Indian Currency and Finance by John Maynard Keynes is part of HackerNoon’s Book Blog Post series. You can jump to any chapter in this book here. Chapter V: Council Bills and Remittance
1. Remittance by means of what are termed Council Bills is a feature peculiar to the Indian system, and is not, so far as I know, to be paralleled elsewhere. It arises partly from the historical circumstance that the Government of India is the successor of a trading company, partly from the necessity under which the Government lies of making very large annual remittances to England.
2. The Home Charges, that is, the payments which the Government of India must make in England, for interest on debt, pensions, payments to the War Office, Government stores (not chargeable to capital), etc., amount to £19,000,000 or £20,000,000 annually. But the amount which it is necessary to remit, apart from extraordinary remittances to be dealt with later, is usually less than this; for the amount of new capital raised by Government in England usually exceeds their capital expenditure in this country on repayments and on railway materials, etc. Thus the amount which it is necessary to remit to England annually is from £15,000,000 to £18,000,000. Rupees to this amount, being part of the revenue from taxation, etc., accumulate in the Indian Treasuries. This value is remitted to England by selling for sterling in London bills which can be cashed in rupees in Calcutta. Thus the Government of India pays out rupees in Calcutta when the bills are presented, and the Secretary of State’s balances at the Bank of England are swelled by a corresponding amount.
The Government is, therefore, one of the largest dealers in foreign exchange, and does for itself business, which Colonial Governments, for example, who have a certain amount of similar transactions to carry through (though on a far smaller scale), would do through a bank. But while the Government saves for itself the commission which it would otherwise have to pay to a bank, it is not, in any real sense, a competitor with the banks for business. In the first place, it sells exchange, save in exceptional circumstances, in one direction only. And in the second place, the Secretary of State’s method of selling exchange results in his dealing exclusively with the Exchange Banks and financial houses, and not directly with the trading public. The Secretary of State is in effect the ultimate source of supply for bills on India, and the banks, after securing what private bills are available, even up their demands for remittance to India by buying bills from him,—provided he is selling them at a rate which makes this form of remittance cheaper than the alternative one of sending sovereigns. The method by which these bills are sold is as follows.
3. The bills are offered in London for tender at the Bank of England every Wednesday morning, the Secretary of State for India in Council (or, for short, the India Council, whence the name Council Bills) having previously announced the amount (70 lakhs, say) for which tenders are invited. There is a reserve price (not published) below which he will not sell, but this reserve price is seldom operative. The tenders name the amount tendered for and the number of pence per rupee which is offered. The total amount of 70 lakhs is then allotted to the highest bidders, the allotment at the minimum rate accepted being proportionate to the amount applied for at that rate.
If the demand is large and the minimum rate of allotment high (say 1s. 43/32d.), the amount offered for tender the following week (which is announced at the same time as the result of the previous allotment) is likely to be increased. In the interval between the allotments on successive Wednesdays, the Secretary of State is usually willing to sell what are known as “specials” at a rate 1/32d. higher than the highest rate of allotment on the preceding Wednesday.
4. It should be added that cash must be paid for the bills in London as soon as they are allotted; but, on account of the time taken by the mail, they cannot be changed into rupees at Calcutta for about a fortnight. A fortnight’s interest is therefore lost, and it is worth paying extra to obtain what are called “telegraphic transfers,” by means of which rupees can be obtained at Calcutta almost as soon as the sovereigns are paid into the Secretary of State’s account at the Bank of England.
The Secretary of State, therefore, is usually willing to sell telegraphic transfers at a rate 1/32d. per rupee higher than the rate for bills. If the purchaser chooses transfers, the effect to him is that he gets his rupees a fortnight earlier in India and pays for this privilege a sum equal to 5 per cent on the money for a fortnight. The question, whether it is worth the purchaser’s while to pay this extra sum, chiefly depends upon the Indian bank rate, because this governs the amount of interest which can be gained by having the money immediately available in India. It may happen, of course, that a particular bank may have a special urgency for funds in India, or that the rate for fortnightly loans does not closely agree with the bank rate. Generally speaking, however, if the purchaser can lend money out at no higher rate than 3 per cent in India, he will certainly prefer bills; but if he can lend at 7 per cent in India, it will be more profitable for him to buy transfers.
