What is RBI?
RBI
(Reserve Bank of India) is the Central Bank of India which is the regulator of
Banking system and one of the moderators of the Indian Economy. It was
established under the Reserve Bank of India Act, 1934 and owned by the Ministry
of Finance. Amongst many functions, it is responsible for printing Indian
Currency except the 1-rupee notes and coins that are issued by the Government
of India under section 6 of the coinage Act, 2011. Central Bank has also the
power to destroy the currency already issued.
What
does issue of currency actually mean?
Issue of
currency means inclusion of liquidity in the economy which increases the money
supply. Money refers to the total volume of currency held by the public at a
particular point of time. Currently, Bank notes in circulation is 31,05,721
Crores having denominations of 10, 20, 50, 100, 200, 500 and 2000 as in March,
2022 as per the Annual Report by the RBI.
These notes
issued by RBI are bearer promissory notes containing the promissory clause
printed on the banknotes i.e., "I promise to pay the bearer the sum of
Rupees …” denotes the obligation on the part of the Bank towards the holder of
the bank note.
In simple
words, just to ensure that the RBI has reserved the gold equal to the value of
printed currency. This promissory note ensures to the note holder that the RBI
can’t be defaulter in any case/situation (Civil war, world war or any natural
calamity, depression or hyperinflation etc.). All
banknotes issued by RBI are backed by assets such as gold, Government Securities
and Foreign Currency Assets, as defined in Section 33 of RBI Act, 1934. Thus, if somebody holds 2000-rupee
currency note then he/she need not to worry about its exchange value because in
any situation the RBI is liable to pay him gold/goods equal to the value of the
2000 rupees.
Who
decides on the volume and value of banknotes to be printed and on what basis?
The volume
and value of banknotes to be printed in a year depends on various factors such
as
(i) the
expected increase in Notes in Circulation to meet the growing needs of the
public and (ii) the need for replacing soiled/mutilated notes
so as to
ensure that only good quality notes are in circulation. The expected increase
in Notes in circulation is estimated using statistical models which consider
macro-economic factors such as expected growth in GDP, inflation, interest
rates, growth in non-cash modes of payment etc.
The
replacement requirement depends on the volume of notes already in circulation
and the average life of banknotes. The Reserve Bank estimates the volume and
value of notes to be printed in a year based on the above factors as well as
feedback received from its own Regional Offices and banks regarding expected
demand for cash and finalizes the same in consultation with the Government of
India and the printing presses.
Why
doesn’t RBI print more money and make us rich?
Our Economy
is affected and controlled by many economic factors. Their interrelatedness
impacts the overall system thus you cannot change a factor without considering
the other. Let us understand in detail.
During post
pandemic chaos, there were many opinions in the country to print more currency
in order to address the situation as many have thought this would boost expenditure
and output as economy might have downturn. But, in response to that, the
Governor of RBI replied that Central banks, with regard to printing of notes,
have their own models and have their own assessment. The central banks, with
regard to printing of notes, take decisions based on so many complex factors
relating to financial stability, inflation and stability of exchange rates,”
Thus, there
is no one reason for our topic. Let us discuss one by one.
Inflation
Suppose you
have 150 rupees in your pocket to buy 100 rupees of goods in market. When you
went to the shop, you saw there is only 1 packet and another person is also
present to buy the same. Normally, you both will start bidding from 100 and the
higher bidder will win the packet but you have restriction up to 150 beyond
which you cannot bid. Now suppose, another 50 rupees is provided by both of
your fathers now both of your pocket is raised by 50 rupees. Now certainly the
bid will now start directly from 150 and not 100. Thus, there is no actual rise
in status for either of you. But, in this case if the 100 rupees was not
distributed equally, it would still increase the nominal price but one would
dominate the other due to relatively more purchasing power.
Inflation
means rise in the general price level in the economy. Inflation is basically of
two types- demand pull inflation due to demand-supply imbalance and cost push
inflation due to rise of cost of production. Here, we are mainly concerned with
the demand-pull inflation. When more currency is pumped into the economy, a
layman would think that a country becomes resourceful but it is not. With more
money in the economy, people get more money but there is no simultaneous
increase in available resources to satisfy the risen demand due to more money
supply. Hence, due to lack of supply, the price of commodity rises towards the
inflation. So, there is no actual increase in purchasing power i.e., PPP or
real GDP or output of the Country.
The threat
of inflation may be absorbed by the riches but it is detrimental to the poor
because their income may not the proportionate to the rate of increasing
inflation.
Many
countries attempted this shortcut for debt financing and led to huge economic
crisis due to excessive money supply resulting into hyperinflation and the
impact of which is still not compensated.
Hyperinflation in Venezuela took off because of the excess
printing of the Venezuelan Bolívar. Printing money is quicker than borrowing
money or getting money from tax revenue, thus the Venezuelan government decided
to print money in urgent times. The excess circulation of the Venezuelan
Bolívar caused its value to decrease. When the value shrank, the government
needed more to fund their spending, so they printed more money. This again led
to a decrease in the value of the Venezuelan Bolívar. This cycle caused the
currency to eventually become worthless.
Zimbabwe during the 2000s, monthly inflation reached as high
as 80 billion percent, according to some estimates. The local currency was
eventually abandoned in favour of the US dollar. Currently in 2022, the
inflation rate is still high as much as 60%.
