be of minimum value not less than Rs 115 crore and the balance of Rs 85 crore can be maintained in terms of foreign currencies, which may be even reduced in times of necessities with the permission of the Government.
At present, the Issue Department is still following the minimum reserve system of note issue which has provided greater elasticity to the Indian currency system. The present currency system has provided ample scope to the government for adopting deficit financing, especially for financing its plans since the Second Plan onwards.
Accordingly total volume of money supply (M1) has increased from Rs 2,870 crore in 1960-61 to Rs 92,770 crore in 1990-91 and then to Rs 17,33,400 crore in 2011-12. Again, total money supply (M3) with the public has also increased from Rs 10,960 crore in 1970-71 to Rs 1,45,000 crore in 1993-94 and then to Rs 73,57,750 crore in 2011-12.
Such increase in money supply is mostly resulted from the policy of deficit financing pursued by the Government and the rise in demand for money for increasing volume of production and trade.
The present minimum reserve system of regulating note issue has been criticised from various quarters. It has been argued that greater degree of elasticity has resulted in undue expansion of money supply which would reduce the confidence and prestige of Indian rupee both within and outside the country.
Secondly, greater degree of elasticity in note issue has provided unlimited power to the Government to issue currency notes, leading to undue expansion of money.
Thirdly, unplanned increase in money supply has resulted in severe and continuous inflation in the country.
Although the present system of note issue has been criticised on aforesaid grounds, but the elasticity of the present system cannot be abandoned. So what is required at this moment is the restraint on the part of the Government to issue currency notes in a most restrictive manner.
During the pre-independence era, the banking sector in India was not at all organised. Since independence, a serious effort has been made to develop an organised banking and a financial system in the country.
In the mean time the country has developed a different type of banking institutions like Commercial/banks, Cooperative banks, regional rural hanks etc. and term lending institutions which are working in various spheres of the country. All these institutions are supervised by the Reserve Bank of India which is the Central Bank of the Country.