Experience accords with these expectations. When the Indian bank rate is high and the difference of 1/32d. between the two prices is in force, the demand is almost entirely for transfers. This is convenient to bankers, and, if he has the rupees waiting in India, profitable to the Secretary of State.
5. The bills and transfers are made payable at the option of the purchaser at Calcutta, Bombay, or Madras. The amount drawn on Madras is relatively small, and Calcutta comes first, with about 45 per cent of the whole.
6. Up to 1900 the volume of sales of Council Bills in any year was mainly governed by the amount required to defray the Home Charges, this amount partly depending on the volume of capital borrowings in the year. But the sales also fluctuated, though within comparatively narrow limits in most years, according to the Secretary of State’s opportunities (depending on the activity of business and the balance of trade) of selling his bills at a satisfactory rate. Since 1900, however, the functions of the Council Bill system have been enlarged, and it has now become a very important part of the general mechanism for the maintenance of the Gold Exchange Standard.
7. The way in which this has arisen is easily explained. On account of the provision by which rupees can always be obtained in India in exchange for sovereigns at the rate of 1s. 4d. per rupee, it can never be worth while for the banks to buy Council Bills at a price which exceeds 1s. 4d. by more than the cost of sending gold to India. This cost varies considerably from time to time, but it seldom exceeds ⅛d. If, therefore, the Secretary of State refuses to sell bills at less than 1s. 4⅛d., when the banks are requiring to remit to India, gold will flow. This gold will be presented at the Treasuries in India to be exchanged for rupees or notes. Thus the only effect of the Secretary of State’s refusing to sell remittances at a price which suits the banks is that sterling resources accumulate in his Treasuries in India instead of in England. This may not be convenient to him. For example, if the banks are sending gold to India on a large scale and are exchanging it for rupees, a time may come when this demand can only be met by minting more rupees; the silver for this must be purchased in London and the profit on the coinage must be credited to the Gold Standard Reserve which, for reasons to be discussed in the next chapter, is kept for the most part in London; thus the gold has eventually to be shipped back again to England to pay for the silver and to be credited to the Gold Standard Reserve. In this case a double loss is involved—the cost of sending the gold to India (for the Secretary of State could probably have got 1s. 4⅛d. per rupee if he had sold transfers, whereas if gold flows he gets only 1s. 4d.) and the cost of bringing it back again, say, 3/32d.; thus a refusal to sell bills would mean an eventual loss of nearly ¼d. per rupee or about 1½ per cent. Or, again, the policy of holding some part of the gold in the Currency Reserve in London for possible use in emergency, may lead to the Secretary of State’s preferring gold to accumulate in London rather than in India; otherwise it will have to be sent back again, in pursuance of this policy, and a double loss incurred, as in the former case. Lastly, if the Secretary of State has considerable cash balances in India, it may be worth his while for a time to cash additional Council Bills out of these, thus in effect transferring his balances to London. The reasons that may make him inclined to do this are, first, that to increase the proportion of his cash balances held in sterling puts him in a stronger position in a case of emergency; second, that selling Council Bills at a good price now will enable him to meet the Home Charges later on when he might not be able to sell his Bills at so good a price (in this case the transference of cash balances from India to London is only temporary); third, that it may put him in a stronger position for carrying out impending loan transactions at the most favourable moment; and fourth, that cash balances held in London can be made to earn a small rate of interest.
All these considerations being taken into account, it can only be worth the Secretary of State’s while to refuse to sell bills within the gold export price, when he deliberately wishes either to increase his cash balances in India at the expense of his balances in London, or to replenish that part of the gold portion of the Currency Reserve which is kept in India.
Thus he will endeavour to make as certain as possible of selling within the year the amount budgeted for (i.e., the Home Charges adjusted with reference to the probable capital transactions of the year and the state of the cash balances); but he will sell more than this if the demand for remittance is so great that, on his refusal to sell, the price of remittance will rise to the gold export point In the words of the annual budget, “the estimate of Council drawings is for the amount necessary to provide for the Secretary of State’s requirements, but additional bills will be sold if needed to meet the demands of trade.”
