Indian Currency and Finance: Chapter VI

1. The Indian authorities have undertaken a double responsibility. They must be prepared to supply rupees in payment for Council Bills or in exchange for sovereigns. And on the other hand they must be prepared also to supply sterling or sterling drafts in exchange for rupees. The maintenance of the Indian system depends on their ability to fulfil this double obligation to whatever extent may be required of them.

The objects to be attained are simple, but the methods of the Government are, largely for historical reasons, exceedingly complicated. I will discuss, first, the nature of the existing methods; second, their adequacy for their purpose; third, some proposals for making them more orderly and intelligible; and lastly, the management of the cash balances.

2. From the profits of rupee coinage a reserve has been built up expressly for the purpose of supporting exchange. This is known as the Gold Standard Reserve. As the reserve is used in practice, not only for holding sterling reserves but also for holding a part of the rupee reserve, this title is a misnomer.

For some years after the closing of the Mints no fresh coinage was undertaken. By 1900 it had become necessary to mint additional rupees, and from that time until 1907 the profits on coinage rapidly raised the Gold Standard Reserve to a respectable total. The crisis of 1907–8 made it necessary to withdraw a great number of rupees from circulation, and no further coinage was necessary on a significant scale until the autumn of 1912. By October 1912 the aggregate profits arising from coinage amounted to about £18,600,000. Of this, however, about £1,100,000 was diverted in 1907 for capital expenditure on railways—leaving about £17,500,000 for the Gold Standard Reserve. In addition to this the receipts on account of interest on that part which was invested amounted to about £3,250,000, against which is to be set about £1,000,000 depreciation in the value of the investments in October 1912 as compared with their original cost. Thus at that date this reserve stood at about £19,750,000, allowing for depreciation. During the winter of 1912–13 profits on the heavy issues of coinage caused a further increase, and we may conveniently think of the Gold Standard Reserve as being worth about £21,000,000 net at the end of 1912.

Of this total the greater part was held in sterling securities—about £16,000,000 (market price). In recent times the policy has been followed of holding at least half of this in securities of the most liquid possible type. On March 31, 1912, £4,500,000 was held in British Treasury Bills, and £4,735,600 in Exchequer Bonds. Of the rest about £7,000,000 (face value) was in Consols and other stock guaranteed by the British Government, and about £1,500,000 (face value) in various Colonial Government Securities.

Apart from the £16,000,000 thus invested, about £1,000,000 was, at the end of 1912, lent at short notice in the London Money Market; about £3,750,000 was held in India in rupees; and £250,000 in gold was “earmarked” at the Bank of England. The holding of some part in actual gold in England was an innovation introduced in November 1912.

It has been announced that the Gold Standard Reserve is to be allowed to accumulate through coinage profits and interest receipts until it stands at £25,000,000, and that £5,000,000 of this will be held in gold. It is possible that when this figure has been reached, some part of its income may be applied to capital expenditure on railways. This would be a reversion to the policy of 1907–8, since abandoned, when one–half of the profits of coinage was thus diverted.

The form in which the Gold Standard Reserve is held has been subject to much criticism. But it will not be useful to consider this until we are in a position to deal with the reserves as a whole.

3. The second reserve is the Paper Currency Reserve held against the note issue. The constitution of this has been explained in Chapter III. The invested portion may not exceed a stated maximum, of which a part only may be held in sterling securities and the rest must be placed in rupee securities. The whole of the balance must be held in gold or silver bullion, rupees, or sovereigns. But the gold may be held either in London or in India. The actual form in which the Currency Reserve was held at the end of December 1912 was approximately as follows:—

4. The Government’s remaining reserve source of supply of cash in the form of rupees or sterling is the Cash Balances. Both the total of these and the proportions held in rupees and sterling respectively vary within wide limits from time to time. Their total amount fluctuates according to the volume of taxes coming in at different seasons of the year, the recency with which loans have been contracted for capital expenditure, the proximity of extraordinary expenditure impending, the receipts of windfalls of income (as, recently, from the opium revenue), the general prosperity of the country, and the degree of caution or optimism which, in the opinion of those responsible for the finances, the general situation warrants. The proportions held in rupees and sterling respectively depend even more on considerations of temporary convenience,—recent or impending capital transactions in London, the likelihood of sterling funds being wanted for the purchase of silver, and trade demands for Council Bills as a means of remittance. The totals of the cash balances at various dates are given below.

Cash Balances(a)

It may be added that the Indian cash balancesare kept partly in District Treasuries all over the country, partly in Reserve Treasuries, and partly on deposit at the Presidency Banks. The District Treasuries do not usually contain more resources than they require for ordinary transactions, and the balances in excess of immediate requirements, which are transferred to the Reserve Treasuries, are mainly held in the form of notes. Thus the Government has no large surplus stock of rupees outside the Currency Reserve. The London Balances are held partly at the Bank of England and partly on loan for short periods with certain financial houses on an approved list. No more than a working balance (about £500,000) is ordinarily held at the Bank of England, and this has been reckoned for many years now (though not formerly) amongst the “other” deposits, not amongst the “public” deposits. It will be seen from the table given above that the London Balances fell to a low level in 1908, the Secretary of State making free use of them to aid him in supporting exchange during the critical months of that year. On October 30, 1908, these balances had sunk to £1,196,691. In 1911 and 1912, on the other hand, they reached a very high figure, and in June of both these years exceeded £19,000,000. By the end of 1912 they had sunk again to a more normal level. This abnormally high level in the first half of 1912 gave rise to much criticism in regard both to the amount of the balances and also to the method adopted of lending them out in the London Money Market. Something will be said about this in the concluding paragraphs of this chapter.

5. We are now in a position to see exactly what resources in sterling and rupees respectively the Indian authorities have, on which to draw for the fulfilment of their currency obligations. Since the surplus balances in India, beyond those required by the District Treasuries and those deposited with the Presidency Banks, are mainly held in notes, we may neglect them for the present purpose.

Rupee Reserves are held partly in the Currency Reserve, partly in the Gold Standard Reserve. In December 1912 the amounts were approximately as follows:—

Sterling Reserves are held partly in the Currency Reserve, partly in the Gold Standard Reserve, and partly in the London Cash Balances. The forms in which they are held are gold (in the Currency Reserve, both in India and London, and to a small extent in the Gold Standard Reserve), money lent at short notice (in the Gold Standard Reserve and in the Cash Balances), and sterling securities (in the Currency Reserve and in the Gold Standard Reserve). In December 1912 the amounts were approximately as follows:—

6. Before we consider the adequacy of these reserves for their purposes, it will be useful to recall the circumstances of the two recent occasions on which their resources were severely taxed. The Government were hard pressed to supply sufficient rupees in 1906, and hard pressed to supply sufficient sterling in 1908. We can deal with both these occasions in a continuous narrative.

The coinage of rupees recommenced on a significant scale in 1900. For the five years following there was a steady annual demand for fresh coinage (low in 1901–2, high in 1903–4, but at no time abnormal) and the Mints were able to meet it with time to spare, though there was some slight difficulty in 1903–4. In 1905–6 the demand quickened, and from July 1905, when the Government’s silver reserves stood at what was then considered the comfortable figure of 1837 lakhs (£12,250,000), it quite outstript the new supplies arising from the mintage of the uncoined silver reserve. The Government were very slow to buy more silver and, in fact, do not seem to have taken steps to do so until, in December 1905, their bullion reserve was quite exhausted. They had then to buy silver in London hurriedly and at rather a high price. In the meantime the rupee reserves had sunk to the very low figure of 761 lakhs (i.e., about 40% of the holdings six months earlier), and the demand for Council Bills in London, which would have to be cashed in rupees in India, showed no signs of abating. In order to give themselves breathing space, and to allow time for the silver recently bought in London to reach India and be coined, the Government had to raise the price of telegraphic transfers to what was then the unusually high figure of 1/45/32. This was the worst that happened. The new coinage very quickly overtook and passed the demand, and by the end of March 1906 the available silver reserves were double what they had been in January.

This slight scare, however, was more than sufficient to make the Government lose their heads. Having once started on a career of furious coinage, they continued to do so with little regard to considerations of ordinary prudence—though their sins did not overtake them immediately. Without waiting to see how the busy season of 1906–7 would turn out, they coined heavily throughout the summer months, and, there being more silver in hand than could be conveniently held in the Currency Reserve, it was maintained, at the expense of the sterling resources, in the Gold Standard Reserve. In July 1906 the silver reserve stood at about 3200 lakhs. As a matter of fact the season of 1906–7 turned out well, and the demand for rupees was on a large scale. Yet the available silver in India hardly fell below 2000 lakhs—nearly three times the minimum at the most critical moment of the preceding year. The more than adequacy of their reserve at the busiest moment of the very busy season 1906–7 did not check, however, the impetuous activity of the Mints. During the summer of 1907, as in the summer of 1906, they continued to coin without waiting until the prosperity of the season 1907–8 was assured. In September 1907 their silver holdings in one form or another stood at the excessive figure of 3148 lakhs. This time they got what they deserved. The season of 1907–8 was a failure, and at the end of 1907 came the crisis in America. In place of there being a demand for new rupees, it was necessary to withdraw from circulation an immense volume of the old ones; and the sterling reserves, not the rupee reserves, were in danger of insufficiency. This leads us to the next chapter of the history.

