The Measures of Money Supply in India

The four traditional aggregates, M1 to M4

From the Reserve Bank's own guide. These are the four every examiner asks for.

The ordering trap, and it is the commonest error in this topic. M2 is not contained in M3, and M3 is not built on M2. M2 adds post office savings deposits to M1; M3 adds time deposits with banks to M1. They are two different extensions of the same base, and only M4, which adds total post office deposits to M3, brings the two lines together. A student who writes that each is simply the previous one plus something has got M2 and M3 the wrong way round.

Currency with the public, from the same guide: currency in circulation minus cash with banks, currency in circulation comprising notes and rupee and small coins.

What the aggregates represent, in the guide's own words: the monetary liability of the money creating sectors, namely the Reserve Bank and commercial and co-operative banks, to the money using sectors within the country, referred to as the public. Data are presented as outstanding on 31 March or on the last reporting Friday of the month.

The new monetary aggregates, NM1 to NM3

Their origin. The Working Group on Money Supply: Analytics and Methodology of Compilation, chaired by Dr Y. V. Reddy, reported in June 1998. The acronyms NM1, NM2 and NM3 distinguish the new aggregates from the existing ones.

The two innovations, and both are examinable.

1. The residency concept. NM2 and NM3 are compiled on residency, so they do not directly reckon non resident foreign currency repatriable fixed deposits, that is FCNR(B) deposits, Resurgent India Bonds and India Millennium Deposits. The reasoning is that money held by non residents in foreign currency is not purchasing power over Indian goods in the same sense as a resident's deposit.
2. The maturity split. Time deposits are divided at one year into short term and long term, so that NM2 measures something closer to spendable purchasing power than the older M3 did, which lumped all time deposits together.

The liquidity aggregates, L1 to L3

These go beyond the banking system altogether, to institutions that hold savings but do not create money.

Frequency, which the guide states and which is worth a mark: L1 and L2 are compiled monthly and L3 quarterly.

The sources side

Every aggregate can be measured two ways: by adding up its components, which is what everything above does, or by adding up its sources, which is where the money came from. The two must give the same total.

Sources of broad money, as the Economic Survey 2025-26 sets them out:

M3 = Net bank credit to Government + Bank credit to the commercial sector + Net foreign exchange assets of the banking sector + Government's currency liabilities to the public minus Net non monetary liabilities of the banking sector

Why the sources side matters more than it looks. It says what caused the money supply to change. If M3 rose because bank credit to the commercial sector rose, the economy is being financed. If it rose because net bank credit to the Government rose, the deficit is being financed. If it rose because foreign exchange assets rose, capital is flowing in. The same increase in the total means three different things, and only the sources side distinguishes them. The Survey uses it exactly so: broad money grew 12.1 per cent in the year to 31 December 2025 against 9 per cent a year earlier, and it identifies bank credit to the commercial sector, growing 14.1 per cent, as a major contributor, with aggregate deposits with banks, the largest component of M3, growing 12.3 per cent.

The current picture, with its dates

All from the Economic Survey 2025-26, as at 31 December 2025 unless stated.

A worked example: classifying seven assets

Say which aggregate each first enters.

The second row is the one that catches people. A note in a bank's vault is part of currency in circulation and therefore of reserve money, but it is not part of currency with the public, because the public cannot spend it. The definition in the guide is explicit: currency with the public equals currency in circulation minus cash with banks.

What beginners get wrong

"M2 is M1 plus time deposits." No. M2 is M1 plus post office savings deposits. M3 is M1 plus time deposits with the banking system.

"The aggregates are each the previous one plus something." True of M1 to M2, of M1 to M3 and of M3 to M4, but M2 and M3 are two separate extensions of M1 and neither contains the other.

"M0 is part of M1." Reserve money is a different construct: it is the Bank's own monetary liability, including bankers' deposits with it, which are not part of anybody's spendable money. Currency in circulation appears in both, but bankers' deposits appear only in M0.

"NM3 replaced M3." Both are published. The new aggregates supplement rather than replace, and the Survey continues to report M0 and M3.

"Falling reserve money means tight money." Not necessarily. The Survey's own example is 2.9 per cent headline against 9.4 per cent adjusted for the cash reserve ratio cut.

Limits and criticism

The boundary is arbitrary. Whether a particular deposit is money depends on how easily it can be spent, and payment technology keeps changing that. Instant transfer from accounts that are not bank deposits did not exist when these categories were designed.

Aggregates say nothing about distribution. A given M3 is consistent with very different distributions of purchasing power.

Velocity is unstable, so a given money supply does not map onto a given price level, which is why the Reserve Bank targets inflation rather than a money aggregate. The aggregates are monitored, not targeted, and that distinction should be made in any answer that mentions the quantity theory.

Data are on reporting Fridays, so a figure is a snapshot on a particular day and can be affected by what happened that week.

