Economists and financial sector analysts do not rule out tightening of the monetary policy, and a rise in interest rates as the spectre of a high inflation rate is looming large.
Over the last 55 years, since 1951, the financial system has witnessed such a huge supply of money only thrice. In 1976, M3 - a broad indicator of the availability of money in the financial system - touched 23.6 per cent, its highest in history. In 1994, it was 22.4 per cent, and in 1978, it was 21.9 per cent.
In its annual policy statement in April, the RBI had projected around 15 per cent expansion of M3 in 2006-07, and hinted that "in normal circumstances, the policy preference would be for maintaining a lower order of money supply growth."
However, by the time the first quarterly review came up in July, on a year-on-year basis, M3 growth was far higher at 18.8 per cent. The overhang of liquidity in the system was to the tune of Rs 91,231 crore (Rs 912.31 billion) in the third week of July.
"A higher money supply signifies economic buoyancy. But if it grows much faster than the nominal GDP growth, one can assume that there is unproductive debt expansion, and inflation will certainly rise," says an economist with a large corporate house.
With the wholesale price-based inflation lower than 5 per cent at this point, the nominal GDP is growing at about 13 per cent. So, M3 is growing at 6.5 per cent higher than the nominal GDP growth. "This is unsustainble," the economist points out.
Even though the WPI is within the RBI projected territory of 5-5.5 per cent, bankers say the higher money supply points at asset price bubble in certain segments like real estate. "We must rein in the growth in consumer credit," they add.
If this is not done, they apprehend that the RBI may raise banks' cash reserve ratio to soak up excess liquidity from the system. Two major sources of supply of money are bank credit to the commercial sector and net foreign exchange assets of the banking system.
Bank credit to the commercial sector rose by 3 per cent this year (Rs 50,861 crore), against 1.9 per cent (Rs 25,894 crore) in the first four months of last year.
Net foreign exchange assets of the banking system, on the other hand, rose by 12.1 per cent this year (Rs 87,882 crore) against -3.1 per cent (decline of Rs 20,195 crore) in April-July last year.
Even net bank credit to the government, another source of money supply, is higher this year at 4.5 per cent (Rs 34,489 crore), against 3 per cent (Rs 22,108 crore) last year.
Among the components of M3, demand deposits with banks actually declined, while there has been a slight rise in currency with the public. However, time deposits with banks have risen by 6.7 per cent, or Rs 1,26,790 crore (Rs 1267.90 billion), against 3 per cent or Rs 50,305 crore (Rs 503.05 billion).
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