7. The coinage policy of the Government of India from 1905 to 1907 suggests one obvious reflection. A succession of years, in which there is a heavy demand for currency, makes it less likely that the heavy demand will persist in the year following. The effects of heavy coinage are cumulative. The Indian authorities do not seem to have understood this. They were, to all appearances, influenced by the crude inductive argument that, because there was a heavy demand in 1905–6, it was likely that there would be an equally heavy demand in 1906–7; and, when there actually was a heavy demand in 1906–7, that this made it yet more likely that there would be a heavy demand in 1907–8. They framed their policy, that is to say, as though a community consumed currency with the same steady appetite with which some communities consume beer. In so far as the new currency is to satisfy the demands, not of hoarding, but of trade, it is hardly necessary to point out the fallacy. Moreover, even a superficial acquaintance with the currency history of India brings experience to the support of reason. Even when the rupee was worth no more than its bullion value, so that it was hoarded and melted much more than it is now, years of unusually heavy coinage were nearly always followed by a reaction. India has taken her coinage in great gulps, and it need not have been difficult to see that the demand of 1905–7 was one of these.

8. The Government of India’s silver policy during the early part of 1907 left them, therefore, in a somewhat worse position to meet the crisis which came at the end of the year, than need have been the case. But their sterling reserves were nevertheless fairly high. On September 1, 1907, they seem to have been, approximately, as follows:—

Thus, to take a round figure, the crisis found the Secretary of State with about £31,000,000 in hand. The storm was soon on him. By the end of October 1907 it had become plain that the Indian harvest would be a bad one, and the financial crisis in the United States was fast developing. On November 4 the Bank of England raised its rate to 6 per cent, and on November 7 (for the first time since 1873) to 7 per cent. On November 6 the Secretary of State could only manage to sell even 30 lakhs of rupees by allowing the rate to drop to the minimum figure of 1s. 329/32d. For several weeks following, at a time of year when the demand for Council Bills is usually strong, he sold none at all. But beyond withdrawing from the market he took no further steps for the support of exchange. This measure was inadequate to effect its purpose, and there is a good deal to be said for the view that he ought to have taken at once the more drastic steps for maintaining the gold value of the rupee which he had to take a few months later. However, it was a perplexing and unprecedented time for every one, and that it was some weeks before his advisers found their bearings is not to be wondered at.

So inadequate was his action that at first the fall in exchange was scarcely stayed at all. Tumbling day by day, it reached on November 25 the rate of 1/311/16. This is below the gold export point (from India), and it could not have fallen so low if the Government had made gold freely available in India. But, as can be seen from the preceding table, their Indian gold reserve was not large. Individuals were not permitted, therefore, to take out more than £10,000 at a time; and in this manner the gold dribbled slowly away over a period of a few months. It would probably have been of more use if it had been allowed to disappear in a week at the moment when it was most badly wanted.

In the meantime the Secretary of State, deprived of his usual source of income from the sale of Council Bills, was meeting his normal expenses from the gold portion of the Currency Reserve in London. But the Gold Standard Reserve, although about £1,000,000 worth of Consols was sold out in order to be ready for use in a more liquid form, was kept so far intact.

Thus matters went on until the end of December 1907, when the authorities nerved themselves, although the immediate necessity had temporarily disappeared through a slight strengthening of exchange, to take whatever drastic steps might be necessary to maintain the gold value of the rupee. It was announced that they would sell in India telegraphic transfers on London at a fixed rate. Before the need arose for acting on this announcement, it was changed into an offer to sell sterling bills on London at the fixed minimum rate of 1/329/32.

By March 1908 the reserves of actual gold were nearly exhausted, but the securities and cash at short notice had not yet been trenched on. Early in April exchange was again weak, and the offer referred to above came into active operation. At first £500,000 a week, and later £1,000,000 a week of sterling bills on London were sold in India at 1/329/32. These were cashed in London from the proceeds of selling securities from the Gold Standard Reserve. By August 1908 about £8,000,000 of bills had been cashed in this way. At the beginning of September 1908 the sterling reserves, which I give for comparison with the amounts in September 1907 quoted above, were, approximately, as follows:—

9. Thus the Secretary of State’s sterling resources sank in the course of a year from about £31,000,000 to about £11,000,000. But these figures do not supply by themselves a complete explanation of the manner in which he had financed himself in London during this period. Between September 1907 and September 1908 railway loans to the aggregate amount of about £12,500,000 and a loan of £2,000,000 for “general purposes” were raised in sterling. A large part of the former was required for the discharge of some previously existing railway debentures, and for the purchase in England of railway materials chargeable to capital account. In so far as the loan was used for these purposes it did not help the general position. But in so far as it was used for railway construction which could be paid for by rupees in India, it had the effect of increasing the Secretary of State’s sterling resources by a corresponding amount. Altogether, during the period under review, the net assistance obtained by loans amounted, I think, to about £4,500,000; so that the total deterioration in the Secretary of State’s position during the first year of the depression was not far short of £25,000,000.

After October 1908 the market still showed some hesitation. If the season had turned out poorly, it is clear that the Secretary of State must have had recourse to borrowing on a fairly heavy scale. In fact the harvest was satisfactory, and by December 1908 the demand for Council Bills was strong. It may be added to complete the story, that in August and September 1909 there was a short period of weakness when it was again necessary to offer sterling bills in Calcutta. Since that time India has enjoyed a period of very great prosperity, and, so far from the reserves being tested, it has been possible to build up the very strong position analysed above.

10. I have looked at the crisis so far from the point of view of its effect in depleting the sterling resources of the Secretary of State. To the authorities in India it presented its other face. There it was a question of how many rupees they would be able to withdraw from circulation. Unless there is a deficiency in the revenue from taxation, and apart from loans, the extent to which the Secretary of State can draw on sterling resources must exactly equal the extent to which the Government of India can withdraw rupees from circulation. For every transfer from the sterling branch of any of the reserves must be balanced by a corresponding transfer into the rupee branch. The amount of the sterling reserves is a measure of the ability of the authorities to withdraw rupees; and conversely, the volume of rupees which can be spared from the circulation (or from hoards) in bad times sets an upper limit to the extent to which they can be compelled to draw on their sterling reserves for the support of the currency.

Regarded from this standpoint, the facts were as follows:—By March 1908 nearly 115 million rupees had been withdrawn into the currency reserve by the release of gold, and by December 1908 the figure had risen to 154 million. Up to March 1908 it had not been necessary to take rupees into the Gold Standard Reserve; but by the end of November 1908 about 130 million rupees had been withdrawn in this way. There was also a small increase of rupees in that part of the Indian Cash Balances which is held in rupees and not in currency notes. Thus the active circulation was reduced altogether by about 285 million rupees (£19,000,000). This figure agrees closely enough with the figures we reached by studying the state of the sterling resources.

11. This completes the narrative of events up to the end of the crisis of 1908. I have given only such details as are relevant to my main topic—the adequacy of the reserves to fulfil their purpose.

12. Let us consider, first, the adequacy of the reserve of coined rupees. The governing facts of the situation are that every addition to the rupee reserve diminishes to an equivalent extent the amount available for the sterling reserve; that if the rupee reserve is insufficient, nothing worse can happen than some delay and inconvenience to merchants at a time of boom, whereas, if the sterling reserve is insufficient, a dangerous crisis may be aggravated to the pitch of panic; that at the last moment the rupee reserve can always be replenished with no very great delay from the resources of the sterling reserve, whereas the reverse is not the case (the silver being not so saleable at a crisis as the gold is in a boom); and that, therefore, it is desirable to keep the rupee reserve at the lowest possible point consistent with probability and ordinary prudence. The practical information chiefly required for settling the proper policy is in regard to the ease with which new rupees can be supplied as they are wanted—as to how far, that is to say, the Government can safely pursue the policy of living from hand to mouth. This depends upon how fast silver can be bought by the Government without its submitting to extravagant charges, and how fast, in relation to the maximum rates of new demand so far experienced, the Indian Mints can turn the silver into rupees.

