Economists worry about high inflation

Money supply grows 19.5%

The growth rate of money supply in the Indian financial system has hit a 12-year high of 19.5 per cent. Economists and financial analysts do not rule out a tightening of the monetary policy and a rise in interest rates as the spectre of high inflation looms.

Over the last 55 years, the financial system has witnessed such a huge spurt in the supply of money only thrice. In 1976, M3 "" a broad indicator of the availability of money in the financial system "" touched 23.6 per cent, its highest in history. In 1994, it was 22.4 per cent, and in 1978, it was 21.9 per cent.

In its annual policy statement in April, the RBI had projected around 15 per cent expansion of M3 in 2006-07, and hinted that "in normal circumstances, the policy preference would be for maintaining a lower order of money supply growth."

However, by the time the first quarterly review came up in July, M3 growth, year on year, was far higher at 18.8 per cent. The overhang of liquidity in the system was around Rs 91,231 crore in the third week of July.

"A higher money supply signifies economic buoyancy. But if it grows much faster than the nominal GDP growth, one can assume that there is unproductive debt expansion, and inflation will certainly rise," says an economist with a large corporate house.

With wholesale inflation lower than 5 per cent at this point, the nominal GDP is growing at around 13 per cent. So, M3 is growing 6.5 per cent higher than the nominal GDP growth. "This is unsustainable," the economist points out.

Even though the WPI is within the RBI projected territory of 5-5.5 per cent, bankers say the higher money supply points to an asset price bubble in certain segments like real estate.

"We must rein in growth in consumer credit," they add. If this is not done, they apprehend that the RBI may raise banks' cash reserve ratio to soak up excess liquidity from the system.

Two major sources of supply of money are bank credit to the commercial sector, and net foreign exchange assets of the banking system. The bank credit to the commercial sector has risen by 3 per cent this year (Rs 50,861 crore), against 1.9 per cent (Rs 25,894 crore) in the first four months of last year.

The net foreign exchange assets of the banking system, on the other hand, rose by 12.1 per cent this year (Rs 87,882 crore), against -3.1 per cent (a decline of Rs 20,195 crore) in April-July last year.

Even net bank credit to the government, another source of money supply, is higher this year at 4.5 per cent (Rs 34,489 crore), against 3 per cent (Rs 22,108 crore) last year.

Among the components of M3, demand deposits with banks actually declined, while there has been a slight rise in currency held by the public. However, time deposits with banks have risen by 6.7 per cent, or Rs 1,26,790 crore, against 3 per cent, or Rs 50,305 crore, last year.