Quick revision

1. The measures are cumulative, adding successively less liquid assets.
2. M0, reserve money = currency in circulation + bankers' deposits with the RBI + other deposits with the RBI. Also called high powered money. Section 42(1) of the RBI Act is the basis of the cash reserve ratio component, cut to 3.0 per cent by November 2025.
3. M1 (narrow money) = currency with the public + demand deposits with the banking system + 'other' deposits with the RBI.
4. M2 = M1 + post office savings deposits.
5. M3 (broad money) = M1 + time deposits with the banking system.
6. M4 = M3 + total post office deposits.
7. M2 and M3 are two different extensions of M1, and neither is contained in the other.
8. Currency with the public = currency in circulation minus cash with banks.
9. NM1, NM2, NM3, from the Working Group on Money Supply chaired by Dr Y. V. Reddy, June 1998. NM2 adds short term resident time deposits up to one year; NM3 adds long term resident time deposits and call and term funding from financial institutions. Based on the residency concept, so FCNR(B) deposits, Resurgent India Bonds and India Millennium Deposits are not directly reckoned.
10. L1 = NM3 + post office total deposits; L2 = L1 + term deposits with term lending and refinancing institutions; L3 = L2 + public deposits with non banking financial companies. L1 and L2 monthly, L3 quarterly.
11. Sources of M3 = net bank credit to Government + bank credit to the commercial sector + net foreign exchange assets of the banking sector + Government's currency liabilities to the public minus net non monetary liabilities of the banking sector.
12. As at 31 December 2025: M0 growth 2.9 per cent, adjusted 9.4 per cent; M3 growth 12.1 per cent; deposits 12.3 per cent; credit to the commercial sector 14.1 per cent; multiplier 6.21 against 5.70.

Test yourself

1. Define the four traditional measures of money supply in India. M1, called narrow money, is currency with the public plus demand deposits with the banking system plus other deposits with the Reserve Bank. M2 is M1 plus post office savings deposits. M3, called broad money, is M1 plus time deposits with the banking system. M4 is M3 plus total post office deposits. It is important to note that M2 and M3 are two different extensions of M1 rather than successive steps, since M2 adds post office savings deposits while M3 adds time deposits with banks, and the two lines are brought together only at M4. Currency with the public is itself defined as currency in circulation minus cash held with banks.

2. What is reserve money, why is it called high powered, and what are its components? Reserve money, denoted M0, is the monetary liability created by the Reserve Bank itself, comprising currency in circulation, bankers' deposits with the Reserve Bank and other deposits with the Reserve Bank. It is called high powered money because a rupee of it supports several rupees of broad money: banks hold it as reserves and lend a multiple of it, so that the money supply is a multiple of the base. The Economic Survey 2025-26 records the money multiplier, defined as the ratio of M3 to M0, at 6.21 as at 31 December 2025 against 5.70 a year earlier, and at 6.0 when adjusted for balances under the standing deposit facility. Bankers' deposits with the Bank arise substantially from section 42(1) of the Reserve Bank of India Act, which requires every scheduled bank to maintain with the Bank an average daily balance at a notified percentage of its net demand and time liabilities.

3. What are the new monetary aggregates, and what two innovations did they introduce? NM1, NM2 and NM3 were recommended by the Working Group on Money Supply: Analytics and Methodology of Compilation, chaired by Dr Y. V. Reddy, which reported in June 1998. NM1 is currency with the public plus demand deposits with the banking system plus other deposits with the Reserve Bank. NM2 is NM1 plus short term time deposits of residents, including those up to a contractual maturity of one year. NM3 is NM2 plus long term time deposits of residents plus call and term funding from financial institutions. The two innovations are, first, the residency concept, so that NM2 and NM3 do not directly reckon non resident foreign currency repatriable fixed deposits such as FCNR(B) deposits, Resurgent India Bonds and India Millennium Deposits, on the reasoning that these are not purchasing power over Indian goods in the same sense; and second, the division of time deposits at one year of contractual maturity into short term and long term, so that the aggregate distinguishes deposits that are close to spendable from those that are not.

4. What are the liquidity aggregates and how often are they compiled? L1 is NM3 plus total post office deposits. L2 is L1 plus term deposits with term lending institutions and refinancing institutions. L3 is L2 plus public deposits with non banking financial companies. They extend the measurement beyond the banking system to institutions that hold the public's savings without creating money, and they are therefore measures of liquidity available in the economy rather than of money in the strict sense. L1 and L2 are compiled monthly and L3 quarterly.

5. What does the sources side of the money supply show, and why does it matter? The sources side records where the money came from: broad money equals net bank credit to the Government, plus bank credit to the commercial sector, plus net foreign exchange assets of the banking sector, plus the Government's currency liabilities to the public, minus the net non monetary liabilities of the banking sector. It matters because the same increase in the total can mean quite different things. An increase driven by bank credit to the commercial sector means the productive economy is being financed; one driven by net bank credit to the Government means the fiscal deficit is being financed by the banking system; and one driven by foreign exchange assets means capital is flowing in from abroad. Only the sources side distinguishes among them, which is why the Economic Survey 2025-26, in recording broad money growth of 12.1 per cent to 31 December 2025, identifies bank credit to the commercial sector, growing at 14.1 per cent, as a major contributor.

6. Reserve money grew by only 2.9 per cent in the year to 31 December 2025. Does that show that monetary policy was tight? No, and the Economic Survey addresses the point directly. The cash reserve ratio was reduced by a hundred basis points to 3.0 per cent of net demand and time liabilities in stages between September and November 2025. Since bankers' deposits with the Reserve Bank are a component of reserve money, a cut in the ratio mechanically reduces those deposits and therefore reduces measured reserve money, whatever the stance of policy. Adjusted for that first round effect, reserve money growth stood at 9.4 per cent against 6.2 per cent a year earlier, and the Survey states that the adjusted figure reflects the true expansionary stance. The episode illustrates a general caution: a raw monetary aggregate can move for accounting reasons unconnected with policy, and the composition must be examined before the movement is interpreted.