This article throws light upon the five main standards of the Indian currency system. The standards are: 1. The Silver Standard 2. The Period of Transition in the Exchange Regime 3. The Gold Exchange Standard 4. The Period of Managed Exchange Standard 5. Hilton-Young Commission—The Gold Bullion Standard 6. Sterling Exchange Standard.
Indian Currency System Standard # 1. The Silver Standard (1835-93):
The monetary standard that India had experimented in the early nineteenth century was extremely confusing.
Before 1835, both gold and silver coins were in circulation. In addition, copper coins and shells were in circulation.
In fact, before this date, an utter chaos and confusion prevailed, particularly after the disintegration of the Mughal Empire. In the middle of the eighteenth century, the country was flooded with a bewildering multiplicity of coins.
There were in India as many as 994 coins of both gold and silver and of varying weight and fineness. To restore some order in this monetary chaos, the East India Company (EIC) gave attention to the problem of evolving a suitable as well as a uniform currency standard in India.
Since bimetallism was the fashionable monetary standard in Europe at that time, the EIC, by an Act of 1818, introduced bimetallism where both gold and silver coins circulated simultaneously.
However, the consequent operation of the Gresham’s Law (“Bad money drives good money out of circulation.”) forced the EIC to stop experiment with bimetallism. At the same time, the Government took a wise decision in 1835 when Indian currency was put on monometallic standard — silver standard — by the Act No. XVIII.
The Currency Act of 1835 was a landmark in the Indian currency which made silver rupee weighing 180 grains (tory)11/12 -ths fine (containing 165 grains of fine silver) as the sole unlimited legal tender throughout British India. As a result, gold coins were demonetized.
In practice, though India was deprived of the gold standard, gold coins by no means continued to circulate. Rather, the Government of India encouraged coinage of gold since it brought revenue in the form of seignior age (a percentage on melted bullion). By a proclamation issued in 1841, gold mohurs were accepted in public treasuries at the rate of one gold mohur equal to 15 silver rupees.
But the great gold discoveries in Australia and California caused prices of gold to tumble down continuously. As a result, gold mohur became overvalued (i.e., bad money) which began to drive silver (i.e., good money) out of circulation. Alarmed by this development, a notification was issued which stated that after 1 January 1853, no gold coins of any sort would be received by public treasuries within the territories of the EIC.
By this notification, gold was thus demonetized. But this gave rise to a new difficulty. The immediate consequence of demonetization of gold currency was that gold coins of £120 million disappeared from circulation resulting in liquidity crisis in the money market.
Side by side, this problem was aggravated by the rising demand for silver owing to increased non-monetary uses. At the same time, after 1850, the production of silver was dwindling.
This “currency famine” was intensified as the Indian economy was gradually switching over from kind economy to cash economy. Growing volume of internal and external commerce added fuel to the fire. In the absence of credit media, a state of acute monetary stringency developed, which even led to the creation and circulation of private gold ingot currency of a particular weight and shape.
An all-round outcry came off for the introduction of gold currency in India. But the government at that time was not in a mood to introduce gold currency in this poor country and instead preferred paper currency system to correct the defects of the silver standard.
Accordingly, the Paper Currency Act of 1861 was passed which gave India a legal tender paper currency. The Act abolished the rights of note issue by the ‘Presidency Banks of Bengal, Bombay, and Madras and unified the issue of currency in the hands of the ‘government’.
Consequent upon the American Civil War (1861-1864), the demand for Indian products in English market rose to a great height. This boom in export trade brought huge quantities of gold to India. During this time, as silver and paper currency could not cope up with the increased monetary demand, gold currency began to be used as money by the people, though gold was not a legal tender money.
To ease the situation, the Government of India, in its notification issued in 1864, decided to receive in payment of public dues the sovereigns and half- sovereigns, and to offer the same to its creditors at the fixed rate of £1 = Rs. 10. As a result of the slight fall in the market value of silver at Rs. 10, the sovereign was undervalued. The 1864 notification became inoperative.
As a result, the currency situation landed into the quagmire of uncertainty and chaos. In response to persistent public demand, the Government of India appointed the Mansfield Commission in 1866.
The Commission recommended the introduction of:
(i) A universal currency note en-cashable throughout the country, and
(ii) Gold coins of Rs. 15, Rs. 10, and Rs. 5. But the Commission’s suggestions did not find favour with the Government.
However, the Government respected the Commission’s recommendation relating to the gold-silver exchange ratio. Following the recommendations, the Government in 1868 slightly altered the sovereign and the revised parity was declared at £1 = Rs. 10.5. In May 1874, the Government categorically announced its unwillingness to take any step towards the adoption of gold currency. Had it been accepted, the country would have been saved from the embarrassment of the subsequent period.
