Money Multiplier – For One Rupee of RBI, How much is generated in Indian Economy?
Money Multiplier – For One Rupee of RBI, How much is generated in Indian Economy?
The concept of Money Multiplier is an interesting one. In this context, the ‘multiplier’ is not about growth in investments, but it refers to ‘Money Supply’. Money Supply as in, for each rupee of money of the Central Bank in India, how many rupees get generated in the Indian Economy. The answer is: around Rs.6. Every rupee of money placed in the disposal of the economy by the Reserve Bank of India (RBI) is able to multiply 6 times to generate Rs.6, which is then used within the economy for various purposes. In this blog, we would see as to how this happens and how we compare with US and Europe on this money multiplier.
It will be useful to know as to why we should understand this ratio. This is simply because, if this ratio moves up, it is an indication of the fact that the banking system in the country is generating a higher quantum of money supply from the money that is provided by the RBI. One of the key reasons this is happening is due to a continuous and persistent decline in the cash holdings with individuals that we have seen in the recent years. This can be attributed to the agenda of financial inclusion that the country has been driving since several years now. The ‘shout’ on the financial inclusion is leading people to hold less cash, in relation to the deposits, which is resulting in an increased multiplier.
There are primarily two factors that affect money supply. One is how much cash do individuals and businesses hold as cash in hand and the other being quantum of money that banks hold as reserves.
As regards the first one, the higher the cash that the individuals and businesses hold in hand, the lesser would be the ability of the banking system to create money and hence a lower multiplier. Conversely, the lower the cash in hand with individuals and businesses (which means, they have placed higher amount in say savings and deposits), the higher would be the ability of banks to multiply that money. In a way, cash-in-hand, acts as a leakage as far as banking system is concerned. As regards the second one, if the reserves that the banks hold with Central Bank is high, the lower would be the multiplier and vice versa.
The increase in India’s money multiplier is more due to the former (holding less cash in hand) and less on account any decline in reserves with Central Bank. The agenda of financial inclusion that has been driven by different governments has resulted in increasing number of bank accounts. This has led to more money moving into banks as savings and deposits. And further banks have been able to convert the RBI money into money for commercial activities in the economy more efficiently.
When we compare with US and Europe, India has fared quite well in showing a higher money multiplier over the years. The following tables give some statistics:
|
Sl.No. |
Measure | India | US | Europe |
| 1. | Money Multiplier (31st October 2015) | 5.8 | 3.01 | 6.61 |
| 2. | Money Multiplier (31st January 2002) | 4.6 | 8.38 |
11.15 |
| 3. | Leakages from the banking system (Excess Reserves as a %age of bank deposits) | 0.14 | 23.24 |
4.67 |
| 4. | Required Reserves | 4 | 1.43 |
1.5 |
Sources: Bloomberg, Indiamint, World Bank Reports
The propensity of Indian population to keep cash in hand, has been on a decline over the last ten to fifteen years. The %age of currency in circulation as compared with bank deposits was 18.68% in January 2002. This figure had dropped to 14.79% in October 2015. Over the last three years, i.e. 2011 to 2014, the penetration of bank accounts has increased from 35% to 53% among the adult population in India. Yes, we are plagued by a large number of zero balance accounts. As per a World Bank Report, over 40% of adults who had bank accounts in India, did not do a transaction in their bank accounts for a period of 12 months in the years 2014-15. Compared to this, in developed countries this percentage is close to 5%.
India does have a long way to go in developing various aspects of its banking and financial inclusion. Having said that, it is still heartening to note that we have been more efficient in managing the circulation of the money in the economy and that the multiplier ratio is going up.
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