India currently compiles four monetary aggregates on the basis of the balance sheet of the banking sector in conformity with the norms of progressive liquidity: M0 (monetary base), M1 (narrow money), M2 and M3 (broad money), which are used in monetary policy making decisions. As per the definition, M0 is the monetary base and its components can never change. M3 (broad money), is defined as the total stock of money (paper notes, coins and demand deposits of bank) in circulation which is held by the public and this measurement needs to change in line with emerging trends.

In the post demonetization period, the digital money (pre-paid instruments) has got a push and reached Rs 21,509 crore in May. Simultaneously, there has been a massive surge in UPI payments and it has touched Rs 41 lakh crore in FY21. During Apr-June, FY22, the amount of UPI transactions has touched Rs 15.32 lakh crore, with 7.9 lakh transactions, says a report prepared by the SBI economists.

Empirical literature suggests that in China during 1990 to 2010 there is robust evidence that electronic money had a negative impact on M0 but a positive impact on M3. Given the significant surge in retail digital transactions in India, it is imperative that measures of monetary aggregates like M3 by RBI incorporate such digital transactions going forward otherwise it might distort the understanding of movements in derived ratios like money multiplier that are important to contemplate impact of monetary aggregates on prices and output.

For example, our empirical analysis for the post-demonetization period to understand the impact of retail digital transactions (RDT) on M0, M3 and money multiplier (MM) suggests that increase in digital transactions has had a negative impact on M0 and money multiplier even though their value is larger than earlier, and a positive impact on M3. Our estimate of MM is also much higher than existing MM, though it shows the same trend. We thus clearly believe that such an increase in digital transactions has played a critical role in the declining trend in money multiplier, even though the overall measure of M3 has been expanded. In particular, there has been a substitution from currency and much of it has gravitated towards digital mode of payments. The increased use of digital money/pre-paid instruments (especially m-wallets) has changed the composition of both reserve money as well as monetary base and has further impacted central bank's control of money supply.

"Interestingly, the use of digital currency by RBI will not impact M3 as central bank liability will be swapped with digital currency assuming there is 1-1 conversion. If the currency is issued on decentralised blockchain, outside the fiat system it is purely supply of high-powered money that drives money supply of crypto. As, M3 = H0 + bank credit, unless crypto creates credit and is fungible for fiat, M3 will not be impacted in theory," says Dr Soumya Kanti Ghosh, chief economic advisor, SBI group. In the coming policy, we expect RBI to hold the rates. However, the RBI forward guidance should clearly lay down the contours of current inflation trajectory by flagging the dangers of fuel prices on which government has a control and clearly elucidate that inflation is unlikely to make a downward movement until and unless the fuel prices are rationalized! The RBI has done its bit, its over to government now.