The following points highlight the four main constituents of total money supply in India.
Total Money Supply # 1. Rupee Coins:
The rupee is treated as the unit of account. The rupee is not a full-valued standard coin. It is a token coin whose face value (i.e., the value written of the face of the coin) is much higher than its metallic (intrinsic) value.
Although a token coin, the rupee is unlimited legal tender. It means that rupee has to be accepted in the settlement of any amount of debt. One can force another individual to accept payment of even Rs. 1 lakh or more in rupee notes. The value of rupee coins in circulation has to be adjusted from time to time according to the demand for such coins arising from the commercial banks and the public in general.
Total Money Supply # 2. Subsidiary Coins:
In India, the subsidiary coins now consist of 50 paise, 25 paise and other decimal coins of a smaller face value, the rupee being divided into 100 paise. The metallic value of each such coin exceeds its face value. Each such coin is maintained in circulation at a fixed ratio to the rupee by the provision that it has to be converted into the rupee on demand. Metallic coins are limited legal tender. So people may refuse to accept such coins in the settlement of a large debt.
Total Money Supply # 3. Rupee Notes:
At present coins are used mainly for small transactions. The major portion of money circulation in India consists of rupee notes. These notes and coins have value, not due to the guarantee given by the R.B.I. Governor, or due to their metallic value, but due to the limitation of their supply. In the past such notes were freely convertible into full-valued metallic money. But such metallic coins do not exist today. So the notes of today are, in most cases, not convertible into any other form of money. Such notes circulate on their own right.
It may also be noted that inconvertible paper notes, however, cannot generally be issued in unlimited amount. In India there are certain rules and regulations which limit the power of the central bank (the monetary authority) to issue paper notes.
In India, all paper notes—except one-rupee notes are issued by the R.B.I. The one-rupee note is issued by the Finance Ministry as it is considered equivalent to a rupee coin. In fact both the rupee coin and the one-rupee note are token coins. Their intrinsic value is much less than their face value.
The issue of notes by the R.B.I is subject to the regulations contained in the R.B.I. Act of 1935. Originally, i.e., when the Act was initially passed before Independence, all notes issued by the R.B.I, (set up in 1934) were to be based on a 40% reserve in gold or British Government securities. The amount of gold in the reserve was never permitted to fall below Rs. 40 crores.
When India joined the IMF as a member in 1947, this provision was slightly relaxed. So the foreign securities other than those of the British Government might also be kept in the form of reserve. From 1956 onwards various amendments were made to the R.B.I. Act, which provided that the link between the note- issue and the gold and foreign exchange reserves could be abandoned with the approval of the Government of India.
The R.B.I. Act, in its original form, allowed the R.B.I, to reduce the reserve ratio and expand the note issue when demand increased sharply. But, on such occasions, it had to pay a tax to the Government for the additional issue. This hampered the objective of imparting elasticity to the note supply. But the difficulty has been removed subsequently. The present provisions permit the issue of additional notes without requiring additional reserves of gold or foreign exchange.
Total Money Supply # 4. Bank Deposits:
We know that commercial banks create money through their power to create deposits. However, only deposits in the current account are included in the country’s money supply because such deposits can be easily transferred from one bank account to another. Most savings deposits and fixed deposits are not included in money supply because they are not withdrawable by cheques and cannot be used as medium of exchange.
Commercial banks are financial intermediaries. They accept deposits from the people and make loans there-from. Thus, the banking system as a whole can convert a small initial deposit into a large amount of credit. This is known as multiple credit creation. In other words, bank deposits, created by an actual deposit of cash with banks, have a tendency to grow in size as a result of the bank’s lending operations. This is known as secondary expansion in bank deposits.
The R.B.I can check this secondary expansion in bank deposits only if:
(i) it does not itself expand its own loans or
(ii) having expanded its own loans it can prevent the commercial banks from lending as much as they could.
The R.B.I can cut down its own loans by raising the rate of interest at which it is prepared to lend.
The relation between the R.B.I and the commercial banking system is that of the leader and its followers. Under the Banking Regulation Act of 1949, all commercial banks are required to maintain deposits with the R.B.I, and to regulate their lending policy according to its directions. The R.B.I has been vested with adequate powers to curb an unwanted expansion of credit brought about by the commercial banks.