Gold-Silver Exchange Ratio:
During the last quarter of the nineteenth century, a dramatic change had occurred in the monetary status following serious depreciation in the international status of silver in terms of gold. The tremendous fall in the value of silver was due to the interplay of various factors.
First, the decline in silver prices became marked in 1873 mainly due to the enormous increase in its output following the discovery of new silver mines in South America and Mexico. Secondly, coupled with this, there was a slackening in its demand following its demonetization in Germany (1873), the Scandinavian countries (1874), and subsequently the Latin Union (countries) and adoption of gold standard in several countries.
All this led to a sharp fall in the price of silver from 58 pence per ounce (1875) to 37½ pence in 1892 and to 27 pence in 1899. As silver lost its value relative to gold, the rupee-sterling exchange ratio also tumbled down. The average sterling-rupee exchange rate declined from 2 shilling (s) in 1872 to 1 shilling 2 pence (d) in 1892.
Whatever the causes of the fall in the value of silver relative to gold and consequently the falling exchange rate, it created financial derangement in the country as Indian currency was based on silver and not on sterling. The effects of depreciation of the rupee can be gauzed from the following developments.
In the first place, it adversely affected the Government. It was noted even in 1876 that every fall of a penny in the exchange rate meant that about a crore of rupees had to be found by the Government to make the same sterling payment in England. Sterling obligations (like interest on public debt, pensions, payments to the War Office, the cost of Government stores, etc.) were necessary to meet the “Home Charges” annually.
The Government had to remit to England “more than forty millions of rupees in excess of the amount what would have been necessary had that fall not taken place”. The total loss due to the fall in exchange rate during 1875-89 stood at roughly Rs. 154 crore. To meet this additional burden, additional taxation (like salt tax, income tax, enhancement of land revenue) became necessary.
In the process, Indian ryots became the worst casualties. In this way, the depreciation of the rupee aggravated the budgetary problem for the Government of India. As a result, the Indian budget became a “gamble in exchange rate” and “nightmare of Indian financiers” who desperately searched ways and means for balancing their budgets.
Secondly, the interests of commercial classes, foreign investors, and European employees were severely jolted following this “loss by exchange”. The flow of foreign capital, mainly British capital, virtually came to a standstill as investors learnt that profits made in India would lose their value in relation to sterling.
On the other hand, for British goods, higher rupee prices had now to be paid. This, therefore, obstructed imports of machinery. Trade and commerce thus became speculative and uncertain in character. It caused undue hardships to civil servants and other Englishmen who had to remit money, i.e., rupees, to England to get the equivalent amount of sovereigns for maintaining their families in England. In fact, a serious discontent was then blowing up in this country among the own people of the Government of India. They insisted on adequate compensation for the loss they had to sustain.
Thirdly, the influx of depreciated silver on a large-scale into India began to be largely minted into rupee coins. This heavy coinage was one of the prime causes of rising domestic price level in India. Thus the exchange problem had become a “continually growing evil”. However, attempts were made to increase the gold price of silver. Proposals were made to adopt bimetallism on an international basis. But England, in the International Monetary Conference held in Brussels in 1892, expressed her strong desire to cling to monolithic gold standard.
As a result, the prospect for any agreement on silver issue on an international level was cold storage. Suggestions for the immediate closure of mints for the free coinage of silver and making measures for the introduction of long-cherished gold standard currency were floated by the Secretary of State and the Indian public.
Indian Currency System Standard # 2. The Period of Transition in the Exchange Regime (1893-98):
The Indian public tenaciously agitated and demanded the adoption of the gold standard for obvious reasons. Proposals were made to close down the mints for the free or unrestricted coinage of silver and to open the mints for the free coinage of gold. In order to study the feasibility of such proposals, a committee under the chairmanship of Lord Herschell was appointed in 1892.
The Committee recommended that the free coinage of silver to the public should be suspended, but empowered the Government to coin rupees in exchange for sovereigns at the rate of £ 1 = Rs. 15 (i.e., Re 1 = Is. 4d.). To give an effect to these recommendations, an Act was passed in 1893 to amend the Indian Coinage Act, 1879 and the Indian Paper Currency Act, 1882.
These amendments provided for the immediate closure of Indian mints for the free coinage of both gold and silver. The Coinage Act of 1893 thus marked the abandonment of the silver standard which was in force since 1835. However, the Government retained the power to coin silver rupees on its own account.
Simultaneously, three notifications were issued:
(i) Mints would accept gold in exchange for rupees (at the rate of 7.53344 grains of fine gold or Is. 4d. per rupee);
(ii) Sovereigns and half-sovereign would be accepted at public treasures at the rate of Rs. 15 per sovereign in payment of sums due to the government; and
(iii) Paper currency notes would be issued in exchange either for British gold coins or for gold bullion.