13. The Government of India’s recent attempt to solve the first part of the problem unhappily involved its officers in a good deal of obloquy. The silver market is a very narrow one and can only be dealt in through the agency of one or other of a very small number of brokers. A ring of speculators lay waiting to force prices up as soon as the Government should appear as a buyer. Apart from the brokers who acted for the ring, there was only one firm in a position to buy large quantities of silver with the secrecy which was necessary if the speculators were to be defeated. Unfortunately the head of this firm was closely related by blood to the Parliamentary Under–Secretary of State. Two courses were open: to buy openly and pay such extra price as the speculators might find themselves in a position to demand, or to risk charges of venality from any one who might have an interest in discrediting the Government—disappointed speculators, currency malcontents, or members of the political party in opposition. The officials, thinking (bureaucratically) more of the Indian Exchequer and the Indian taxpayer than of the House of Commons, chose, in fact, the second of the two alternatives—in a spirit, perhaps, of too great innocence, bred of long immunity from charges of personal corruption. It turned out that they had made insufficient allowance for the deep interest which the House of Commons takes in suggestions of personal scandal. The question of Indian currency became almost interesting. Members asked one another what the Gold Standard Reserve might be, and, when writers in the Press told them, were duly horrified to learn that it contained no gold. Closer inquiry elicited further facts unsuspected hitherto. It was discovered that a number of the most prominent members of the London Money Market were Jews, and that the Government of India’s holdings of Consols had depreciated in market value since they were bought. But attention was specially concentrated on the fact that the cash balances held in London, after fluctuating considerably from time to time, had risen for a year past to an unusually high level, and had been lent out at low rates of interest to persons many of whom bore foreign names. How was the ordinary member of Parliament to be sure that some cosmopolitan syndicate of Jews was not fattening at the expense of the ryots of India, whose trustee he had often declared himself to be? Indian currency is too complicated a subject to be mastered at a moment’s notice; and many persons, without paying much attention to random charges of corruption, felt, quite legitimately, that there was a great deal going on of which they had no conception, and that they would like to be fully satisfied for themselves, and not merely on the word of the officials, that everything was really in order. The situation in its fundamentals has arisen before, and will arise from time to time in the future so long as the relations of the House of Commons to India combine in a high degree responsibility and ignorance.

14. The circumstances themselves are of very transient importance, but they are likely to have some permanent effect on the particular question which we are now discussing. It will be too much to expect the officials to expose their personal reputations again to a suspicion, however ill–founded, even in the interests of the Indian Exchequer. Next time that the Government of India have to buy silver on a large scale, it is likely that they will do so publicly and pay such extra price as this policy involves. It is not worth a Government’s while to risk its transactions falling into suspicion in order to save half a million pounds. Assuming, therefore, that in future the Government will have to buy publicly, we have to consider whether it is likely to be cheaper for them to buy when the price of silver seems low, and hold stocks in hand, or to wait until the last moment and buy at whatever price is then ruling. I am inclined to think that the second of these two policies is the better—though it is plainly a matter on which it is not possible at present to see one’s way clearly. It is outside the ordinary run of Government officials’ duties to judge whether or not a given time is a good one at which to buy silver. The speculative business of estimating the future of silver is best left to experts in the matter, even though the price ultimately paid has to include some commission to them for their services or their foresight. In the second place the history of the recent speculative ring in silver, so far as it can be known to an outsider, does not suggest that such a transaction is a very easy or profitable thing to carry through, or that the speculators have had a sufficiently striking success to encourage similar attempts on a large scale in the future. I do not know with what profit the ring have emerged from the transaction; but the expense of carrying silver for a long period is great, and the rise in its price in the last two years, though substantial, has not been enough—so far as one can judge—to leave a surplus of profits at all commensurate with the great risks run. In the third place, it does not seem certain that the urgent demands for fresh coinage of rupees, to which India is subject from time to time, will be as frequent in the future as they have been in the immediate past. On the one hand the heavy coinages since 1900 are cumulative in their effect and render further coinages in the future less probable; and on the other hand an increased use (it is to be hoped) of other media of exchange will allow an urgent demand for currency to be met in other ways.

15. I do not think, therefore, that the Government need show a very long foresight lest they should have to buy silver dear. But when their stocks are falling low and there are apparently signs of demand in the immediate future, how long can coinage be delayed safely? To answer this we need to know the maximum rate of output of the Mints, and the maximum rate of absorption of new currency so far experienced.

16. The rates of absorption of rupees in various years have been given in the Table on p. 55. The maximum absorption in the October to December quarter was 11·39 lakhs in 1905–6, and the maximum in the January to March quarter was 2·68 lakhs in 1909–10. It has been estimated that the Indian Mints can turn out 2·25 lakhs of rupees per month without overtime, and 4·50 lakhs per month with overtime. There seems little reason, therefore, for over–anxiety lest the Government be caught short of rupees. If they were to start the busy season with a surplus of 500 or 600 lakhs over what was considered a safe minimum, the reasonable demands of prudence would have been fully satisfied. The safe minimum in question must necessarily depend on circumstances, especially on the volume of the note issue and on the amount of gold held in India; it is impossible to suggest any figure which would be permanently suitable. I am dealing merely with the surplus over this minimum which, on the basis of experience, the Government might reasonably take pains to have in stock at the beginning of a busy season. The calculation refers throughout to their aggregate rupee resources in the Currency Reserve and Gold Standard Reserve combined.

17. We now come to the much more important question of the adequacy of the sterling reserves.

I do not think it has ever been thought out quite clearly for what precise purposes these reserves are held. The difficulty can be put shortly in this question,—Are they held purely as a currency reserve, or are they to fulfil also the purpose of a banking reserve? Is their only purpose, that is to say, to make certain that the Government will always be able to exchange for sterling such rupees and notes as may be presented to them, or are they also intended to ensure India’s being able to meet her international obligations at a time of dangerous crisis? The two purposes are plainly not identical. If all bankers and merchants keep adequate reserves in rupees and notes, then it will be sufficient if the Government are always able to turn these rupees and notes into sterling. But if in a financial crisis the Indian Money Market as a whole is in fact unable to meet its international obligations without Government assistance, is it the Government’s intention to stand calmly aside and permit (for example) a suspension of cash payments by the three Presidency Banks, or will they, if necessary, use their sterling reserves to give some support to the Indian Money Market in extremis?

If the Government’s Reserve is held purely to support the currency, then the maximum volume of rupees and notes, which could, so far as one can anticipate, be spared from the circulation and tendered to the Government for exchange, sets an upper limit to the necessary amount of this Reserve. If, on the other hand, it is intended to act as a banking reserve and to ensure India’s ability to meet her international obligations at all times, then its upper limit is set by the probable maximum amount of the adverse balance which could arise against India for immediate payment.

18. I will begin by discussing this question on the first hypothesis—that what the Government has been accumulating is intended to serve as a currency reserve only—and will return later to the problem of a reserve held for wider purposes, and of the possible magnitude of the balance of international indebtedness against India.

19. To estimate the demand that the reserves might have to meet merely in order to support the currency, the existing volume of currency is what we chiefly require to know. For this sets, or suggests, a limit to the maximum amount which can possibly be spared from the active circulation.

Attempts to estimate the rupee circulation of India have been the occasion of some very interesting calculations. For many years past (since 1875) an annual census of rupees has been taken by examining in each Government Treasury a bag containing 2000. This enabled Mr. F. C. Harrison, when he was Comptroller of Currency, to apply the Jevonian method very fully; and he was also able to corroborate his estimates by reference to the numbers of the older issues, 1835 and 1840 (e.g.), actually withdrawn from circulation on the occasions when the Mint recalled them. Mr. Harrison’s results were checked by the labours of a later Comptroller of Currency, Mr. Adie, who applied to the same material two alternative methods of much greater technical complexity than Mr. Harrison’s.

Jevons’s method is based on the assumptions that the proportions of coins issued at different dates found in the given samples roughly correspond to their proportions in the circulation at large, and that the numbers in circulation of the latest issues do not much differ from the numbers issued from the Mint. In short, if we know the relative proportions of coins of 1860 and of 1912 in the circulation, and if we know, approximately, the absolute number of coins of 1912, we can calculate the absolute number still circulating of the coins of 1860. In applying this method to the Indian data, we are assuming that the proportions of rupees of each date found in the bags examined in a great number of scattered Government Treasuries are a fair sample of the proportions still in circulation throughout the country. In a country such as India, however, there may be great stagnancy in a part of the circulation, and the coins finding their way to the Government Treasuries may be a sample rather of the floating surplus of coinage, which has a relatively high velocity of circulation, than of the total stock, which includes semi–hoards passing from hand to hand comparatively seldom. Since these samples are likely, therefore, to contain an undue proportion of recent issues, estimates of the total circulation, which are based on them, may be expected to fall short of the truth rather than to exceed it. There is reason, also, for supposing that in some cases the officials charged with the duty of examining the samples did not always deal with them conscientiously. A tendency was noticed for the returns of one year to resemble those of the previous year more closely than they should, and not infrequently a batch of coins would be attributed to a year in which it is known that none were minted. Nevertheless the calculations of Mr. Harrison and Mr. Adie, and the data on which they are based, seem on the whole coherent, and bear, so far as one can judge, the marks of substantial accuracy.

