In India, policies for financial liberalisation and restructuring undertaken since the late 1980s have led to a gradual withdrawal of external constraints on the financial system, the freeing of interest rates and other financial prices as well as improved access to a greater variety of financial assets and liabilities, both internal and external. There has also occurred a fading of the distinction between various participants in the financial system i.e., commercial and cooperative banks, development financial institutions and non-banking financial companies. In recent years, the importance of financial institutions other than banks in financial intermediation has increased considerably. These developments have affected the efficacy of the existing monetary aggregates in explaining the impact of monetary conditions on aggregate spending and more generally, in providing insights into the state of liquidity in the economy.

Against this background, the Working Group on Money Supply:Analytics and Methodology of Compilation (Chairman: Dr. Y.V. Reddy) (RBI 1998) sought to differentiate monetary aggregates from other financial aggregates. As regards monetary aggregates, the Working Group recommended their compilation on a residency basis i.e., excluding non-resident repatriable foreign currency fixed liabilities {Foreign Currency Non-Resident (Banks) [FCNRB] and Resurgent India Bonds [RIBs] type deposits, at present}. Furthermore, it was of the view that it is necessary to take explicit cognisance of the importance of non-depository financial corporations in a set of liquidity aggregates, incorporating but distinct from, new measures of monetary aggregates proposed by it. Drawing from cross-country experience and the provisions of the benchmark Manual on Monetary and Financial Statistics (MFS) of the International Monetary Fund (IMF), it recommended the compilation and monitoring of three liquidity aggregates i.e and ., L₁, L₂ L₃, consistent with two new measures of monetary aggregates and a comprehensive financial sector survey.

This article constitutes a major step forward in implementing the recommendations of the Working Group. It draws heavily upon the ground work laid by the interdepartmental Core Group (Convenor: Dr. R.Kannan) which was set up to oversee the implementation of the Working Group's recommendations. Series on the new monetary aggregates and the liquidity aggregates from April 1993 to September 2000 are presented with a view to establishing a fortnightly/ monthly/quarterly calendar for publishing these aggregates in the future. It is expected that as experience with the reporting environment is accumulated, the information content and explanatory power of these aggregates would improve on an on-going basis.

Given the new ground being covered in terms of conceptual and information issues, tentative data on new monetary aggregates i.e were presented for the first ., NM₂ and NM₃ time in the October 1999 issue of this Bulletin, along with a note on conceptual and definitional issues. Their release was, however, suspended from January 2000 due to data discrepancies. This article restores the publication of the new monetary aggregates. On-going refinements in data collection and processing have enabled updating of the series up to September 2000.

The principal refinements under the new monetary aggregates relate to a more comprehensive and disaggregated survey of the sources of money supply i.e., credit aggregates. As recommended by the Working Group, credit to the commercial sector by the banking system now includes banks' investments in non-SLR securities and net lending to primary dealers (PDs) besides the banking system's conventional credit to the commercial sector and investment in other approved securities. This makes it possible for a detailed analysis of the behaviour of bank credit to the commercial sector, including flows in terms of investments in commercial paper, units of the Unit Trust of India, shares/debentures/ bonds of the non-bank sector including public financial institutions, revaluation thereof, and subscription to primary issues and private placements. Forthcoming analyses of the commercial bank survey would contain the disaggregation of scheduled commercial banks' credit to the commercial sector in the representative format presented in Exhibit I.

As regards credit to Government from the banking sector, the most important change in the recent period has been the growing market orientation of monetary policy and the management of the public debt issue. This has entailed day-to-day management of liquidity conditions and interest rates involving (i) primary operations in the form of loans and advances, subscription to new issues including devolvement and private placements, and the management of government deposit balances, and (ii) secondary operations in the form of open market operations and repos. The high-powered monetisation of the fiscal deficit is measured in (i) whereas (ii) represents off-setting operations conducted by the Reserve Bank to neutralize/modulate the monetary impact of (i). Accordingly, the variations in the Reserve Bank's credit to the Government does not provide the true picture of the monetisation of the fiscal deficit, since open market operations are essentially changes in the ownership of the underlying securities without any effect on the primary financing of the fiscal deficit. Thus, for instance, a reversal of a repo transaction results in an increase in the Reserve Bank's ownership of government securities and therefore, in the Reserve Bank's credit to the Central Government without any increase whatsoever in the money financing of the fiscal deficit. Therefore, forthcoming analyses of the credit to government will incorporate a disaggregated presentation of the variations in the Reserve Bank's credit to the Central Government in the format given in Exhibit II.

Net foreign assets of the banking sector i.e., net claims of the banking system to the foreign sector have hitherto consisted of gross foreign currency assets of the banking system and gross foreign assets of the Reserve Bank net of the gross foreign liabilities of the Reserve Bank (essentially liabilities to the IMF adjusted for the minimum quota subscription in rupees). This is an anomalous situation in which the net foreign assets of the banking system are overstated since they are not adjusted for foreign liabilities. In line with the recommendation of the Working Group, net foreign currency assets of the banking system now comprise their holdings of foreign currency assets net of (i) their holdings of non-resident repatriable foreign currency fixed deposits which is defined to include FCNR(B) deposits at present, and (ii) overseas foreign currency borrowings.