As a result of these arrangements, the Indian rupee became a token coin and India ceased to be on a full-fledged silver standard. Indian rupee was retained as an unlimited legal tender. The resultant monetary system thus resembled an inconvertible standard. The rationale of this system was “avowedly transitional”.
Government measures were interpreted as a preparatory stage for the eventual establishment of the gold standard with a gold currency. The aims of the 1893 Act were many. It intended to (i) arrest the decline in the exchange value of the silver, (ii) discourage the inflow of silver, (iii) familiarize the use of gold, and (iv) import of foreign capital.
The Act of 1893 came in for sharp condemnation at the hands of the national leaders. It is true that the main object of the Government was fulfilled. The value of rupee rose after 1893. European officials welcomed the measure. But Indian leaders thought otherwise.
Dadabhai Naoroji was against the artificial bolstering of the value, of silver since it amounted to “covert exaction of about 45 p.c. more taxation”. He denounced the closure of mints as “illegal, dishonourable and a despotic Act”. R. C. Dutt also complained of the Act in the same vein. To him, the Act was “unnatural and desperate and dangerous”.
Though the immediate object of the Act of 1893 was fulfilled, a vicious circle was set up in which the interdependent variables were (i) an increase of extract, (ii) an increase of sterling indebtedness, and (iii) an increase in taxation to extract, as much as possible, internal resources.
In addition, the closure of mints resulted in stringency in money market, but the introduction of a gold standard currency was characteristically ignored by the Government and the transition period continued. Meanwhile, exchange value of rupee had risen from 1s. 1½ d. in 1894 to nearly Is. 4d. in 1898.
Thus India was “approaching the attainment of stability in exchange”. People thought that the time was quite opportune for the introduction of a gold standard. Above all, the Government of India continued to press for gold standard and urged the Secretary of State to bring an end to the period, of transition. This led to the appointment of a committee under the chairmanship of Henry Fowler.
Indian Currency System Standard # 3. The Gold Exchange Standard (1898-1916):
Indian leaders throughout the nineteenth century were constantly demanding the introduction of a gold standard currency, but the Secretary of State showed its deadening indifference towards this demand. Not only the Indian public but also the Government of India was intermittently raising hullabaloo for the introduction of the gold standard.
However, when the free coinage of silver was stopped by the Act of 1893, it was interpreted to be a preparatory stage for introducing a full-fledged gold standard. Seeing a virtual stability in the exchange value of rupee, it seemed that the Indian currency was going to be established on a gold basis. This led to the appointment of a Currency Committee—popularly known as the Fowler Committee in 1898 to suggest measures for the ‘establishment of a satisfactory system of currency in India, and for securing, as far as practicable, a stable exchange’ between India and the British Government.
The Fowler Committee reported in 1898 and made the following recommendations:
(i) The Indian mints should be thrown open to unrestricted coinage of gold and mints should remain closed to the free coinage of silver.
(ii) The British gold coins (sovereigns and half-sovereigns) should be made legal tender in India at the rate of £1 = Rs. 15 (or Re 1 = 1s. 4d.)
(iii) The rupee should remain unlimited legal tender.
(iv) The government should continue to give rupees in exchange of gold for remittance abroad but the government should be under no obligation to give gold in exchange for rupees for internal purposes.
(v) To secure the convertibility of rupees into sovereigns, a special Gold Reserve should be established by buying gold and sterling securities with the profits of rupee coinage.
The Committee’s other recommendations subsequently proved detrimental for the establishment of a gold standard with gold currency. For example, it recommended rupee to remain unlimited legal tender. Although under the full- fledged gold standard, rupee should have been a token coin (whose intrinsic value or metallic value is less than the face value) of limited legal tender, subsidiary to the sovereign.
The Government faithfully complied with all the recommendations of the Committee, except the one relating to the establishment of gold mints. Frankly speaking, attempts for opening a gold mint in India proved abortive on account of the opposition of the British Treasury.
A Gold Standard Reserve was formed in 1900 out of the profits of rupee coinage on ‘government account’ and the Government of India decided to keep the gold reserve in a chest in India. But the Secretary of State refused to oblige this decision and decided that profits from the rupee coinage were to be shipped to London in the form of gold.
Side by side, an Indian Branch of the Gold Standard Reserve was constituted in 1906 in order to maintain a part of the reserve in India in the form of rupees. The purpose of this Indian Branch was to meet the demand for rupees by the people of the country so that the exchange rate could be stabilized at the accepted rate, viz. 1s. 4d. per rupee.
In addition, gold held in the paper currency chest in London, known as the Paper Currency Reserve, was utilised for the purchase of silver coinage of rupee. Thus the currency standard that came into operation since 1898 created three funds: the Gold Standard Reserve, Silver Branch of the Gold Standard Reserve, and the Paper Currency Reserve.