A quite different method of estimating the circulation has been adopted by Mr. F. J. Atkinson. His method is direct; and consists in a calculation or estimate of the additions to the currency and the losses from export, melting, etc., year by year, from 1831 when the modern coinage first began. Some of the items in the calculation are definitely known, but others, the amount annually melted, for example, are almost entirely a matter of guesswork. The fact that his calculations contain altogether a great number of separate guesses does not prevent his final result from being a guess too. For the period previous to the closing of the Mints some of his estimates for the amount melted seem very low, and this may possibly explain why his final results yield a much higher total for the circulation than those of Mr. Harrison and Mr. Adie. In recent times, i.e. since the closing of the Mints, and specially since the new equilibrium which was reached in 1900, Mr. Atkinson’s method is much more satisfactory than for earlier years and, since the doubtful items are in these later years a far smaller proportion of the whole, much less likely to lead us wrong. For the earlier years, therefore, I am inclined to prefer Mr. Harrison’s conclusions; but I think they can be brought up to date by a year–to–year method resembling Mr. Atkinson’s. The increase in Mr. Atkinson’s estimate during the ’nineties is due to the fact that, as his figures purport to exclude rupees in hoards, he must make large allowance for the coins from this source then entering into circulation.

The actual figures are as follows:—

Estimate of the Rupee Currency in Crores (10,000,000) Of Rupees

(a) Of Mr. Atkinson’s two separate calculations, made in 1897 and 1903, I have taken the latter. His calculation explicitly excludes rupees in hoards, currency reserves, and Government balances; and is not, therefore, entirely comparable with the others. If it were, the excess would be considerably greater than it actually appears above.

20. These are the data. It is very difficult to estimate the extent to which rupees may have emerged from hoards during the period which succeeded the closing of the Mints. Mr. Atkinson’s figures suggest that rupees from this source not only made good the natural wastage in the active circulation but actually brought about a large increase in it. Judging from the course of prices, I think he must have made an excessive allowance under this head. The figures of Mr. Harrison and Mr. Adie, on the other hand (which refer to the total circulation), point to a more moderate influx out of hoards into current use. I propose to take a middle course, nearer, however, to Mr. Harrison than to Mr. Atkinson, and to assume a public circulation in 1900 (i.e., excluding rupees in the Currency Reserve and Government Balances) of 120 crores of rupees. This estimate is probably near enough to the truth for our purpose. If it is incorrect, I think it is more likely to be an underestimate than an overestimate.

Starting from this assumption, I have worked out the details given in the following table as a guide to the probable circulation at the present time. By public circulation, whether of rupees or notes, I mean the whole circulation not in the hands of the Government—i.e., including that in the hands of the banks. I am primarily concerned with the circulation of rupees; but the public circulation of notes has been added in the last column but one, as it is useful to know at the same time the total public circulation of currency.

Currency in Lakhs of Rupees

(a) This column is derived from the figures given by the Currency Department, and the total of net coinage issued in individual years differs somewhat from the total amount minted as stated in the Mint Statistics.

(b) In one or two of the earlier years deduction is made on account of an appreciable sum in rupees paid out to native states. This deduction is in accordance with the practice of the reports of the Currency Department.

(c) For Bahrain Islands, Ceylon, Arabia, Mauritius, and East African Coast.

(d) Not allowing for natural wastage of rupees (see below).

This calculation makes no allowance for the general wastage through loss and various causes, or for the steady drain of rupees across the land frontiers. This last item is probably considerable and is not adequately accounted for in the trade returns. The recorded statistics of trade overland show a large annual balance against India, which is probably met by an unrecorded export of gold, silver bullion, and rupees. In the case of Nepal, for example, the recorded statistics show a considerable net balance of imports of treasure into India; and in the case of Tibet, Afghanistan and, in fact, all the land frontiers, the official statistics of the export of treasure do not tally with what we know of the circulation of the rupee beyond the frontiers. Taking all these causes of loss together, I do not think we should overestimate the wastage of rupees from the circulation in placing it between half a crore and a crore annually. For the twelve years 1900 to 1912, therefore, I propose to make an aggregate deduction of 941 lakhs.

This leaves us with a public circulation of 175 crores of rupees (£116,500,000) on March 31, 1912, and a total public circulation, including notes, of 228 crores (£152,000,000), being an increase since 1900 of 46 per cent in the rupee circulation and of 58 per cent in the total circulation. If Mr. Atkinson’s estimate of the circulation in 1900 is nearer the truth than Mr. Harrison’s, then the public rupee circulation in 1912 may have been as much as 200 crores. In the course of 1912 there was a good deal of fresh coinage, of which, at the time of writing, accurate statistics are not yet available. For our present purpose it will be quite sufficiently cautious to think of the public rupee and note circulation together as amounting to not more than 250 crores.

21. How much of this could possibly be spared from circulation at a time of crisis? In 1908 the rupee circulation fell (at its lowest point) by somewhat less than 30 crores, or less than 20 per cent of the estimated rupee circulation at that time. The note circulation (see p. 55) fell much less seriously. It does not seem to me likely that the Government could be called on at the present time to redeem more than 25 per cent of the total circulation (notes and rupees together), or, on the basis of the foregoing calculations, 60 crores (say) of rupees (£40,000,000). If the Government were to keep in one way or another a reserve of this amount for purely currency purposes, I think they would have done as much as reasonable prudence could require. I do not say that it is impossible that they should be called on to redeem a greater amount than this. But it would be extravagant to maintain a reserve adequate for all conceivable emergencies, since there is a further resort of which use might fairly be made without great reluctance. Unless the London Money Market has collapsed as well as the Indian, it is always open to the Secretary of State to borrow by means of India Bills. There would be nothing shameful in this—though possibly some expense. But the expense, even if the Secretary of State had to pay a rate of interest appropriate to Turkey or China, would be much less than the expense of maintaining a very great reserve against unlikely emergencies.

22. So much for the proper magnitude of the Reserve, regarded as a Currency Reserve. The question of its use as a Banking Reserve raises two problems—a problem of policy and a problem of statistics. Ought the Government to allow its Reserve to be used as a Banking Reserve? If so, how large ought this Reserve to be? Let us consider policy first.

23. There are three kinds of crises by which the Indian Money Market might be assailed—a purely internal crisis, in which the banks have difficulty in meeting a run on them by their Indian depositors; a purely external crisis, in which India owes, and is called on to pay, large sums in the London Market, but is free from serious banking trouble at home; and a general crisis, in which the features of an internal and an external crisis are combined.

A purely internal crisis of the first kind might require assistance from the resources of Government, but would involve no claims on their sterling resources specifically, as distinguished from their rupee resources. The trouble would probably begin with a boom of the usual type, heavy commitments on the part of the banks, large importations of foreign goods, and (in the future) a good deal of internal company promoting. If, early in the autumn, a serious failure of the monsoon became apparent, a widespread suspension on the part of the numerous bubble banks, which have been springing up lately all over India, would be a probable consequence. Indian depositors generally might take alarm and hoard money in their own houses on a large scale. Exchange Banks have such large deposits in India and so little cash there that they would probably require to import funds from London as fast as possible. The Indian Joint Stock Banks, however, are now so important that the part played by the Exchange Banks might not be adequate to save the situation. The Government would then be called on to make advances to the Presidency Banks. This has happened from time to time in the past, the last occasion being in April 1898, when the Bank of Bombay, whose bank rate was then at 13 per cent, asked the Government for an advance of 25 lakhs.

This raises the first question of policy—whether the Government should help the bankers’ reserves on an occasion of internal crisis by making rupee advances to them. But it is hardly relevant to the question of the Government’s sterling resources; and, unless the Government Savings Banks were to be in trouble at the same time, it is not likely that there would be any difficulty in helping the bankers, if it were thought right to do so.

A crisis of the second kind, due to general depression or bad harvests, in which India has to meet a heavy adverse balance in London, provided that, as in 1907, it is not accompanied by internal banking difficulties of the kind just described, causes, it is true, a drain on the Government’s sterling resources through the necessity of providing remittance on London, but only in proportion to the volume of notes and rupees which are brought to the Government for encashment or in payment of sterling drafts.

At first, therefore, in such a case, there is no question of the Government’s using its reserves otherwise than as currency reserves; and the banks will have plenty of notes and rupees with which to buy the Government’s sterling drafts. Only if the depression is very prolonged, and one bad harvest follows another, is the need likely to arise for sterling advances from Government, otherwise than against a corresponding face value of notes and rupees.

