Icra Takes Up Project To Study Financial Sector
ICRA, the Industrial Finance Corporation of India-sponsored rating major, has taken up a project to study the monetary and financial sectors of the economy.
The project, led by noted economist Mihir Rakshit, will develop analytical models to explain the inter-related movements of the principal macro-variables guiding the domestic financial sector.
The project has highlighted several paradoxes in recent developments in the field of money and finance.
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The critical issues being debated include the significant expansion in broad money despite a decline in reserve money and the expansion in M3 inspite of a relative squeeze in the real economy.
A study published by Icra has pointed to a curious aspect of the behaviour of financial flows this year - the relationship between broad money and credit supplied by commercial banks.
It has been noted that despite a much faster growth in M3, the increase in the quantum of credit advanced by scheduled commercial banks was much smaller in 1996-97 compared with that in 1995-96.
Between April and Dece-mber 1996, the increase in M3 was a little over Rs 57,000 crore.
In contrast, the total bank credit in this period rose by only Rs 5,404 crore while non-food credit increased by Rs 6,169 crore. This is in marked contrast to the period between April and December 1995, when M3 rose by under Rs 36,000 crore and bank credit expanded by over Rs 21,000 crore.
The study observed that the two-way relationship between M3 and bank credit arises from the fact that an increase in money supply automatically implies an increase in bank deposit and larger deposits permit commercial banks to extend credit.
Paradoxically, statistics show that only a negligible fraction of additional resources garnered by banks during April and December was used for providing credit.
This was different from the situation in 1995-96 , when the growth in credit exceeded the growth in deposits. The report also pointed out that there is a huge overhang of excess SLR bonds and a continued expansion of lending to government - despite a decline in the Statutory Liquidity Ratio (SLR).
The negligible increase in credit extended by the banking sector to industry and commerce, despite the strong growth in M3 and bank deposits, is related to the sharp rise in banks investment in government securities.
The rise in banks holding of government securities in preference to expansion of credit to the commercial sector suggests that the problem lies not so much in adequate monetary expansion but in government borrowing.