Thus the Indian currency system deflected from the lines suggested by the Fowler Committee and landed into the patchwork of improvisations that resulted in a Gold Exchange Standard instead of a gold standard. The newly found currency standard let to the establishment of a gold standard without a gold currency! Gold was to be made available only for the purpose of foreign remittances.
Despite repeated representations, establishment of a gold mint in Bombay once again became a distant cry. In the ultimate analysis, Gold Exchange Standard (GES) operated as a sterling exchange standard since the bulk of Indian remittances was to England.
The Mechanism of GES:
The operation of the GES in India had been facilitated by the:
(i) Periodical sales of Council Bills in England; and
(ii) Sales of gold by Reverse Councils.
In the past, normal method of remittance of gold was made to pay India’s export surplus. But as India was not on the pure gold standard at the beginning of the 20th century, an inflow of gold to pay her export surplus was not only became token coin but also became inconvertible.
In view of this distinguishing characteristic of GES, any excess demand for rupees in terms of sterling would cause a rise in the exchange value of rupee above the stipulated ceiling rate (the upper specie point) of Is. d. To prevent the rupee from rising, the Secretary of State undertook to sell Council Bills in unlimited amounts at a rate of 1s. 4 1/8 d. per rupee whenever there was a demand for rupees from foreigners in London.
So these Council Bills were sold in England to British importers of Indian goods for which they paid pound sterling in England. The Government of India gave rupees to Indian exporters mentioned in the bill and thus they were paid for their goods. In view of this arrangement, the Council Bills were also called the ‘Rupee Drafts’.
Anyway, the Council Bills or the Rupee Drafts were the orders of the Secretary of State to the Government of India to pay the holder of the bill a sum of rupees specified in the bill. The system of Council Bills avoided the rather complicated as well as the costly method of payment in gold by the foreigners for payments to the Indian merchants.
Further, it was utilised to lay down funds in London for facilitating the smooth payment of Home Charges. The proceeds of the sale of the Council Bills were also used for purchasing silver to coin rupees in India. Meanwhile, general monetary stringency gripped all over the world in 1907. As a result, exchange value of the rupee sagged.
Indian exports declined leading to an excess demand for sterling. In consequence of this development, the sterling value of rupee tended to fall below the lower limit (or lower specie point) of 1s.3 ⅔ 9/2 d. To prevent this fall, the Government of India started selling Reverse Councils (or the Selling Drafts) at the rate of 1s. 3 ⅔ 9/2 d. per rupee. Thus the Reverse Councils were the orders by the Government of India on the Secretary of State to make payment a certain sum of sterling specified to British exporters in return for rupees received by them from the Indian importers of British goods. Thus the GES through its Council Bills and Reverse Councils aimed at exchange stability.
Due to the interplay of various forces, the Indian monetary standard drifted towards the GES to which Indian people was averse. The main reason behind this move was that the Government was in conflicting mind for the introduction of gold currency in this country. Threatened by pressure from the Indian people and the bewildering monetary situation, the Government of India often committed that it would respect Indian demand of introducing gold currency. Once the monetary conditions improved, it un-hesitantly betrayed its own commitment.
Thus what is clear is that the Government of India did not make any sincere, serious and sustained efforts to put India on a gold standard currency. It is true that the Government made an active attempt in 1899 and 1900 to introduce gold of 2 million pounds only in circulation, knowing fully well that such a paltry sum was awfully inadequate considering the needs of the country.
Further, the Government showed its indifference to the urgent demand for coins of small denominations in normal times. Gold coins that it circulated did not suit admirably for that purpose. Many of the gold coins, therefore, returned back to the government who outcries at that time that Indians were not keen on having a gold standard currency in currency in circulation. The Chamberlain Commission in 1914, while pointing on the failure of such experiments, remarked that the fault did not lie with the British Government but with the Indian people who disliked gold coins. In fact, likes and dislikes of the Government of India caused currency standard to drift aimlessly.
The following wordings of the Royal Commission on Indian Finance and Currency, 1914, may be recorded here: “The investment of the Gold Standard Reserve in securities in London, the dropping of the scheme for a gold mint in India, the practice of selling Council Drafts at something below gold point against the Currency Reserve, the establishment of the silver branch of the Gold Standard Reserve, the diversion of money from that Reserve for capital expenditure in 1907 and its use in 1908 for meeting drafts sold by the Government of India on London to private traders are all examples of divergences from the scheme adumbrated by the Committee. The Indian currency system today differs considerably from that contemplated by the Committee …”
Following the recommendations of the Fowler Committee, three funds—the Gold Standard Reserve, silver branch of the Gold Standard Reserve and the Paper Currency Reserve—were set up. Unfortunately, these funds were jumbled up resulting in chaos and confusion. The effect of these experiments was indeed the emergence of the Gold Exchange Standard, an act of aberration from the cherished goal of gold standard.