It is not very improbable, however, that in the future there might be a general crisis of the third kind—a heavy adverse balance against India, and an internal banking crisis at the same time. It is in these circumstances that the most difficult question of policy arises. The Indian Money Market would need to remit funds to London, but, on account of the internal banking crisis and an outbreak of hoarding amongst depositors, would not have even rupee resources with which to do it. Consequently the Government’s offer to sell sterling drafts in Calcutta, or to release gold from the Currency Reserve would not meet the case. If general distrust of banking was widely spread, and notes, gold, and rupees were being hoarded in the old–fashioned way on a large scale, the banks would not be able to put their hands on sufficient cash resources of any kind to enable them to pay for the Government’s drafts on a scale adequate to their necessities. The position would be that the Indian Money Market was on the verge of general insolvency with the Presidency Bank Rates at (say) 12 per cent, and that the Indian Government had (say) £40,000,000 sterling resources in hand with demands on only a modest scale for the encashment of notes and rupees. The Government would be vehemently urged to save the situation by making sterling advances, not simply in exchange for notes or rupees, but on some other non–monetary security.

24. We now have the possibilities before us. If in any of these sets of circumstances the Government were faced with demands for advances either in rupees or sterling, what line would it be proper to take?

On the one hand the policy of advances may introduce into the Indian Money Market a serious element of weakness,—an element, perhaps, inseparable from a system where there is no central banking authority and where the currency authority stands, normally, outside the money market. It is not the business of the Government to hold any of the reserves which the bankers ought to hold. But if the Government does, in fact, for another purpose hold large reserves in its hands, and if it is believed that it will in case of extreme necessity come to the market’s rescue, the bankers may tend to keep somewhat lower reserves than they ought, and than they otherwise would. We have over again the situation which has long existed, to its detriment, in the United States. There, as in India, the Government, with immense currency reserves of gold, is normally aloof from the money market. There also they have no central banking authority. The expectation that the Government will bring some of its gold to the rescue in extreme circumstances, has always been said to exert an enervating influence on the banks themselves in the matter of the precautions they take for times of crisis. The ultimate solution probably lies in the establishment of a Central Bank for India which shall be the Government Bank and shall hold the banking and currency reserves at the same time.

In the meantime, in spite of this consideration, the Government will not, I think, be able to resist the pressure on them in a crisis to come to the assistance of the market. Indeed, I do not know that they ought to resist it. It would be absurd to have large reserves in hand, and not to use them to avert a general calamity. The awkwardness of the situation is intrinsic, and cannot be avoided so long as the present divorce is maintained between the banking and the currency authorities. The plans of the Government ought, therefore, to be laid accordingly.

25. If there is force in this contention, and unless the Government of India have definitely made up their minds that their sterling reserves are to be used in no circumstances except for the support of exchange and of the sterling value of their currency, it is important to understand that immediate action is essential, and that to delay action for a few weeks may be fatal. I would emphatically apply to India the well–known doctrine which the powerful advocacy of Mr. Bagehot raised in England, many years ago, to an impregnable position in the unwritten constitution of this country—the doctrine, namely, that in a time of panic the reserves of the Bank of England must, at a suitably high rate, be placed at the disposal of the public without stint and without delay. There is a danger that the matter may not be thought out until, quite suddenly, the financial crisis comes, and that then, while the decision is being taken and the best advice sought, an inadvertent delay will intervene. If there were signs of a general banking crisis in India, and particularly if the position of the Exchange Banks were weakening in England, I am inclined to think that it would be a wise policy on the part of Government to make an immediate announcement that they would place up to (say) £10,000,000 at the disposal of the Presidency Banks (or other approved borrowers) at a rate of (say) 10 per cent. If this action stayed, as it well might, the run on the banks in India, and the difficulties of the Exchange Banks in raising temporary loans in London, the Government might with a very moderate loss of funds (the mere announcement that they were available being sufficient) find itself in a far more favourable position for dealing with the subsequent depression; whereas after a delay a similar announcement might eventually be forced upon them, and if the panic had then gained impetus, the £10,000,000 quickly lapt up.

26. Two points connected with the above may be emphasised before we pass on to the statistical problem. In the first place, in the event of a financial crisis, accompanied by numerous bank failures, I do not think it likely that the Government would be overwhelmed with demands for the encashment in sterling of notes and rupees. It would be much more in accordance with what we know of similar crises elsewhere to expect hoarding on a large scale, rather than a diminished demand for currency and an ability to export it. In this matter the experience of 1907–8, when the monetary position in India was easy throughout, may prove, I think, misleading. During the eventful weeks in November 1907, when the Bank of England rate stood at 7 per cent, the Bank of Bengal rate did not rise above 6 per cent. No tendency whatever was apparent for there to be withdrawals of money from the banks in India, or for hoarding to reassert itself amongst the class which is learning to bank. On the other hand, the comparative failure of the crops left financiers with considerable rupee funds in their hands which they could not use. The banks had, therefore, no special difficulty in putting their hands on rupees and notes, and the only problem was for the Government to turn these into sterling. The easiness of the internal money market at that time and the total absence of banking trouble have produced the impression that there will be plenty of rupee funds available at a crisis, and that the only question will be as to whether the Government can turn these into sterling. The great development of Indian Joint Stock Banking since that time on not perfectly sound lines makes it doubtful whether bank troubles will be absent in an equal degree on the next occasion of difficulty.

There is no one now living in England within whose memory hoarding has been a normal thing. But in countries where the tradition is but lately dead or still lingers, it is apt to revive with astonishing vitality at the least sign of danger. The extent to which the people resorted to hoarding in France, Germany, and Austria (especially in the latter country) during the Balkan War was very remarkable, and has exhibited a danger to which the banking systems of those countries are still subject, although some had begun to forget it. If this is the case in European countries, there cannot be much doubt as to what would happen in India. Some banking failures, a hint of political trouble,—and the old habits will come back, whatever progress banking may seem to have made in a time of prosperity.

But, secondly, assuming a sharp financial crisis to be accompanied by increased hoarding, it would plainly be better if it were a hoarding of rupees and notes rather than of gold. It is not impossible that this might be the case. A trust in the Government’s capacity to meet its obligations will persist some time after all confidence in private institutions has been dissolved. In Austria, for example, the hoarding was not so much of gold or silver as of notes. I believe that in some parts of India, especially in those where gold has made relatively little progress, hoards are sometimes held already to a fair extent in notes. I know, for example, a very conservative Brahmin family, small landowners in Eastern Bengal, where this is the case. Once a week the head of the family will retire privately to a corner of the roof of the house, take out the little hoard of notes with ritual care, count and check them, dust each with a feather brush, and lay them out in the sun to air and to recover from any trace of damp. If a note shows signs of age or wear, it is taken to the nearest currency office and changed for a new one. In troubled times such a family would hoard more notes or silver, not gold. This, however, is no more than an illustration of the point I have already dwelt on and emphasised—the manner in which any increase in the popularity of gold diminishes the stability of the currency.

27. Returning from these digressions, I conclude that the Government will not be able in practice to restrict its responsibility to the currency, and may have to take a part in moderating the consequences of rash or unfortunate banking, and in meeting an adverse balance of indebtedness. This conclusion brings us to the statistical problem. Is the £40,000,000, which I put forward as a safe maximum for the reserves, so far as the convertibility of the currency is concerned, still adequate when the possible magnitude of India’s adverse balance of indebtedness is our test of sufficiency?

This problem is even less capable than the former of exact solution. The variable elements in India’s international balance–sheet are chiefly (i.) the excess of exports over imports, including treasure, i.e. the trade balance; (ii.) the amount of new fixed capital lent to India by European capitalists; and (iii.) the amount of short–period loans afforded to India by the European Money Market.

We require to know the magnitude of possible variation in these items, rather than the absolute amount of the various annual payments which India has to make, in order to gauge the possible balance of indebtedness against her. The greatest stress is commonly placed on the first of them—the trade balance. But in the normal state of affairs receipts and payments only balance after account has been taken of capital transactions; and if a certain amount of new capital has been flowing in every year, a slackening of this flow affects the balance as adversely as a reduction in the volume of exports affects it. In 1907–8 the adverse balance of indebtedness was largely due to a change in the trade balance;—on the one hand, goods ordered during the boom continued to pour into Bombay for some weeks after they had become unsaleable, thus continuing for a time a large supply of bills on India, while, on the other hand, the failure of the monsoon and consequent anticipations of a scanty harvest cut off a considerable part of the normal supply of trade bills on London. But even on this occasion the adverse balance arose to a considerable extent out of changes in capital transactions under items (ii.) and (iii.). The acute stringency in the international money markets, occasioned by the position in America, made it necessary for Exchange Banks and others to reduce below their normal level their short–period borrowings (direct or indirect) in London for use in India; and this stringency also caused the flow of new investment to India to fall short of its usual volume.