In Germany during the 1920s, citizens were pictured taking
wheelbarrows full of cash to shops to pay for basic goods.
Gross
Domestic Product
GDP is the
final value of the goods and services produced within the geographic boundaries
of a country during a specified period. The government prints money of the same
value, as its value has gained into their economy or, in a simple way, GDP. So,
rising economic productivity - GDP increases the value of money in circulation
since each currency unit can later be traded for more valuable goods and
services. The point worth noting is, the government gives people the same
amount of physical currency as a medium of exchange as the value it is getting
in return from GDP and inflation.
Foreign
Exchange Rates & Depreciation
International
investors could lose confidence in a country if its central bank is directly
financing the government. Money supply and exchange rates are meant to reflect
the size of an economy. If central banks are simply pumping out more money to
pay off debt, it’s almost like a snake eating its own tail. Exchange rates
would likely drop if this were to happen, leaving a country poorer and everyone
worse off. Simply stating, due to increase in money supply, the value of
domestic currency will depreciate making import costlier which will further
increase the cost of production. As a country like India which depends on many
resources from abroad, the goods will become unaffordable. It can lead to a
currency crisis — something India has dealt with in the past, as recently as
mid-2013.
Minimum
Reserve System
Currency
issued in the country relies upon the reserves RBI has with it after meeting
all its liabilities. Now by reserves, it means the following
1. Bullion
reserves
2. Foreign
exchange reserves
3. Balance
of Payment (BOP) only receivables.
In India,
currencies are supplied by the RBI with the backing of bullion reserves,
foreign exchange reserves (foreign currencies), and Balance of payment. For the
new issue of currencies, the RBI follows the Minimum Reserve System at present.
The system has been followed since 1956. Under MRS, the RBI has to keep a
minimum reserve of Rs 200 crore comprising gold bullion and gold coin, and
foreign currencies. Out of the total Rs 200 crores, Rs115 crore should be in
the form of gold bullion or gold coins.
Under the
Minimum Reserve System, RBI can give the limitless measure of currency by
keeping the reserve. Yet, RBI observes some rules or rules for giving new
monetary standards dependent on financial development and transaction needs of
the individuals.
Traits
of a developing country
Most
economists and experts who recommend money printing do that on the basis of something
called the Modern Monetary Theory. MMT basically states that the government
which issues its own currency can always act as the employer of the last
resort. It can afford to print money, create some work, and hire unemployed
workers. When we say that during tough economic times the government needs to
be the spender of the last resort, what we are essentially saying is that it
needs to be the employer of the last resort. All this can happen only because
people are willing to transact in the fiat money that the government deems to
be money. Hence, the purpose of printing is congruent to the demand for the
money.
The
government creates demand for fiat money by essentially accepting taxes in it. In
developed countries governments can print money and spend it and create
employment in the process. But things can get a little tricky for a developing
country, where paying taxes honestly is not really the order of the day. Given
the general tax avoidance and the fact that the informal economy forms a large
part of the overall economy, the Indian government cannot print money and spend
it in the same way as governments of more developed nations can. The US dollar
is deemed to be the global safe haven. Hence, there is perpetual demand for the
US dollar globally. This allows the US Federal Reserve, the central bank of the
country, to print money without having to face any negative repercussions for
the same. What applies to the US dollar applies to currencies of other
developed countries as well. As Wray writes: “To a lesser degree, the financial
assets denominated in UK pounds, Japanese yen, European euros, and Canadian and
Australian dollars are also highly desired.” This allows these countries to
print money.
Until 1997, the RBI
“automatically” monetised the government’s deficit but In 1994, Manmohan Singh
(former RBI Governor and then Finance Minister) and C Rangarajan, then RBI
Governor, decided to end this facility by 1997.
Methodology
to evaluate the need for currency: -
* The
projected GDP figure is available from Govt, CMIE, and RBIs own Research Wing
(D). (It considers the factors like Inflation and GDP)
* We know
the cash with RBI and Banks -under Note stock account (N).
*Then there
is replacement demand due to the destruction of soiled notes (R).
Total Notes
to be printed = D - N +R
Then
denomination wise break up is taken for printing and print order is given to
printing presses and printed in 4 quarters and remittances planned accordingly,
and the entire procedure is monitored by RBI Issue Department.
Quantitative
Easing vs Printing money
Though both
intends to induce the money supply in the economy but the approach is
significantly different. If a country, beyond the adequate reserve, prints
currency, it will ultimately yield no worsen the macroeconomic stability but
through quantitative easing, Central Bank purchases securities from the open
market to reduce interest rate and increase money supply. It is popularly known
as Open market operation. Quantitative easing creates new bank reserves,
providing banks with more liquidity and encouraging lending and investment. For
example, In the United States, the Federal Reserve implements QE policies.
Sources:
https://www.linkedin.com/feed/update/urn:li:activity:6664154377692958721/
https://insider.finology.in/investing/why-cant-rbi-print-unlimited-currency
https://www.youtube.com/watch?v=btpgJ25aETk
https://www.youtube.com/watch?v=os_7n2CwrCM
Researched by Soumyadeep Pramanick
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