Evaluation of the GES:
Now we will see how far this currency standard accompanied benefits or troubles for India. Although GES did not satisfy the Indian people, yet it was an accidental find for India that received praise from Lord Keynes and the Chamberlain Commission. It did not receive unanimous censure like other currency arrangements since it enabled the country to have the benefits of long period exchange stability within narrow limits, without having to maintain a large gold reserve for maintaining the convertibility of currency into gold. “But so far the Indian economy as a whole is concerned, probably stability of the rate of exchange was not so significant as making the monetary system adjustable and flexible to meet seasonal requirements within the country.”
Maintenance of the stability in the exchange rate got utmost priority since it acted as a great prop for India-British trade.
Secondly, it was economical than a full-fledged gold standard since it did not require gold standard with a gold currency in circulation. Hence a greater economy in the use of gold.
Further, gold reserves kept in London earned some interest on being invested there. Had it been kept here, it would have been quite unfruitful.
However, most of these merits proved to be illusory. Dhires Bhattacharyya argued that the GES—which was evolved out of a series of make-shift currency experiments’—”mystified Indian opinion to such an extent that it was often believed to be the root cause of all economic ills from which India suffered.”
The system came under fierce attack from the following angles:
Firstly, the structure of the GES and its operations were too complex and complicated that can be apprehended only by the intellect. Its operations required the maintenance of three-tier reserves whose functions were not readily understood in the early days resulting in utter confusion and suspicion.
The gold kept in the reserves was shipped to London while India had to remain content with a currency system “which neither maintained a visible link with gold nor used a full-valued coin made of silver”.
Secondly, the system involved a cumbrous duplication of reserves. Though these reserves had specific division of responsibilities, but, sadly, in practice, these reserves met with duplicating functions.
That is to say, these reserves were not allowed to do their respective functions. For instance, the Paper Currency Reserve was supposed to ensure the convertibility of rupee notes. In practice, the other two reserves—in tandem with the Paper Currency Reserve—were utilised for maintaining the exchange stability.
Thirdly, the location and use of Gold Standard Reserve also came under big fire. Of course, the Chamberlain Commission justified the location of this reserve in London “which is the centre of the world’s money market”. In fact, it was “one of the chief buttresses” of the then currency arrangements. But the English capitalists obtained the benefit of reserves kept in England and invested in short loans.
On the one hand, such arrangement yielded some benefits to the monetary authorities in the form of interest income out of the Gold Standard Reserve. On the other hand, this caused liquidity crisis in the Indian money market since reserves were kept in London. “The system thus operated on a deflationary bias at a time when Indian economic interests might be galvanized into action by the stimulus of a profit inflation.”
Fourthly, the system did not inspire public confidence. The two things that were constantly agitating the Indian minds almost right from the British rule were the establishment of a full-fledged gold standard currency system and the central bank. But what was actually offered in the name of the GES was a currency system consisting of two kinds of tokens—rupee notes and silver rupees.
The gold sovereigns did not circulate at all. Rupee notes were convertible into silver rupees, but these silver rupees were ‘since 1893’ little better than notes printed on silver. This meant that one form of token money was convertible into another form of token money. The country had to wait till 1935 for the establishment of a central bank. Thus the currency and exchange policy followed by the British rulers intended to humiliate public demand.
Fifthly, the exchange standard of 1898-1917 could be interpreted as a ‘fair weather standard’. It was not an automatic standard but wholly dependent on the will of the Government. For the efficient functioning of this currency standard, it required that India’s trade surplus should remain within moderate limit and the price of silver should remain at such a level that the face value must not exceed the metallic value.
If any of the conditions were not satisfied, GES would get disrupted. The working of this currency arrangement required an artificial mechanism—the sale of Council Bills and the Reverse Councils; the system had no self-correcting mechanism.
Finally, the system lacked elasticity, particularly contract-ability—there was no provision to meet the genuine demand for an increase in currency during the harvesting of crops. It is true that the Gold Standard was expensive and the GES was cheap. Cheapness is not the only criterion to have an ideal currency system. GES turned out to be a poor substitute for a full-fledged gold standard in the context of the disadvantages mentioned above.
Breakdown of the GES:
The idea of having gold coins in circulation never died down in this country. Around 1911, again fresh proposals were made for gold coinage and a gold mint. This led to the establishment of a Royal Commission of Indian Currency and Finance in 1913 under the chairmanship of Austin Chamberlain “to enquire into the location and management” of the gold reserve in addition to the question of introducing gold coinage. The major recommendations of the Commission were under the consideration of the Government of India when the First World War broke out and created a-new situation which called for new remedies.