Thus, of the adverse balance of some £25,000,000 which had to be met between September 1907 and September 1908, perhaps £18,000,000 was due to a change in the trade balance and £7,000,000 to a diminution of new capital transactions and to the non–renewal of some short–period loans. It is not easy, however, to argue from the experience of 1907–8 as to what will happen in the future. The volume of trade has expanded very greatly since that time, and the absolute variation in the favourable balance between good years and bad is likely to be correspondingly greater. In addition, the growth of banking in the intervening period has been on a very great scale; and there is, therefore, greater room for disturbance in the short–period loan market. If, moreover, the internal banking position in India is as weak as in Chapter VII. I make it out to be, a serious breakdown there may embarrass the Exchange Banks in London, however intrinsically sound the position of these Banks may really be, in their efforts to assist the Indian market.

28. These are the relevant considerations. But any conclusion as to the possible magnitude of the adverse balance at which one can arrive on the basis of them is little better than a guess. I will give my guess for what it is worth. I think the £40,000,000, which I have fixed as the maximum figure of what is required for the redemption in sterling of such notes and rupees as may be presented, is more than sufficient to meet the adverse balance that is at all likely to emerge in any single year. But I do not think it certain that this sum would be adequate to the necessities of two successive bad years. On the other hand, it is necessary to bear in mind that by the second bad year there would have been time for a very great reduction in the volume of imports, on account of the greatly reduced purchasing power of the people, and that this might go a long way towards righting the balance; also that, if there was a considerable liquidation of short–period loans in the first year, it would not be necessary to repeat this to anything like the same extent in the second year. In short, the natural forces tending towards equilibrium would begin in the second year to show themselves more strongly. Nor is it necessary to accumulate reserves in advance for every eventuality. Two bad years in succession are not very likely; and, if they do come, the Secretary of State will have ample time to make his arrangements for borrowing.

I think it a sufficient concession, therefore, if the £40,000,000 be given as the proper limit, not as before of the aggregate sterling resources of all kinds, but of the Gold Standard Reserve and the sterling branch of the Paper Currency Reserve (i.e. excluding the Cash Balances).

In a country such as India, where all available resources are required for capital expansion, and where it is not sound or humane policy to burden the present overmuch for the sake of the future, it is nearly as important to avoid extravagance in the reserve policy as to avoid undue parsimony. As the rupee and note circulation is increased, the proportion of reserves ought to grow, of course, pari passu. But in existing circumstances to hold much more than £40,000,000 in sterling in the Gold Standard Reserve and the Paper Currency Reserve together would border on extravagance. If the reserves were somewhat lower than this, I do not think it would necessarily be blameworthy to leave them so, provided it would prove a very burdensome thing to raise them. For the expedient of a loan is always available.My conclusion, rather, is that the reserves should be allowed to reach some such figure as this by the natural processes of growth, before sums are diverted from them to other purposes.

A very few years ago hopes of reaching so secure a position as this would have seemed chimerical. But the details given on p. 131 show that in December 1912 the sterling reserves already amounted to somewhat more than this. It is not yet clear, however, that their present amount is normal. If it turns out to be so, then a position of adequate strength has been attained already. But the form in which these reserves are held is open to much criticism, and this must be my next topic.

29. The criticisms which have had most popular vogue have been mainly directed against the absolute amount of the Gold Standard Reserve, against the investment of a large part of this reserve in securities, and against the maintenance in London of some part of the gold in the Currency Reserve.

In regard to the amount of the Gold Standard Reserve, Lord Curzon, in 1904, was inclined to think that £10,000,000 would be a proper figure. In 1905 Sir E. Law, the Financial Member of the Viceroy’s Council, suggested £20,000,000. In 1906 Sir E. Baker thought £20,000,000 a suitable minimum. More recently, in 1912, £25,000,000 is the amount which responsible officials have announced that they are aiming at. Sir E. Law and Sir E. Baker both based their estimates on the amount which the Secretary of State would require for his Home Charges if he had to curtail his drawings of Council Bills by one–third or one–half for a considerable period. I do not think that this is the most useful point of view from which to approach the question, or that the proper magnitude of the Gold Standard Reserve can be discussed without reference to the magnitude of the other reserves.

30. The other two criticisms quoted above lead on to the general question of how the sterling resources should be held and how they should be divided between the several Reserves. The second of these questions is mainly a matter of book–keeping, but has nevertheless some importance. The Government of India’s present system has no logical basis, is exceedingly difficult to understand, and has often led, in consequence, to a good deal of misunderstanding. The ideal system should be as simple and logical as is compatible with leaving the authorities a free hand to shift and adjust as the necessities of the moment may require. The present system is the outcome partly of historical origins, partly of the authorities not having allowed themselves by law a perfectly free hand. The much criticised practice, for example, of holding six crores of coined rupees in the Gold Standard Reserve is probably due to the provision by which that portion of the Currency Reserve, which is held in London, can be held only in gold. If rupees have to be released hurriedly from the silver portion of the Gold Standard Reserve in India, the authorities have a completely free hand as to the form in which they make the corresponding addition to their sterling reserves in London; whereas, if they are released from the Currency Reserve, the corresponding transference in London must be made wholly in gold coin—a course which may sometimes be exceedingly inconvenient at the moment.

31. If the authorities allowed themselves more latitude as to the manner in which the Currency Reserve might be held, it would be a mere book–keeping transaction to transfer to this reserve the rupees now held in silver in the Gold Standard Reserve and to replace them by a corresponding transfer of gold; but such an arrangement would be more logical and easier to understand.

32. I think, therefore, that there might be considerable advantages in the adoption of some general scheme for the reserves such as the following:—

(1) While it would be legal to hold the Gold Standard Reserve in any form—gold, securities, bills of exchange, loans, or rupees—it should be normal in good times to hold, say, £11,000,000 in sterling securities and the rest in gold either in London or India, but preferably in London.

(2) Power should be taken to invest a larger amount of the Currency Reserve than at present (say £7,500,000 sterling securities in addition to the rupee securities instead of £2,500,000 as at present), and to hold a prescribed maximum proportion (say one–third) of it in bills of exchange or on loan at short notice either in India or London.

All this, after the necessary change of law, could be effected by a change in book–keeping; and in December 1912 the account would have stood as follows (compare the actual state of affairs as given on p. 131):—

33. Some changes of substance might be added to these changes in book–keeping and are naturally suggested by them. There is, first, the question whether the gold portion of the reserves ought to be held in India or in London. Readers of Chapter IV. will know that there are, in my opinion, no advantages in keeping gold in India, and that such a policy involves a direct money loss through the cost of originally carrying the gold to India and the cost of bringing it back again to London when, at a later date, it is required to support exchange. But Indian opinion views with suspicion the holding in London of the greater part of India’s gold reserve, and this opinion, though ill–founded, is likely to persist for some time to come. The amount of expense involved in keeping gold in the Indian reserves is, in relation to the issues involved, not great; and it might be well worth while to incur it in order to avoid the currency system’s falling under a suspicion, however ill–founded. It might be a satisfactory compromise, therefore, if, as a normal practice (but not as a legal requirement), the gold in the Gold Standard Reserve were held “ear–marked” at the Bank of England, but the gold in the Currency Reserve retained in India. It may be added that the authorities seem, in fact, to be moving somewhat in this direction; for it is understood to be their intention to accumulate £5,000,000 in gold “earmarked” for the Gold Standard Reserve.

If, however, a large part of the gold be held in India, it is of the utmost importance, in the event of a crisis, that the gold should be shipped by the Government to London and sterling drafts on London sold against it, or, if it were released in India, that the banks only should be allowed to get it, and on an undertaking to export it. Otherwise, if it were made freely available in India, a part might be lost and wasted (so far as the support of exchange is concerned) in hoards.

34. The suspicion which is felt with regard to the holding of Indian gold in London is exceedingly natural, and can be completely dissipated only by a fuller knowledge of the currency system and of the mechanism of the foreign exchanges, than the generality is likely to possess. It is natural to think that this gold is more at the disposal of the London Money Market than it would be if it were in India, and that the Secretary of State, under corrupt or interested pressure, can easily place it at the disposal of London financiers. Apart from the question how far the Secretary of State is really open to such pressure, it may be doubted whether he is likely to be exposed to it, because at a time of real stringency it will prove easy, I believe, for the London Market to get hold of some part of the Indian gold, whether held in London or in India, by perfectly legitimate means. India is normally in the position of owing London money; this debt is discharged partly by the consignment of goods, partly by the renewal at frequent intervals of short loans or credits made by the London Market to the Indian Market on bills of exchange or through the Exchange Banks, and partly by new permanent loans. If there is great stringency in the London Market and London is in urgent need of funds, the use of the last two methods can be so much restricted that India can be practically forced to pay what is owing in gold. It is, in fact, precisely because she is open to this pressure that it is necessary for a considerable gold reserve to be kept. So long, therefore, as the gold is freely available either in India or in London for the support of exchange, it is unlikely that it can be withheld from the London Money Market if this Market really wants it. If it is in London, India will be able, by the sale of telegraphic sterling transfers in Calcutta, to discharge her due obligations cheaply and without delay; if it is in Calcutta, additional charges and a loss of time must be incurred.