Net non-monetary liabilities of the banking system, which has hitherto been calculated as the residual derived from balancing the components of money supply against the identified sources thereof, is now disaggregated into an identified capital account, comprising capital and reserves, and an unidentified residual i.e., other items (net) which is a balancing entry. The size of the entry under other items (net) provides an indication of the exhaustiveness of compilation. In the monetary aggregates presented in this article, other items (net) works out to barely five per cent of the money stock, which is reasonable by international standards.

For the first time, this article presents a monthly series on the liquidity aggregates recommended by the Working Group over the period April 1993 to September 2000. It needs to be noted that the movements in the liquidity aggregates have to be evaluated in conjunction with those of the new monetary aggregates, presented separately in this issue of the Bulletin, for an appropriate assessment of the liquidity conditions in the Indian economy. In terms of the norm of progressivity, the liquidity aggregates represent the extension of the monetary aggregates to encompass financial claims which compete with monetary claims in measuring overall liquidity, without the special characteristics conventionally attributable to monetary aggregates. The liquidity aggregates are classified into three categories. and would henceforth be L₁ L₂ published as a monthly series in this Bulletin, would be published on a quarterly while L₃ is set basis. The definition of L₁, L₂ and L₃ out below.

Consistent with the UN's System of National Accounts (UN, 1993) and the IMF's MFS, the domestic economy can be divided into four sectors as proposed by the Working Group i.e., households, non-financial corporations, general government and financial corporations. For the purpose of the compilation of monetary/liquidity aggregates, the financial corporations sector can be subdivided into (i) depository corporations, comprising the Reserve Bank and the banking system, which have the 'franchise' to issue monetary liabilities, and (ii) other financial corporations, comprising the development (term-lending and refinancing) financial institutions, insurance corporations, mutual funds and non-banking financial companies accepting deposits from the public, which have deposit liabilities or close substitutes that compete with liabilities of the depository corporations in the process of financial intermediation. While the liabilities of (i) are considered for the compilation of monetary aggregates, liabilities of (ii) are considered along with those of (i) for measures of liquidity (Tables I and II and Current Statistics Tables 11A, 11B and 11C).

L₁ is the sum of the broadest monetary aggregate NM₃ and all postal deposits. Postal deposits include savings deposits, time deposits and recurring deposits with the Post Office Savings Banks. L₁ excludes deposits under the National Savings Scheme 1992, Post Office Monthly Income Schemes and National Savings Certificates. Postal deposits are excluded from the monetary aggregates since post offices form part of general government in the national accounts and moreover, postal deposits have lost their relevance with the spread of banking. They are, however, included under the liquidity aggregates due to their chequability.

L₂ is the sum of L₁ and term deposits, term borrowings and certificates of deposit of financial institutions (FIs) (term-lending and refinancing institutions). Term deposits include public and corporate deposits with financial institutions as well as home loan accounts. They exclude priority sector shortfalls deposited with the Small Industrial Development Bank of India (SIDBI) and the National Bank for Agriculture and Rural Development (NABARD) including those under the Rural Infrastructure Development Fund (RIDF) and other special deposits which do not compete with bank deposits. Borrowings by financial institutions are generally in the maturity range of 3-6 months, while the maturity spread of term deposits and certificates of deposits is 1 to 5 years and 1 to 3 years, respectively.

L₃ is the sum of L₂ and public deposits with non-bank financial companies (NBFCs), and is the broadest measure of liquidity. Deposits with non-bank financial companies are tentative estimates based on information reported by such companies with a public deposit base of Rs.20 crore and above and accounting for about 90 per cent of total public deposits held with non-bank financial companies. It is expected that the coverage of these deposits under L₃ will improve with time and experience.

The relationship between the monetary and liquidity aggregates is summarised in Exhibit III.

NM₃ = Currency with the Public + Demand Deposits with Banks + Time Deposits with Banks - FCNR(B) and RIB deposits + "Other" Deposits with RBI + Other borrowings by Banks

L₁ = NM₃ + Post Office Deposits

L₂ = L₁ + Term Deposits with FIs + Term Borrowings by FIs + CDs issued by FIs

L₃ = L₂+ Public Deposits with NBFCs

It may be noted that the liquidity aggregates, unlike the monetary aggregates, are compiled by the principle of aggregation on a gross basis i.e., by summing up information reported for all instruments within a group. Transactions and claims between members of a group or between groups are not netted out because of lack of information mainly on re-intermediation i.e., the flow of funds/instruments from other financial corporations to the depository corporations. To this extent, the liquidity aggregates may be marginally overstated vis-à-vis the monetary aggregates. Nevertheless, many countries of the world are now monitoring broader measures of money and liquidity. The USA, for instance, introduced a liquidity aggregate in 1980; the experience has been that the liquidity aggregate has tended to grow more rapidly than the monetary aggregate, reflecting an increasing proportion of financial instruments issued outside the depository corporations. In a cross-country survey, the Working Group found that Japan, Italy and Spain have introduced liquidity aggregates, while other countries have chosen to broaden their monetary aggregates. With improvements in data coverage, it is expected that the broader measures of liquidity will more appropriately relate to overall economic and market activity in India.