The Reserve Bank of India's policy of mopping up the huge inflow of dollars, which in turn releases rupees into the system, is having an impact on money supply and could, in the long run, push up the rate of inflation. What is more, this surge in money supply has taken place since November 2003.

Money supply growth has exceeded the RBI's target for 2003-2004. On March 5, with 26 days left to go for the close of the financial year, money supply (M3) growth in 2003-2004 was 14.6 per cent, overshooting the RBI's target of 14 per cent.

Runaway growth

Money supply growth in 2003-04 is 14.6% against the RBI's target of 14% Year on year, the growth is higher at 14.8% Economists say prices may rise later on in 2004-05

During the same period of last year, M3 grew by 13 per cent. On a year-on-year basis, M3 growth is higher at 14.8 per cent, compared with14 per cent last year.

Interestingly, year-on-year money supply growth at the time of the mid-term review of monetary policy in November was 11.9 per cent, well within the 14 per cent target.

Since then, however, money supply has shot up. Since November 1, 2003, M3 has grown by 6 per cent in four months, giving an annualised growth rate of 18 per cent, much above the RBI's target.

Contrast the situation in the last fiscal year, when M3 growth was a mere 3 per cent between November 2002 and March 2003 -- less than half the growth rate this year.

So far, the rise in money supply has not led to an increase in prices. But economists point out that the effect on the rate of inflation of money supply occurs with a lag, and we may see rising prices later on in 2004-2005.

The runaway growth in M3 in the last four months has occurred solely because of the influx of dollars. So the net foreign exchange assets of the banking industry have risen 33.9 per cent to March 5 this year, up from 26.2 per cent over the same period last year. Of this rise, as much as 53 per cent has occurred over the last four months.

Bankers point out that the RBI is unable to sterilise the inflows, because of the lack of government securities for conducting open market operations.

While that defect will be remedied by the issue of stabilisation bonds, dealers say that the Rs 60,000 crore (Rs 600 billion) worth of such bonds proposed to be issued in 2004-2005 will not be enough to mop up the liquidity.

Apart from the rise in foreign exchange assets, the other sources of money supply have increased at a lower rate than in the preceding year.

For instance, bank credit to the commercial sector has risen by 10.5 per cent this fiscal year, versus 17.3 per cent last year. Similarly, net bank credit to the government is up 9 per cent, compared to 13.7 per cent last year.