A feeling of jealousy on a country’s part, lest some other country should have a lien on its gold reserve, is frequently liable to arise at the present time, but is essentially opposed in spirit to the whole purpose and meaning of keeping gold reserves at all. Gold reserves are meant to be used in times of difficulty, and for the discharge of pressing obligations. It is absurd for a man with a large balance at his bank to default to his creditors, because a feeling of jealousy, in regard to any one in whose favour he draws a cheque, prevents him from ever drawing one. Mr. Bagehot certainly did England a great service in dissipating from the minds of her financiers this primitive prejudice;—for wonderfully few other countries have yet learnt that gold reserves, although no doubt they serve some purpose when they are held for show only, exist to much better purpose if they are held for use also.

Vague stirrings of the original sin of mercantilism always inherent in the mind of the natural man and urging him to regard gold as beyond everything essential wealth; jealousy of the too powerful magnates of the London Money Market obtaining what should belong to India’s Market for their own purposes; jealousy of the Secretary of State seeming, like a man who invests abroad, to seek in this way an independence of India in case of trouble; jealousy of Great Britain, who might use or regard India’s “ear–marked” gold as her own war–chest;—all combine to make a powerful, natural, and yet unfounded prejudice which it is exceedingly difficult to combat. Nothing is commoner than to read incitements against malevolent financiers who would seek to deprive India of her “fair share” of the world’s new gold. India must be allowed, I suppose, to hug her sterile favourite. In spite of the notorious fact that the Bank of England holds less gold than the Central Bank of any other first–class Power,—far less even than the Caja of the Argentine,—the belief will continue that the amount of gold a country holds at home, rather than the degree of promptness and certainty with which at all times it can meet its international engagements, is the measure of its financial strength.

35. What other changes of substance might be made usefully? By far the most important is connected with the proposed power to make advances from the Currency Reserve on bills of exchange and other approved security, as briefly described in Chapter III.

The policy pursued during 1912 of holding large cash balances in London and of lending them out in the London Market provoked widespread criticism both in India and at home. The line of thought underlying this criticism appears to me to be entirely reasonable. If the Government of India hold in London a penny more than is required to establish the stability of their financial system, they are certainly diverting resources from India, where they are greatly required, to the detriment of India’s own trade. I do not think, however, that the authorities are in fact open to any serious blame up to the present time. The holding of such large balances in London has not been part of a permanent policy, and was due in 1912 to a combination of circumstances which could not easily have been foreseen. And further, the Government have not until quite lately held more sterling resources altogether than have been required for the stability of the system. Public feeling points, nevertheless, in the direction of what, in the future, will be the right policy. If I am right in thinking that about £40,000,000 in the sterling Reserves is in present circumstances adequate, further accumulations in the hands of Government ought to be put at the disposal of the Indian Money Market and not converted into sterling. At present there is no machinery for doing this; and the absence of the appropriate arrangements constitutes a serious gap in the country’s financial system. What would be thought in France or Germany, or in any other European country, if an expansion of the note issue could not be made against the discount of home bills, but only against a corresponding deposit in cash cent per cent? Yet this is the position in India. The Government (apart from their deposits in the Presidency Banks, which will be dealt with later on) have no choice between allowing the funds which accumulate in their hands to lie absolutely idle in India and transferring them to London to earn a low rate of interest there.

If the use of notes continues to increase, and if £40,000,000 is an adequate figure for the sterling Reserves, a considerable sum may soon be available in India from the funds of the Paper Currency Reserve. Every addition, moreover, to the Gold Standard Reserve reduces to some extent the need for holding large amounts of sterling in the Paper Currency Reserve. Great advantages may be obtained if the surplus funds in the Paper Currency Reserve be used, not as a permanent or quasi–permanent loan to Indian traders, but to provide elasticity in the seasonal supply of currency and to make possible the increase in the stock of purchasing power in the form of money which is temporarily required in the busy season, without having to raise it in London. Permanent additions to the currency must be obtained in the future as they are at present. But temporary additions, due to seasonal demand, ought to be provided by a suitable organisation of credit money in India herself.

The advances from the Currency Reserve, therefore, must be made at a fairly high rate of interest and for periods not exceeding three months; and they should be so arranged that the Government would regain possession of its funds and the advances be reduced to nil in each slack season. Thus the Government would begin each busy season with their funds intact; and they would not lend until the success of the season was assured, and it was plain that the general position warranted it. The advances would be made in notes or rupees, according to the demand. These prosperity advances, therefore, are to be sharply distinguished from the adversity advances, discussed on pp. 160–163, which would be made in sterling drafts, and which would be governed by wholly different considerations.

36. There remains for discussion the question of the Government’s Cash Balances.I will begin with the method of managing that part of them which is held in India. It will be useful to know in what way this method has grown up.

When, in 1862, the right of note issue was taken away from the Presidency Banks, they were given as part recompense the use of the whole of that part of the Government balances which would otherwise have been received at the General Treasury, or at places where the Banks had branches, provided that sums in excess of a prescribed amount (70 lakhs in the case of the Bank of Bengal), if not held in cash, should be invested in Government paper and other authorised securities. Difficulties very soon arose (in 1863) through the Government’s requiring the use of its funds at a time when the Bank of Bengal could only sell out the securities in which it had invested them at a considerable loss. The system of virtually compelling the Banks to lock up the Government funds in securities, not easily saleable at all times, was plainly vicious, and in 1866 a new arrangement was made by which the Banks were permitted to use the whole of the balances, placed with them for the time being, for banking purposes. This seems to have worked satisfactorily up to 1874. In that year there was a famine in Bengal, and the Government had to buy rice in Burma and send it to Bengal for relief purposes. The rice had to be paid for in cash; but when the Government intimated to the Bank of Bombay that they would have to draw out about 30 lakhs (£300,000), their balance at the Bank then being about a crore (£1,000,000), the Bank was unable to let them have the money. In the correspondence which the Viceroy (Lord Northbrook) raised in regard to this, the Secretary of State (Lord Salisbury) suggested that the Government should release themselves from their engagement to leave their whole balances with the Banks and that they should retain the surplus in their own Treasury, or “lend it for short terms under suitable conditions as to interest and security.” This interesting suggestion, closely anticipating more recent proposals, was not acted on, the Indian authorities thinking it improper that the Government should appear to enter into competition with the Banks. But in 1876 the Reserve Treasury system was set up, the Government undertaking to leave, ordinarily, certain minimum amounts at the Banks and diverting the bulk of the rest of their funds into their own Reserve Treasury. In 1878 it proved inconvenient to divert from the Banks immediately the whole of the proceeds of a newly raised loan, and the Comptroller–General was told that he “would be at liberty, to the extent to which he could conveniently do so, to accommodate the Banks with temporary advances from the Reserve Treasury, provided they were willing to pay interest on such advances at the current rates.” No special security was taken from the Banks for the sums thus lent to them. For some time loans were freely given in this way. In 1889 the Government declared “that any assistance in relief of the Money Market which may be afforded by means of the Treasury Reserve can only be made (1) through the Bank, (2) at its published rate of discount, (3) in relief of temporary stringency.” Up to 1892, however, loans were made as before. From 1892 to 1899 loans were made very rarely. In 1899 the Secretary of State wrote to the authorities in India:—“I see no objection to your lending to the Presidency Banks, on the security of Government paper, at such rates of interest from time to time and for such periods as you think best. I am inclined to think that the rate should, as a rule, be not below the Bank rate.” Between 1899 and 1906 such loans were made on four or five occasions; but since 1906 there have been none. The balances left with the Banks without interest normally exceed, however, the prescribed minima.

The question of the proper employment of the Indian Cash Balances is, therefore, a very old one, and one in regard to which the Government have pursued no consistent policy. The effect of recent practice, however, has been on the whole to divert more funds than formerly from banking purposes. On the one hand the Government have been less willing to allow the Banks loans in addition to the normal balances kept with them, and on the other hand the general level of the cash balances has been getting higher.

While the Government’s practice has become stricter, it is arguable, I think, that there is less need for it. Originally, we have seen, the Government banked with the Presidency Banks, and difficulties arose because, the Government’s deposits bearing a high proportion to the Bank’s total resources, it was not easy to release a large part of these deposits suddenly. This would no longer be the case to nearly the same extent, even if the Government were to place much larger sums with the Banks. In 1870 the public deposits at £3,600,000 fell not far short of the total private deposits and exceeded by 50 per cent the capital and reserve of the Banks; in 1880 they were £1,900,000, and were about one–third of the private deposits; in 1890 the figures were £2,400,000, equal to about a quarter of the private deposits; in 1900, £1,900,000, equal to less than a quarter; in 1912 the Government deposits at £2,500,000 were not much more than a tenth of the private deposits. Moreover, the capital and reserves of the Banks have doubled since 1870.