8. Let us sum up the argument so far, and enforce at the same time the contention, brought up at the end of Chapter I., that the volume of currency circulating in India does not depend, as some critics have maintained, on the caprice of the India Office in the amount of Council Bills that it offers for sale. So far as Council Bills are sold for the ordinary purposes of remittance of Government funds from India to London, they are cashed in India out of the general balances of Government. But when they are sold in larger quantities, to obviate the necessity of sovereigns being sent, sufficient rupees are not forthcoming from this source. One expedient is to pay out some of the rupees in the Paper Currency Reserve or in the silver branch of the Gold Standard Reserve, and to pay an equivalent sum into the branches of these reserves which are held in London, “earmarked” at the Bank of England, or in other sterling forms. If, on the other hand, the India Council had refused to sell bills freely, gold would have been exported to India, taken to the Paper Currency Department, and exchanged for rupees in notes or silver. In either case there is a similar increase in the volume of currency in India not held by the Government. The volume of currency which finds its way into circulation in India is, therefore, quite independent of the Secretary of State’s action. Exceptional amounts of Council Bills are only sold when exchange has reached a point at which it is nearly as profitable to remit gold; and if Council Bills were not sold sovereigns would go instead (the expense of sending them being lost), for which the Government of India would have to give rupees in exchange. This point is important, for it is often assumed in controversy regarding the currency and its relation to prices that the issue of rupees into circulation depends in some way upon the amount of Council Bills sold by the Government, and can, therefore, be expanded or contracted by them at will, according to the policy of the moment. Broadly speaking, this is false. Even if the Government were to hasten the flow of rupees into circulation by selling an exceptional quantity of bills at a relatively low rate (which would be equivalent to lowering by a fraction of a penny the normal value of the rupee as measured in sterling), and were to pursue this policy over a long period, the permanent effect could be no more than in proportion to the amount by which they had thus lowered the par value of the rupee in terms of sterling. This is the amount of their conceivable executive power, if the Government were to exercise it. In fact, it has not been exercised.
If, however, the stock of rupees in the reserves is running low (for a considerable quantity of rupees must always be kept there in order to ensure the ready convertibility of the notes in terms of rupees), and more Council Bills are sold in London than can be conveniently cashed in Calcutta in the above ways, more rupees must be issued from the Mint. The silver out of which they are minted is purchased in England out of the proceeds of selling the additional Council Bills, and the surplus due to the fact that rupees are worth more than the silver they contain, is credited to the Gold Standard Reserve. According to the present practice the process in these circumstances also is, therefore, automatic, and the amount of new rupees put into circulation does not depend on the arbitrary action of the Secretary of State in selling or withholding Council Bills. If he did not sell bills, sovereigns would be sent to India, new rupees would have to be coined to meet the obligation under which the Government of India has placed itself of giving rupees in exchange for sovereigns on demand, and a great part of the sovereigns would have to be credited in some form or other to the Gold Standard Reserve or shipped back to England again to pay for the silver.
It is true that, if a different practice were adopted (a practice which was adopted in part in 1907), and if the profits on the coinage of rupees, instead of being credited to the Gold Standard Reserve, were turned into rupees and spent by the Government in India on goods and services (whether for capital or any other purpose), more rupees would be in circulation for the time being than would have been the case otherwise. But even in this case the effect on the volume of circulation must be temporary, so long as the provisions for the maintenance of the rupee at 1s. 4d. are in operation. For this additional issue of rupees would, eventually, have the effect of delaying additional demands for coinage in the future or of precipitating an occasion for the withdrawal of rupees from circulation.
While, therefore, it is to a certain extent within the power of Government (though not at present according to their usual practice) to urge a certain number of rupees into circulation more rapidly than is necessary, they cannot permanently increase the circulation without depreciating its gold value, that is, they cannot permanently increase the circulation beyond what it would otherwise be and at the same time maintain the rupee at 1s. 4d. It may be added that a release of rupees from any other reserve, or even a temporary increase in the amount of capital funds annually raised by Government abroad for use in India, would have a similar effect to the release of rupees from the Gold Standard Reserve. But, however all this might be, at present the Government of India do not, in fact, exert such discretionary powers as they possess for affecting, even temporarily, the volume of circulation.
9. I have said that the cost of sending gold to India does not generally exceed ⅛d. per rupee. The Secretary of State has, therefore, a standing notification (since January 1904) that he will sell bills at 1s. 4⅛d. Up to January 1900 he undertook to sell telegraphic transfers at 1s. 45/32d. without limit of quantity, and since that time he has usually been willing to do so. The cost of sending gold to India depends, however, on complex causes, varying considerably from time to time, and is often a good deal less than ⅛d. It is not easy, therefore, for the Secretary of State to know at exactly what price gold will become a serious competitor of bills as a means of remittance; and not infrequently Council Bills are, unintentionally, at a price which makes it cheaper to send gold. It will be interesting to consider briefly the kinds of causes which influence the gold import point.
