QE may succeed in bringing India’s economy out of a coma

bringing India’s economy out of a coma. To see why the quantity of money is a bigger problem than its price, consider M4.

The growth rate of India’s broadest measure of money supply has collapsed to singledigit levels for some time now, and is refusing to budge. New loans automatically create new deposits in the banking system.

But until there are creditworthy takers for fresh advances, deposits won’t revive. Time and demand deposits at banks account for 84 per cent of money supply, so it’s hard for the latter to get a boost without an uptick in the former.

Unconventional asset purchases can make a difference, though not the vanilla Japanese variety in which the central bank buys government bonds

For India, it would help much more for the central bank to buy government bonds from non-banks, following in the footsteps of the US Federal Reserve, which primarily purchased securities from hedge funds, broker-dealers and insurance companies. Since nonbank sellers of bonds don’t have accounts at the Reserve Bank of India, they’ll deposit any cash they receive with commercial lenders.

Money supply would accelerate even without new loans being made. from banks for cash, which they stuff into their current accounts with the monetary authority.

If the demand side of the economy is struggling, the impact may be limited because of the one thing it doesn’t do: lift money supply in the broader economy. That’s a point Invesco Asset Management chief economist John Greenwood has made in Japan’s case.

That may be quite useful in India’s current circumstances. The Indian government is already helping itself to practically all of the household sector’s savings. It doesn’t have more scope for deficit spending.

Following the Fed

If the RBI does experiment with Fed-style quantitative easing, how far can it go? As much as 15 per cent of the outstanding Rs59 trillion (Dh3.02 trillion) of federal Indian debt is already owned by the central bank, while commercial lenders are sitting on another 40 per cent.

Were the RBI to buy half of non-banks’ $365 billion stockpile of bonds, India’s $1.8 trillion in bank deposits could rise by 10 per cent, injecting new life into the anaemic expansion of money supply.

A more liquid non-bank sector would want to buy new government debt to earn a yield. New Delhi’s financing constraints would ease, allowing for a round of fiscal pumppriming that hopefully would create new machinery and project orders for the private sector.

If the RBI thinks of asset purchases as a way to further reduce the price of money, then it will want to wait until it has exhausted its conventional firepower by cutting the 5.15 per cent policy rate further. Given the primacy of food and fuel in India’s inflation, currently at 4.6 per cent, policymakers have some limited elbow room.

But if the central bank views asset purchases as a way to influence the waning quantity of money, then it should act now. Doing so may well save the day.