The period from August 1914 to 1915 could be called a crisis of confidence and the general dislocation of trade and business. This led to a weakening of the exchange, a run on the Indian gold stocks which took the form of a pressing demand for gold in exchange for notes, growing demand for encashment of notes and heavy withdrawal of Post Office Saving Bank deposits.
As all these events were anticipated, after about one year confidence in the currency was restored by freely meeting the demands of the public. But the Government faced serious unanticipated difficulties towards the end of 1916. Complications arose out of the sudden expansion of foreign demand for Indian currency and the rise in the price of silver.
This was due to the interplay of two factors:
(i) Huge excess of exports over imports due to the increased demand of Indian goods for the prosecution of the World War I, and
(ii) The reduction of imports.
The net result was an exceptionally favourable balance of trade leading to an impressive increase in the demand for Indian rupees. To meet this demand, the Government resorted to an enormous mintage of rupees. For coinage purposes, imports of silver rose to a new height resulting in a tremendous spurt in silver prices from 27 d. per ounce in 1915 to 55 d. in September 1917 and to 78 d. per ounce in December 1919.
The results were catastrophic. Due to such abnormal rise in the price of silver and the reduction of gold imports, all mathematics of exchange stability went haywire; the Government could not go on coining rupees at 1s. 4d. The exchange rate sky-rocketed to 2s. 4d. in December 1919. As the price of silver rose, the rupee ceased to be a token coin; people found profit in melting and exporting it.
For the Government of India, the sale of Council Bills at the prevailing exchange rate of 1s. 4d. became well-nigh impossible without incurring a loss. To avoid loss, the Government took several measures, but without any halt in the rising trends of exchange rate. Thus the GES broke down around 1917 and the rupee was allowed to find its level of international value.
Indian Currency System Standard # 4. The Period of Managed Exchange Standard (1919-27)—the Post-War-Bungling:
Meanwhile, the Government of India appointed another Committee in May 1919 with Sir Babington-Smith as chairman to consider the on-going currency crisis and to make recommendations for ensuring a stable gold exchange standard.
The principal recommendations of the Committee were:
(i) Rupee should remain unlimited legal tender;
(ii) Rupee should have a fixed exchange value which should be expressed in terms of gold at the rate of Re 1 = 2s. or 24 d.;
(iii) Sovereigns should be made legal tender at the rate of Rs. 10 to one sovereign;
(iv) Export and import of gold into and from India should be free from government control; and
(v) Gold mint at Bombay should be opened for the coinage of sovereigns and half-sovereigns.
One of the Indian members of the Committee, D. M. Dalai, strongly pleaded for the old ratio of 1s. 4d. per rupee as the rise in the price level was artificial and, hence, temporary. Anyway, most of these recommendations of the Committee were accepted by the Government.
The main assumptions of the Committee, however, proved wrong. It misread the prevailing circumstances.
Its recommendations were based on:
(i) Highly favourable balance of trade consequent upon the World War I, and
(ii) The high price of silver.
But once the War was terminated, the post-War trading boom exhausted its force. As soon as the War was over, balance of trade as usual turned unfavorable. The Committee thought that the rise in the exchange rate was caused by the high price of silver. Unfortunately, the effort to maintain the rupee at 2s. gold rate which meant a considerable “overvaluation of the rupee” failed.
The Government, however, vainly took steps to stabilise the rupee at 2s. sterling. As sterling balances dwindled, the exchange rate fell below Is. 3d. sterling and Is. gold in early 1921. The 2s. ratio remained on the statute book, but it was ineffective. Thus the policy “which was avowedly adopted to secure fixity of exchange produced the greatest fluctuations in the exchanges of any solvent country and widespread disturbance of trade, heavy loss to government, and brought hundreds of big traders to the verge of bankruptcy”.
Attempts were made to stem the rot by adopting the policy of contraction of currency and the curtailment of public expenditure. The exchange rate was allowed to find its level as the government remained simply a watcher of events without taking any decisive action. By January 1923, the exchange rate began to rise with the revival of favourable balance of trade. It rose to the level of Is. 6d. sterling in October 1924 at which price it was equivalent to above Is. 4d. gold.
The period 1917-27 could be characterised as the period of managed exchange rate. Following the recommendations of the Committee’s report, rupee was linked to sterling at the rate of Re 1 = 2s. gold. But after the failure of the attempt to stabilise the exchange rate, the Government directed its efforts to prevent a fall in exchange below Is. 4d. gold from October 1924. This phase of currency arrangement has been described as a policy of ‘masterly inactivity’—thus allowing the rupee to become a free currency delinked from gold and sterling.