10. The expense of remitting gold from one country to another is made up of insurance, freight, and loss of interest. Even the first item is sometimes capable of variation. For example, after the recent robbery of sovereigns in transit from London to Alexandria, the ordinary rate quoted on gold, consigned by the route (Bremen and Trieste) by which the stolen gold had been sent, was doubled, rising from 1s. 3d. to 2s. 6d. per cent. Again, on one recent occasion, it was stated that more gold would have been shipped if it had not been for the fact that the mail–boat was already carrying a million and a half sterling in gold and silver, the underwriters requiring a higher premium than usual if they were to insure a larger sum than this on a single voyage. But if it is a matter of shipping sovereigns from England the variations in the cost of insurance and freight are relatively small. The main part of variation in the gold point arises either out of the possibility of getting sovereigns from other sources, or from variations in the rate of interest.
These other sources are either sovereigns in transit from Australia or sovereigns ready for export from Egypt. As India lies between Australia and England, it is naturally cheaper (mainly on account of the smaller loss of interest) to send sovereigns from Australia to India than from Australia to England. Let us suppose that the state of the Australian exchanges is such that it pays to remit sovereigns from Australia to London anyhow, and assume, for the sake of simplicity (and without, in fact, any substantial sacrifice of truth), that the cost of freight and insurance from Australia to London is the same as from Australia to India. Now if, when the Australian sovereigns are off India, the bank which is remitting them can receive cash in London against their delivery in India, it will get its money at least a fortnight sooner, and will probably accept, therefore, about 1s. 331/32d. in London for 1s. 4d. delivered in India (1/32d. being the interest on 1s. 4d. for a fortnight at 5 per cent per annum). Gold bought in this way for immediate delivery in India is as good as a telegraphic transfer, i.e., is worth 1/32d. per rupee more than Council Bills. If, therefore, Council Bills are at a price in excess of 1s. 315/16d., gold about to be shipped from Australia competes with them as a means of remittance to India. Normally, of course, an Australian bank is able to get more than 1s. 315/16d. for gold delivered in India. I mean only that the Secretary of State cannot hope to undercut Australian gold, when it is available for export in large quantities, unless he is prepared to put down his price for Council Bills to this level. If, in these circumstances, he wants the gold in England rather than in India, his cheapest course, therefore, is to buy the gold in transit himself for delivery in England, selling for it telegraphic transfers at a suitable rate. This was done on a large scale in 1905–6 and 1906–7.
Surplus gold from Egypt is not capable of undercutting Council Bills so seriously as surplus gold from Australia; for in this case it is Egypt which lies between. If we assume, for the sake of precise illustration, that the cost of sending gold from Egypt to London is nearly the same as that of sending it from Egypt to India, an Egyptian bank, about to ship sovereigns in any case, will take any price in excess of 1s. 4d. paid in London for the delivery in India of the value in gold of a rupee. This is the extreme case. If Council Bills are at a higher rate than 1s. 4d., say at 1s. 41/16d., the Alexandrian exchanges may be at a level which makes it profitable to ship gold from Egypt to India for payment in London, when it is not profitable to ship gold from Egypt to London. If we still make the above illustrative (but not exactly accurate) assumption, when Council Bills are at about 1s. 4–1/16d. and the Alexandrian exchange on London below par, Egyptian gold competes with Councils as a means of remittance to India. Of course the supply of remittance from this source is usually somewhat limited; when some Egyptian gold has flowed away to India under the influence of the above conditions, this is likely to have the effect of strengthening the Alexandrian exchange, and therefore, by modifying the conditions, of making the continuance of a flow less likely. The Egyptian gold is of great practical importance, because the busy season in Egypt comes rather earlier than the busy season in India, so that in the winter months the gold which has served the purpose of moving the crops in Egypt can be sent on to be changed into rupees which are to serve the same purpose in India. Of the gold, therefore, which flows from London to Egypt every autumn, very little finds its way back again to London; what is not kept by the cultivators in Egypt travels on in due course to India. The precise moment at which this movement takes place and its extent depend, as we have seen above, on the rate at which Council Bills are being sold in London, and also upon whether the Egyptian cotton crop is dealt with late or early. But when towards the end of their busy season the Egyptian banks find themselves with more gold than they need, Council Bills must be sold at a relatively low rate if the flow of this gold to India is to be prevented. The dealings between the Egyptian and the Indian banks must thus present very delicate problems of arbitrage.
