How digital transactions impact India’s monetary aggregates: SBI Ecowrap

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In the post-demonetization period, digital money (pre-paid instruments) has got a push and reached Rs 21,509 crore in May 2021. There has also been a massive surge in UPI payments and it has touched Rs 41 lakh crore in FY21. During Apr-June, FY22, the amount of UPI transactions has touched Rs 15.32 lakh crore, with 7.9 lakh transactions.

Monetary aggregates

India currently compiles four monetary aggregates on the basis of the balance sheet of the banking sector in conformity with the norms of progressive liquidity: M0 (monetary base), M1 (narrow money), M2 and M3 (broad money), which are used in monetary policymaking decisions. As per the definition, M0 is the monetary base and its components can never change. M3 (broad money), is defined as the total stock of money (paper notes, coins, and demand deposits of bank) in circulation which is held by the public and this measurement needs to change in line with emerging trends.

With the significant surge in retail digital transactions in India, it is imperative that measures of monetary aggregates like M3 by RBI incorporate such digital transactions going forward otherwise it might distort the understanding of movements in derived ratios like money multiplier (MM) that are important to contemplate the impact of monetary aggregates on prices and output.

Digital transactions and their impact

According to SBI Ecowrap, the increase in digital transactions has had a negative impact on M0 and money multiplier even though their value is larger than earlier, and a positive impact on M3.  The reports’ estimate of MM is also much higher than the existing MM.

An increase in digital transactions has played a critical role in the declining trend in money multiplier, even though the overall measure of M3 has been expanded.

In particular, there has been a substitution from currency and much of it has gravitated towards the digital mode of payments. The increased use of digital money/pre-paid instruments (especially m-wallets) has changed the composition of both reserve money as well as monetary base and has further impacted central bank’s control of money supply.

The use of digital currency by RBI will not impact M3 as central bank liability will be swapped with digital currency assuming there is one-to-one conversion. If the currency is issued on decentralised blockchain, outside the fiat system it is purely a supply of high-powered money that drives the money supply of crypto. As, M3 = H0 + bank credit, unless crypto creates credit and is fungible for fiat, M3 will not be impacted in theory.

RBI to maintain the status quo

The SBI report suggests that RBI will hold the rates. However, the RBI forward guidance should clearly lay down the contours of the current inflation trajectory by flagging the dangers of fuel prices on which Government has control.