Indian Currency System Standard # 5. Hilton-Young Commission—The Gold Bullion Standard (1927-31):
After the abandonment of GES in 1917, the governmental policy of the period 1921 -.to 1925 came to be known as the policy of ‘masterly inactivity’ when rupee was delinked from gold and sterling. Meanwhile, public criticism was coming to an ugly head. In response to persistent public demand, the Government of India appointed, in August 1925, a Royal Commission on Indian Finance and Currency under the chairmanship of Edward Hilton-Young to consider whether any modifications were desirable and to make appropriate recommendations. It submitted its ‘epoch making’ report in July 1926.
Its three main recommendations related to:
(i) The currency system best fitted for India;
(ii) The rate at which rupee should be stabilized; and
(iii) The establishment of a central bank.
In regard to the selection of a currency system best fitted for India, the Commission examined the pros and cons of four possible alternatives:
(i) The sterling exchange standard,
(ii) The gold standard with gold currency,
(iii) The GES, and
(iv) The gold bullion standard (GBS).
All these except the last one were rejected. The Commission rejected the rehabilitation of GES because it lacked elasticity. Further, it involved duplication of reserves with a division of responsibility for the control of credit and currency policy. Above all, expansion and contraction of currency under the GES was wholly dependent on the whims of the currency authority. In view of the defects that crept into the functioning of the GES, the Commission proposed a “gold standard without gold currency in circulation”, called the GBS, as the future monetary system for India.
Some other alternative monetary standards did not find favour with the Commission. On the contrary, the Commission was of the opinion that the GBS would be a simple, cheap and elastic form of monetary system. This would inspire public confidence by linking the currency with gold “in a manner that is real and conspicuously simple” and would also promote habits of banking and investment among people.
The essence of the proposal was that the stability of the currency note and the silver rupee in terms of gold would be secured by making the currency convertible directly into gold for all purposes. But gold would not circulate as money.
Features of the GBS:
The main features of the GBS, as proposed by the Commission, were:
(i) Silver rupee and currency notes should remain the ordinary medium of circulation. The rupee should be linked to gold and not to sterling.
(ii) Sovereigns and half-sovereigns should cease to be legal tender. Gold should not circulate as money. Gold saving certificates should be issued.
(iii) One-rupee note should be re-issued and no new rupee coins should be coined.
(iv) Rupee should be stabilized in relation to gold which would be secured by making the currency directly convertible into gold bars.
(v) Rate of exchange should be determined at the value of 1s. 6d. for the rupee.
(vi) The currency authority should buy and sell gold without limit at fixed rate, but in quantities of not less than 400 fine oz. (Such quantity restriction was intended to prevent the country’s gold reserves from being dissipated internally).
(vii) The government should establish a private shareholders’ central bank, to be called the Reserve Bank of India. For note issue, the proportional reserve system should be adopted with gold and gold securities not less than 40 per cent of the reserve.
(viii) Paper Currency and Gold Standard Reserves should be amalgamated into one currency reserve.
The Government of India accepted the Commission’s recommendations and passed the Currency Act of 1927. This Act entitled the holders of legal tender currency (i.e., silver rupee and currency notes) to obtain either gold, or at the option of the Government, sterling at the exchange rate of Re 1 = 1s. 6d., provided that it was demanded in quantities not less than 400 oz. fine gold.
Government was to purchase gold in unlimited quantities at the rate of Rs. 21-3-10 per tola. The monetary standard, thus established, may better be designated as Gold Bullion-cum-Sterling Exchange Standard, since the currency system which resulted from this arrangement gave the option to the Government to provide gold or sterling at their option against rupees. However, the establishment of a central bank was delayed due to the differences in opinion regarding the ownership of the proposed bank.
Critique of the GBS:
The GBS, as recommended by the Commission, was claimed to be an ideal currency standard. It was a remedy for the evils of the GES. GBS enjoyed the advantages of a true gold standard—the advantages of safety, elasticity, and securing public confidence. Besides, it was cheap as gold coins need not circulate. Further, the proposed standard would be capable, in weathering the possible fluctuations in the world’s silver market and consequent capital depreciation.
Lastly, it provided for automatic expansion and contraction for domestic currency in response to gold movements into and out of the country.
“But it was the recommendation of a 1s. 6d. ratio for the rupee as against the 1s. 4d. ratio which excited Indian public opinion more than the question of the currency standard and led to the historic ratio controversy in the following period (1927-39).”
The Commission recommended exchange rate to be fixed at 1s. 6d. per rupee on the ground that at this rate prices, wages, and other elements in the Indian currency had attained a “substantial measure of adjustment with those in the world at large”. Further, this rate was already in existence for several months before it was taken up for stabilisation. Therefore, any change of this rate would cause widespread disturbance.
But Sir Purushottom Das Thakurdas, the Indian member of the Commission, pleaded for pre-war sterling parity of Re 1 = 1s. 4d. He argued that the 1s. 6d. rate was not a ‘natural rate’, adjustments to Indian price and wages had not taken place and this rate would benefit foreign exporters at the expense of Indian industries and the Indian exporters. This higher rate would confer a bounty of 12½ p.c. on British exporters to India.
