The strange problem of too much money.

"The liquidity bulge in the banking sector is keeping all stakeholders busy," wrote Ghosh and Samanta. After the sudden banning of Rs 1,000 and Rs 500 notes on 8 November, known as demonetisation, people rushed to deposit all their old currencies into their bank accounts, leading to banks receiving near Rs 15 trillion in deposits. Surely this is good news for banks, especially public sector ones, which are struggling under massive bad loans, in excess of Rs 6 trillion. All this money belongs to the people and maybe withdrawn at a later date but till then banks will have plenty of capital to lend to businesses, to increase their earnings. But apparently too much money is also a problem for banks. Last year India received $56 billion, or Rs 3.64 trillion, in foreign direct investment. Foreign portfolio investment was Rs 228 billion in April, most of it in government debt, because of a hardening of yields. In March FPIs poured in Rs 569 billion for a total of Rs 914 billion, or $14 billion, this year. With so much money sloshing around yields should be coming down but they are rising. Why? Apparently, excess of money will cause inflation to rise, so the Reserve Bank has kept interest rate at 6.25% and signaled that it may raise rates later if necessary. With all the foreign exchange coming into India the rupee has become stronger. A strong rupee reduces the cost of imports, especially oil, and so reduces inflation, so it should be a good thing. But a strong rupee also makes exports more expensive and could be a drag on export growth just as the International Monetary Fund is predicting that the global economy will grow by 3.5%, compared to 3.1% in 2016. The rupee appreciated by 11% against the dollar in 2008 and has gone up by 4.5% in the last quarter, this year, wrote Aparna Iyer. Normally the RBI would buy up dollars from the market to prevent the rupee from becoming too strong but now its hands are tied because of the excess money already in the system. So what can it do? "To address the urgent need for sterilization of the abnormal surge of liquidity, the market stabilization scheme (MSS) limit was hiked to Rs 6 trillion. Under MSS, issuance of cash-management bills (CMBs) absorbed entire frictional liquidity, but elevated short-term rates. Besides putting pressure on government finances in the form of higher interest expense, this move substantially reduced demand for long-dated bonds thereby creating the effect of partially crowding out debt-burdened private sector," wrote Ghosh and Samanta. That means, what the RBI does to absorb the excess money in the banks will raise sort term interest rates and reduce lending to the private sector. Which means that banks will be sitting on massive piles of cash with nowhere to invest it. What a conundrum.