Liquidity is ebbing away. The chart shows the year-on-year (y-o-y) growth in money supply (M3)—notice how growth has been steadily decelerating. At the same time, estimates of growth in gross domestic product (GDP) are being revised upwards, with the government’s mid-year review revising its GDP forecast for the current fiscal year up to 7.8% or thereabouts. The combination of lower money supply growth and higher growth in GDP would mean there is less money left over to boost product and asset prices.

But Indian asset prices are determined not only by domestic liquidity but also by foreign funds coming into our markets. So we took a look at money supply growth in the major economies and found that liquidity is being slowly tightened in the West, but not in China and Japan.

For instance, in the US y-o-y M2 growth (seasonally adjusted) was 3.7% on 7 December, down from 5.7% at the beginning of November and 8.1% at the beginning of September. This is not a consequence of a high base effect—the data shows that M2 growth between March and December this year has been all of 1%. This raises an interesting question: We’ve all heard the story of how loose monetary policy followed by central banks has been flooding the stock markets of emerging economies. Unfortunately, the numbers show that money supply growth in the US has been very small. So what explains the rush of money to emerging markets? Part of it is a reallocation of portfolios away from the US money market funds. The data shows that while assets under these money market funds totalled $3.9 trillion (Rs182.9 trillion) on 11 March 2009, it’s now down to $3.26 trillion, around the same level as in January 2008.

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For the UK, seasonally adjusted M4 numbers for November show y-o-y growth of 9.2%, down from 12.4% in August, 11.6% in September and 10.8% in October. For Europe, data from the European Central Bank show that M3 has been contracting since August 2009.

The two large Asian economies, China and Japan, however, show no signs of a deceleration in money supply growth. Y-o-y growth in M2 for China was 29.7% in November, the highest in several months. The M2 growth rate has remained around 28-29% for quite a few months. In Japan, M3 growth was at 2.4% y-o-y, the highest rate of growth in 2009.

So at the end of 2009, while money supply growth in the West and in India has already started to fall, liquidity continues to grow in China and Japan. Indian asset markets, however, are linked to flows from the West, pointing to lower inflows in future. Add to that the fact that growth in “shadow money", such as over-the-counter credit derivatives, will be much lower, unlike during the boom years. On the other hand, the continued growth of lending in China will mean that commodity prices will be supported.

Graphics by Ahmed Raza Khan / Mint

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