It is probably within the power of the Secretary of State, if he wishes, to regulate the flow of gold direct from London to Bombay by means of the sales of Council Bills. But when gold is available in Australia or Egypt, the matter is not susceptible of such easy control.
The remaining element which determines the cost of remittance—variation in the market rate of interest—has been dealt with already, 1/32d. represents the interest on 1s. 4d. for a fortnight at 5 per cent per annum. It is easy to calculate how the gold export point is affected by fluctuations in the market rate of discount in India on either side of 5 per cent.
11. So far we have been dealing with the upper limit of exchange and with the results of a heavy demand for Council Bills. The effects at the lower limit differ in this important respect, that the Government are under no legal obligation to prevent the depreciation of the rupee, and have not undertaken to give sovereigns for rupees in the way that they have undertaken to give rupees for sovereigns. There is nothing in law, therefore, to prevent exchange from falling indefinitely. There has been no change in law in this respect since 1895, when exchange actually did fall below 1s. 1d. The Government has, however, practically pledged its word to do all in its power to prevent the depreciation of the gold value of the rupee and to prevent exchange from falling below the lower limit of 1s. 329/32d. The business community would rightly regard it as a breach of faith if the Government were to permit exchange to fall below this rate, unless all reasonable resources had been exhausted.
12. We now see how intimately the management of Council Bills and of Government remittance is bound up with the Gold–Exchange Standard. The disadvantages from the point of view of regulating a Gold–Exchange Standard, which arise out of there being no Government bank, are partly compensated by the Secretary of State’s being the largest dealer in foreign exchange. By regulating the amount of bills he offers for tender, he is able to regulate to a great extent the level of exchange. When exchange is falling below par he can support it by greatly restricting his offers; and if he cannot get at least 1s. 329/32d. for his bills, he withdraws from the market. In the meantime, of course, he has payments to make in England, while on the other hand rupees accumulate in India, as the revenue flows in and no Council Bills are presented for payment. If the cash balances in London are not sufficient to stand the drain on them, gold at the Bank of England may be “un–earmarked” and placed to the Secretary of State’s current account, rupees in India being transferred at the same time from the Government balances to the silver portion of the Paper Currency Reserve—the reverse process from that which has been described already as the result of exceptionally large sales of Council Bills.
If the Secretary of State’s withdrawal from the market and the consequent scarcity of bills on India is insufficient to support exchange at 1s. 329/32d., more drastic measures are necessary. The method adopted on the last occasion of this kind was the offer by the Government of India in Calcutta of sterling bills on London at the rate of 1s. 329/32d., these bills being cashed in London out of the Gold Standard Reserve.
These measures were sufficient during the severe crisis of 1908. Their sufficiency for the future will be discussed in Chapter VI. in dealing with the Secretary of State’s Reserves.
13. If we turn from the mechanism of remittance to the question of Government remittance as a whole, this can be explained most clearly by reference to a hypothetical India Office balance–sheet. The whole account for the year balances out in some such manner as this:—
14. I will conclude this chapter with some statistics.
(a) After deduction of certain small sources of revenue in England and various minor adjustments.
(b) Apart from dividends earned and reinvested in England.
(c) Excluding balances in Gold Standard Reserve.
(d) Deducting bills on London sold in India.
(e) Excluding reduction of debt by annuities and sinking funds included in Home Charges.
The table given above analyses the Home Accounts in a way which brings out the essential facts more clearly than the Government’s own published accounts. These actual figures may be compared with the hypothetical balance–sheet given in § 13.
The principal items of the Home Charges are analysed below. As these do not vary much from year to year it has been thought sufficient to give the figures of one recent year, namely, 1911–12. It will be seen that in that year about £5,000,000 was spent on pensions and leave allowances, £11,000,000 on debt services, and £2,250,000 on military services (excluding pensions). Other expenses were of a very small amount.
Analysis of Home Charges in 1911–12
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Keynes, John Maynard, 2015. Indian Currency and Finance. Urbana, Illinois: Project Gutenberg. Retrieved May 2022 from https://www.gutenberg.org/files/49166/49166-h/49166-h.htm
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