Category Archives: Economics

Money Supply and Equity markets

We often here the word “Money Supply” while referring to our economy condition. So today i will try to explain in simple term, what exactly is Money Supply.

Money supply can be defined as amount of money or its equivalent in circulation at any particular time in an economy. Money includes:

  • Coins and Currency
  • Foreign Exchange Reserves with RBI
  • Time Deposits and Demand Deposits
  • Post office deposits
  • Or any such instruments

Supply measure of money in the economy could help monetary policy maker to take a interest rate decision to control inflation. As money supply in the economy increases, so will the purchasing power in hands of public. As public have more and more liquidity to spend, their need would rise which results in increasing demand of all goods and services. This causes inflation. Inflation to some extent is necessary for growth but hyper-inflation is dangerous for the country’s financial system. So with money supply in act with inflation, RBI balances economy by controlling the driving tool Interest rate.

Now going further there are mainly 5 components considered while calculating money circulation.

M0  also known as Reserve Money includes: Currency in circulation + Bankers’ deposits with the RBI + Other’ deposits with the RBI = Net RBI credit to the Government + RBI credit to the commercial sector + RBI’s claims on banks + RBI’s net foreign assets + Government’s currency liabilities to the public – RBI’s net non-monetary liabilities.

M1: Currency with the public + Deposit money of the public in banks

M2: M1 + Savings deposits with Post office savings banks.

M3: M1+ Time deposits with the banking system = Net bank credit to the Government + Bank credit to the commercial sector + Net foreign exchange assets of the banking sector + Government’s currency liabilities to the public – Net non-monetary liabilities of the banking sector (Other than Time Deposits).

M4: M3 + All deposits with post office savings banks (excluding National Savings Certificates).

To Sum up M0 is the money which is owned by RBI and its known as systems reserve money. while other all components are owned by public and are in circulation or with banks as deposits or with post office. So higher the money supply with public higher would be the inflation.

Now lets take some example with the graph

in the graph Yellow line is M3 which means its the M1 (Currency with the public) +Banks foreign reserve and lending to commercial sectors and the Blue line is our Nifty index. While Pink line is our Repo rate. Time frame for charts is Monthly

Observations:

  • 2008-2009: We experienced Lehman crisis because of which markets , which squeezed money from the circulation and foreign reserves which is a part of M3 decreased as FII sold off and took out dollars from the banking sector. So we saw all three leading downside as rate cut also didnt spur buying as FII were not confident yet.
  • 2009 bottom: We saw interest rates bottoming out, which led some money supply in the market and it spur equity market from the low of 2260 on Nifty.
  • Since 2010-2014: We have seen rising repo rates which has squeezed some money from the circulation but still markets performed as FII were buying during the time of post crisis. Banking and financial sector already in having huge NPA’s post 2008 crisis, it has squeezed its lending to commercial sector which is seen clearly with money supply line decreasing YoY on the charts since 2008 
  • 2014-2015 March As Money supply continued to decrease but markets pinched a new high, it was clear that FII money was driving market as there was no money circulation or supply in the domestic market as represented by yellow line which is M3
  • 2015 April-to present: As we knew that there wasnnt domestic buying in the markets as  liquidity was squeezing, our markets were purely dominated by global factors. Since March 2015, crude supply rising spurred crisis fear in the global markets which made FII exit our markets which was the result of the correction in last one year.

But now……..

I Expect that next rally would be surely dominated by the domestic players and that would be strong rally. Points for my support are:

  • We Have seen many banking companies cleaning up balance sheet as per new guidelines and as we have rate cuts now, they will surely start lending to good commercial sectors which have shown confidence.
  • As the money supply to commercial sector rises, it will rise money supply in manufacturing which improve profits which will eventually results in rally on the markets

But ofcourse it will take some time and we cant predict the low exactly as the divergence between domestic money supply and Nifty is the most widened in last 20 decades and it should narrow. I expect markets to stay volatile for next few months. Dont be saddened or fearful, if you are sitting on cash or can arrange some liquidity start shopping from here on..its honeymoon period for you guys…

Hope you guys find this post useful…..do leave a comment for any suggestion.