MONEY AND CREDIT, 1858–1947

MONEY AND CREDIT, 1858–1947 The singularity of India's monetary experience derives from the fact that India witnessed practically every type of monetary regime, passing successively from a silver standard to a managed inconvertible silver currency, then almost fortuitously to the gold exchange standard; subsequently to a paper standard, a gold bullion standard, and after 1931 to a sterling exchange standard. Also, India moved from a fixed fiduciary to a proportional reserve system without ever adopting the 100 percent reserve Currency Board system of the British colonies. There were no less than six high-powered official commissions of inquiry between 1893 and 1931, a number unmatched by any other country.

Monetary Standard

The major issues, which related to the exchange rate of the Indian rupee and the size and composition of India's currency cover, were hotly debated between the principal interest groups, namely, the British business community in India, the government of India, and the India Office in London under the secretary of state for India, and Indian public opinion, which was fractured by the rivalries between the regional financial centers, Calcutta, Bombay, and Madras.

The recent history of Indian currency falls into well-defined periods from 1835, when the silver rupee of 180 troy 11/12th fine was declared the sole legal tender. India was on a monometallic silver standard from 1835 to 1893, and a paper currency reserve with a maximum of 40 million rupees (Rs.) in government securities, the rest in silver coin and bullion, with provision for the inclusion of gold coin and bullion up to 25 percent. The period from 1893 to 1898 was one of transition because of the depreciation of the silver rupee, whose gold value had remained at fell from about 2s. since 1871, fell to 1s. (shilling) 2d. (pence) in 1892, precipitating the amendment of the Indian Coinage Act of 1879 and the Indian Paper Currency Act of 1882, following the recommendations of the 1892 Herschell Committee. The subsequent improvisations, following the recommendations of the Fowler Committee (1898) and the Act of 1899, resulted in an effective gold exchange standard, which was more economical than a gold standard and ensured practically

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all the advantages of a gold currency. Nevertheless, proposals for gold coinage and a gold mint led to the appointment in 1913 of the Royal Commission, which broadly endorsed the existing standard. The extraordinary rise in the price of silver to about 89d. per ounce in February 1920 made it extremely difficult to maintain exchange stability. The British government therefore decided to raise the exchange rate in accordance with the silver price and appointed yet another committee in 1919 to make recommendations for a stable gold-exchange standard. Its report recommended stabilization of the rupee at 2s. gold, with a fixed exchange value for the rupee in terms of gold at 11.30016 g of fine gold. But the effort to maintain the rupee at 2s. gold failed, and with the return of sterling to gold in 1925 the rupee exchange rate fell back to 1s. 6d.

In 1926 the Hilton-Young Commission recommended: the creation of a gold bullion standard; an exchange rate of 1s. 6d. for the rupee; amalgamation of India's paper currency and gold standard reserves; and the creation of a central bank. Thus, the Currency Act of 1927 established a gold-bullion-and-sterling currency. But the rupee ratio of 1s. 6d., rather than a fairer 1s. 4d., provoked Indian public opinion and led to the heated ratio controversy in the following period (1927–1939). Following the British home government's decision to abandon the gold standard, the rupee was linked to sterling from 24 September 1931. The unchanged rupee-sterling ratio, however, led to a depreciation of the rupee in terms of gold and a rise in the price of gold in terms of rupees, which led to India's massive exports of gold over the next decade, a dramatic reversal of India's previous role as a perennial magnet for gold.

Commercial Banking

Since before 1860 there was no legal provision in India for limited liability, virtually all banks were started on the basis of unlimited liability, and until the Indian

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Companies Act (1913), which contained a few sections relating to joint-stock banks, there was no special legislation dealing with commercial banking. The amended Indian Companies Act of 1936 added many provisions relating to minimum capital, cash reserve requirements, and other operating conditions, but there was still no integrated statutory regulation of commercial banks in India until 1949. The main constituents of modern banking were: the quasi-official Presidency Banks of Bengal, Bombay, and Madras, which were amalgamated in 1921 into the Imperial Bank of India; the foreign-owned exchange banks; and the Indian joint stock banks, which played a marginal role in foreign exchange business and rural credit and specialized largely in short-term urban credit against conventional collateral. Bank failures occurred mostly because of individual imprudence and mismanagement and occurred in years when the system as a whole did not experience any exceptional stress; the failure rate was much higher among foreign-owned exchange banks.

Central Banking

The Royal Commission on Indian Finance and Currency (1913–1914) requested one of its members, J. M. Keynes, to prepare a scheme for a central Indian bank. It is particularly noteworthy that Keynes exhorted the framers of the Indian central bank's constitution to "put far from their minds all thoughts of the Bank of England" and to look to the state banks, especially those of Germany, or perhaps of Holland, for the "proper model." Ironically, when India did establish the Reserve Bank of India, it was modeled on the Bank of England under the influence of the then governor of the Bank of England, Montagu Norman. What finally emerged was the amalgamation of the three Presidency Banks into the Imperial Bank of India in 1921, as a commercial bank, but with the functions of banker to the government and manager of the public debt. Although there was no statutory provision, major commercial banks kept the bulk of their cash balances with the Imperial Bank, which also granted them liquidity credit and managed the clearing houses. But the note issue and foreign exchange were entrusted to the Finance Department of the government of India, until the Royal Commission on Indian Currency and Finance (1926) strongly recommended the creation of a full-fledged central bank, to be called the Reserve Bank of India.

The Reserve Bank of India was inaugurated on 1 April 1935, with a share capital of Rs. 50 million, divided into 500,000 fully paid-up shares of Rs. 100 each, subject to a maximum dividend of 6 percent. The first Indian Governor was C. D. Deshmukh, who assumed office in 1943.

The Reserve Bank of India in its initial phase had limited monetary powers. It was unable to activate the bank rate until about 1951, and its open market operations were largely net purchases in a narrow market. In its formative years (1935–1939), the Reserve Bank, in addition to promoting agricultural credit and acting as India's lender of last resort, was better able to coordinate the different segments of the money market, which resulted in a narrowing of seasonal and regional differentials in interest rates. The wartime phase (1939–1945) of the Reserve Bank was most notable for its well designed government borrowing program and the innovative technique of open market gold sales as an anti-inflationary device.

Anand Chandavarkar

See alsoBalance of Payments ; Fiscal System and Policy from 1858 to 1947

BIBLIOGRAPHY

The following government reports are the basic primary sources useful alike for their evidence, analysis, and findings: India Currency (Herschell) Committee (1893); Indian Currency (Fowler) Committee (1898); Royal Commission (Chamberlain) on Indian Currency and Finance (1913–1914); Committee (Babington-Smith) on Indian Currency and Exchange (1919); Royal Commission (Hilton-Young) on Indian Currency and Finance (1926); Indian Central Banking Enquiry Committee (1931).

The primary statistical source is the Banking and Monetary Statistics of India, Reserve Bank of India, Bombay, 1954. A fascinating insider's account is Central Banking in India (A Retrospect) by Sir Chintaman D. Deshmukh, Poona: Gokhale Institute of Economics and Politics, 1948. A classic on the reform of the rupee and the pioneering case for a state bank for India is J. M. Keynes, Indian Currency and Finance, Collected Writings, vol. 1, London: Macmillan, 1971.