Did we unwittingly have an easing in monetary policy in the first quarter (Q1) of the current fiscal year? The chart plots the year-on-year (y-o-y) percentage change in money supply (M3) at the end of each quarter with the change in nominal gross domestic product (GDP, at factor prices) for the quarter. The results show that in Q1 of the current fiscal, money supply growth exceeded the growth in quarterly GDP for the first time in six quarters.
The chart shows that money supply growth has always been below the quarterly nominal GDP growth between Q4 of fiscal 2010 (FY10) and Q4 of FY11. That was the result of the Reserve Bank of India’s (RBI) monetary tightening measures. As is seen from the chart, prior to Q4 of FY10, money supply growth was much higher than the quarterly nominal GDP growth, except for a blip during Q2 of FY10.
When output goes up without a corresponding increase in money supply, interest rates rise, because the supply of money is not going up to the extent of demand. That is precisely what has happened after RBI tightened policy. On the other hand, when money supply growth is higher than the GDP growth, the implication is there’s excess liquidity, which could spill over into either higher asset prices or higher prices of goods and services, thus resulting in higher inflation. Was that the reason the RBI governor, aware of the danger, decided to increase the policy rate by a higher-than-expected 50 basis points at the 26 July monetary policy meeting?
Also See | Trend Reversal (PDF)
The latest RBI data shows that as on 26 August, the y-o-y growth in M3 was 16.7%, slightly lower than the 17.1% growth rate notched up at the end of June. But then GDP growth, too, would be lower in the current quarter, so it’s difficult to know whether money supply growth in the current quarter, too, would be higher than the nominal GDP growth.
Notice, however, that the gap between money supply growth and GDP growth was much higher in Q1 of FY11 and has been steadily decreasing, implying an easing of restrictive monetary conditions.
Graphic by Yogesh Kumar/Mint
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