In my previous post What is the Monetary Base, I explained that the Monetary base of an economy = Cash held by the public (i.e. cash held outside the banking system, the central bank and the government) + Cash held by banks (at their branches) + Banks' reserves with the Central bank.
This Monetary base is the total amount of physical cash available in the economy, and is quite literally the 'base' on which the banking system creates the economy's money supply.
After one understands what the Monetary base is, it’s natural to question why cash in government accounts with the Central Bank is not included in the nation's Monetary base. Before I answer this, I’m going to give the readers a little background about India's Central Bank - the Reserve Bank of India (RBI), and its relationship with the Indian government.
The RBI is the banker to the central government of India. As far as state governments are concerned, per the RBI Act, the RBI can transact the banking business of a state government through an agreement with this government. All states except Sikkim have entered into agreements with the RBI and the RBI performs the role of banker to these governments as well.
Being the banker to the central government entails accepting monies and making payments on behalf of the government, carrying out exchange, remittance, clearing and other banking functions, investing surplus cash of the government over and above the minimum cash balance requirement, managing data on direct tax collections by various RBI offices, management of public debt, and giving advice to the government on policy matters.
Central Government’s Accounts with the RBI
The following accounts of the central government are maintained in all the regional offices of the RBI:
1. Central Government - Civil
2. Railway Fund
3. Post Fund
4. Telecommunication Fund
5. Defence Fund
6. Departmentalised Ministries
7. Agency Transaction Account
The Principal account of these accounts are maintained at the Central Accounts Section (CAS), RBI, Nagpur.
The central government is required to maintain a minimum daily cash balance of Rs. 10 crore with the RBI. On Fridays, March 31 (FY end) and June 30 (RBI accounting yr end), the minimum balance must be Rs. 100 crore.
Why Government Cash Balances with the Central Bank are not included in the Monetary Base
The RBI and the central government are producers of money. RBI issues all paper currency, while the government issues all coins and 1 rupee notes. Now, as we discussed in my previous post What is the Monetary Base, the monetary base is the physical currency that these producers release to the public and banks. Hence, in order to be part of the monetary base, this currency has to leave these producers and find its way to the public or banks.
This is why the government’s cash balances lying with the RBI are not part of the monetary base. They become part of the base when the government spends from these balances i.e. pays salaries to government employees or spends money on public works projects. Similarly, when we pay taxes to the government, this currency is wiped from the monetary base because it now lies in the government’s account with the RBI.
If you haven’t understood the logic, think of a producer of cars, say Maruti. When one asks, “what is the number of cars in India?”, we count the cars delivered by Maruti to its customers (these are out on the streets), but not those lying in its factory, which haven’t yet be delivered or those that have been returned for some reason. We simply don’t count the stock of product lying with a producer while counting the quantity of product out in the market. This is also why we do not include the cash lying in RBI's printing presses in the nation's monetary base.
This post ends here, but I’d encourage interested readers to read How Advance Tax Payments and Government Spending Impact System Liquidity. While I did this post earlier in the year mostly from a liquidity perspective, it’ll make more sense after reading the current post.
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