37. The portion of the Cash Balances deposited, under the above arrangements, with the three Presidency Banks varies, of course, from week to week. The amount normally placed with the Head Offices of the Banks has fluctuated for some time in the neighbourhood of £1,000,000. In addition to this, further sums, fluctuating about £1,500,000, are held at branch offices of the Banks. These are deposited on a different understanding (see p. 184, footnote) from that governing the sums at the Head Offices, and are held literally at call, the amounts at particular branches being subject to wide variations. The total sums placed with the Banks, head and branch offices together, are usually about £2,000,000, and the maximum deposits in recent years have been about £3,000,000. On these deposits, as in the case of the Bank of England and the British Government deposits, the Banks pay no interest. The whole of the rest of the Government Balances is maintained in cash (rupees, notes, or sovereigns) in the various Government Treasuries. This is the present position. The Government are free in exceptional circumstances, as we have seen above, to place additional sums with the Presidency Banks on which interest is payable. But advantage has not been taken of these powers recently.

38. In view of the facts mentioned at the end of § 36, I am of opinion that the Reserve Treasury system needs reconsideration and that at present rather more funds, perhaps, than is necessary are withdrawn from the use of the Money Market into the Treasuries.

But the critics referred to in § 35 are following a false track when they argue that much offence lies in the present use of the Cash Balances, and that the main remedy for the seasonal stringency of the Indian Money Market is to be found in lending out these balances in India during the busy season. In thinking that any substantial remedy is to be obtained by loans from this source, they are paying too much attention to the transient circumstances of a single year. I believe, for the reasons given below, that the Indian Money Market cannot expect very much assistance from the Cash Balances, and that they have much more to hope for in the future from the growing resources of the Paper Currency Reserve.

Only under one or other of two conditions could loans from the Cash Balances be important: first, if the proceeds of taxation tended to accumulate in the Government Treasuries in the autumn and winter months so that the balances tended to be above their normal level at the busy season; and second, if the Government were to pursue the foolish policy of habitually keeping more ample balances than they really required. The first of these conditions is not fulfilled to any important extent. The land tax is collected, naturally, after the harvest has been sold, not during it; and at the end of the calendar year the surplus balances are small. The totals of the Indian Balances on August 1 and January 1 of recent years are shown below:—

(In Lakhs of Rupees)

The total balances include the working balances in the innumerable District Treasuries all over India and the sums already deposited with the Presidency Banks. When, therefore, we are considering to what extent the Government could lend at the height of the busy season, we must chiefly pay attention to the sums in the Reserve Treasuries on January 1. The above figures show conclusively that, as a rule, the Indian Money Market cannot expect substantial assistance from this source at the time of year when it is most needed. Except in 1913, the resources of the Reserve Treasuries on January 1 have been in recent years between £1,000,000 and £2,000,000.

After January 1, it is true, the revenue comes in rapidly. But as a matter of fact, the funds which accumulate from the proceeds of revenue between January and April are quickly released and returned to the Money Market, as matters now are, through the encashment of the Council Bills which are generally sold in large quantities at this time of year. If this money were to be released by loan instead of by the encashment of Council Bills, the effect would be that less funds would be remitted to London; and unless we assume that more funds are being remitted to London than are really required, this would put the Secretary of State to inconvenience in meeting the Home Charges. Only in years when sufficient funds had been remitted to London earlier in the financial year, therefore, would surplus funds be available in the Indian Treasury to any important extent even in the latter half of the busy season.

I do not say that the Government should not lend from the Cash Balances in India whenever exceptional circumstances may lead to their being at an unnecessarily high level in the busy season. But the sums which could be lent in this way would not generally be important, and the amount of elasticity which the financial system could gain by these loans would be small compared with what it might acquire from a reform of the Paper Currency Reserve. I should prefer, therefore, that the Indian Cash Balances should be held, so far as possible, in notes, thus increasing the capacity of the Currency Reserve, and that all advances should be made in form from the Currency Reserve. The question of the use of funds in the Cash Balances would then lapse into the question of the use of funds in the Paper Currency Reserve. But if a different system of book–keeping be preferred, no substantial change is involved in what I propose. The method of loaning from the Currency Reserve is applicable mutatis mutandis to loans from the Cash Balances.

39. Of the Cash Balances in London no more than a working account is kept with the Bank of England. The manner in which the rest is dealt with is best described in the words of an official memorandum issued by the India Office in 1913 [Cd. 6619]:—

The practice followed since 1838 has been to keep a certain part of the balance at the Bank (of England) and to lend the remainder at interest. The usual method is to lend to certain banks, discount houses, and stock–brokers of high standing, whose names are included in an approved list, now containing sixty–two names. The list is revised periodically, and applications for admission are carefully considered with reference to the standing and resources of the applicants and the nature of their business. Loans to borrowers on the approved list are granted as a rule for periods from three to five weeks, occasionally for six weeks, so that the whole balance could, if needed, be called in within six weeks. The Accountant–General informs the Secretary of State’s broker daily of the amount of loans that may be renewed, the amount of new loans that may be placed, or the amount that must be called. The broker is responsible for obtaining the best possible rate of interest. The amount of a loan is not paid out from the Secretary of State’s account at the Bank of England until the security has been lodged at the Bank. In 1909 it was found that the borrowers on the approved list could not take the full amount of the balances available for loan; and, in order to obtain employment for the funds, the broker was instructed, as a temporary measure, to deposit the excess amount from time to time with leading London banks, usually for periods of between one and three months.

40. In the autumn of 1912 a determined attack was made, in the Press and by means of questions in the House of Commons, on the management of the English Balances, as described above, and on their amount. Many of the questions were framed rather with some other object than to elicit information. But they undoubtedly had the result that the authorities published to the public much ampler details than were previously available. A valuable summary of these will be found in the official memorandum [Cd. 6619] from which I have just quoted. As the outcome of this very full inquisition into the whole subject, only two points have emerged in which, in my opinion, the authorities are open to criticism in detail—i.e., apart from wide questions of policy. They renewed India Bills (which were eventually paid off in December 1912) when they could have very well afforded to discharge them. If the season of 1912–13 had been a bad one, or if their expectations had been upset in any other way, it would always have been open to the India Council to issue the Bills afresh. Their action appears to the outside critic to have been one of ill–considered caution. The other point is a trifle and reflects, perhaps, on a curiosity of our economic organism rather than on the India Office. It was slightly shocking to discover that the Government broker, who is not even a whole–time officer, and has a separate business of his own besides his official duties, is the highest paid official of the Government with the sole exception of the Viceroy. He has probably been paid too high even on current city standards. But it suggests once again the old question how long it will be found necessary to pay city men so entirely out of proportion to what other servants of society commonly receive for performing social services not less useful or difficult.

41. Some of the conclusions of this chapter may be summarised. All countries, since the practice has been generally adopted of employing a medium of exchange composed of some cheaper material than the standard of value, must keep a monetary reserve. Where there is a State bank, the bank is usually entrusted with this duty. Where the State regulates the currency and the note issue without the intervention of a bank, the State must itself undertake it. The proper magnitude of the reserve must depend upon the particular circumstances of each country. In India the reserve must be unusually large, first, because India is a great country specially liable to wide fluctuations in her prosperity and trade on account of climatic conditions the character of which cannot be easily foreseen; and second, because a large amount of foreign capital is employed, not only in permanent investment, but in temporary loans withdrawable at short notice, and because against these foreign liabilities India holds no appreciable amount of international Stock Exchange securities capable of easy realisation. I have argued that £40,000,000 may be, perhaps, at present a suitable amount to be held by Government in its sterling Reserves. These Reserves are most useful if they are held in London, where they must necessarily be wanted whenever there is need to make use of them. In deference to a public opinion which does not clearly understand the purpose of the Reserves or the limitations under which the Secretary of State must needs act in managing his sterling resources, it may be worth while to allay a groundless suspicion by the compromise of holding a fair proportion of the reserve of actual gold coin in India herself. When a Reserve of some such amount as the above has been firmly established, the diversion of further funds into any form of sterling or into the London Market should be deliberately avoided.

Stability has been attained already, or is about to be. So, on the whole, has economy, though some current opinion in regard to the use of gold puts it in jeopardy. The system still wants elasticity. A machinery ought to be set up, therefore, by which further funds, accumulating in the hands of Government through the increased use of notes, may be used in India to afford the needed elasticity in the seasonal supply of currency.

Let the Indian public learn that it is extravagant to use gold as a medium of exchange, foolish to lessen the utility of their reserves through suspicion of the London Money Market, and highly advantageous to their own trade and to the resources of their own money market to develop the use of notes; and their financial system may soon become wonderfully well adapted to the particular circumstances of their situation. The history of the last twelve years has been transitional. The authorities have been—wisely—building up the reserves they ought to have. This process has necessarily diverted funds from the Indian Money Market, and has naturally excited some measure of opposition. But the fruits of cautious growth may soon be reaped.

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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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