Further, he argued that this rate would involve an additional burden on the debtor class in India. The majority member of the Commission pointed out that if a lower rate was fixed, India would have to pay a large amount on account of Home Charges. Admitting this problem, he argued that such burden of Home Charges would not be as heavy as the Commission thought.
Consequent upon a lower parity, production and trade would flourish in India and consequently increased revenue for the Government. For about 20 years, the rate of exchange remained stationary at 1s. 4d. per rupee and therefore, there was no justification for reversion to the 1s. 6d. rate.
“Indian public opinion accused the Government of artificially jacking up the foreign exchange rate by internal deflation…” The Commission’s proposed rupee-sterling rate appeared viable initially for at least three years because of favourable balance of trade.
The onset of the Great Depression of 1930s heralded a strain on India’s foreign exchange accompanied with a steep fall in the price of agricultural exportable.
Further, the GBS failed to inspire public confidence to any extent because, primarily, Indian people were interested in the issue of gold standard with gold coins in circulation. The then prevailing atmosphere was quite in tune with the gold standard currency arrangement. No longer gold currency was “an unnecessary luxury” and a mere matter of “traditional etiquette”. Even the leading British witnesses like Dr. Canan and Dr. Gregory voted for gold currency standard.
In accordance with the recommendations made by the Commission, the Currency Act of 1927 stated that currency could be converted into gold weighting no less than 400 oz. at a time. Such limit made convertibility unreal for the masses; it was good enough for the bankers and bullion dealers.
Demonetization of sovereigns and half-sovereigns strengthened the suspicions of the Indian people regarding the intention of the government’s currency policy. It was definitely a retrograde step since the public held about £ 6 million sovereigns in their hands. Even in England, no such demonetization action was taken.
Another provision that brought suspicion to the fore was that the selling price of gold would be higher than its buying price. This amounts to saying that the gold would be cheaper in London than in India. What was meant was that India’s gold would be utilised for the benefit of London’s money market —a glaring example of step-motherly attitude of the British Government.
The Currency Act of 1927 resulted in what may be designated as Sterling Exchange Standard since it gave the option to the Government to provide gold or sterling “at their option” against rupees. But so long as sterling was convertible into gold, the system could conveniently be dubbed Gold Exchange Standard. Thus, India was forced to adopt a hotchpotch or a hybrid type of currency standard for the period 1927-31.
With the onset of the Great Depression, dramatic developments in the world currency and exchange situation took place. The camouflaged GBS that continued for only four years vanished away when the British Government went off the Gold Standard. In consequence of this development, the Government of India also abandoned the gold links of the rupee. The rupee, however, was officially linked to sterling from 24 September 1931. From that date, Indian currency became a purely Sterling Exchange Standard.
Indian Currency System Standard # 6. Sterling Exchange Standard (1931-46):
The Great Depression of the 1930s had a profound impact on India’s currency policy. With the onset of the Great Depression, England witnessed a massive withdrawal of gold by her creditors. Finding no other alternative, she gave good bye to the Gold Standard on September 1931. Immediately, the Government of India suspended the operation of the obligation to sell gold or sterling.
Subsequently, the rupee was linked to sterling at the old rate of 1s. 6d. per rupee. Thus the currency standard in India became a purely Sterling Exchange Standard (SES). “This meant that as long as sterling was on gold, the Indian currency was on the gold exchange standard and when sterling was off gold it degenerated into a pure sterling exchange standard.”
Several strong arguments were put forward by the Government supporting the measures for maintaining link with the sterling. First was the predominance of trade of India with Great Britain and other sterling bloc countries. But one is tempted to argue that such advantages could even perhaps be secured by a judicious policy of the devaluation of rupee in terms of sterling without bringing rupee-sterling link.
Secondly, export trade of India with the gold standard countries would receive a great fillip owing to the depreciation of rupee in relation to gold owing to the depreciation of sterling. Again, this sounds illogical since such advantages could be reaped by the policy of devaluation. Thirdly, a debtor country like India with huge sterling obligations necessitated stable sterling-rupee rate.
However, the rupee-sterling link at 1s. 6d. left the price of gold in India lower than the price abroad. Consequently, there occurred a heavy exodus of gold from India as it was deemed to be profitable. It is true that such exports of gold turned adverse balance of payments consequent upon the Great Depression into a favourable one. But the country’s gold stock was depleted (1931-March 1941) by 43 million ounces, valued at Rs. 375 crore or an average price of Rs. 32-12 per tola.
“The real nature of these gold exports, which marked a dramatic reversal of India’s historic role as a perennial sink for precious metals from the West, was hotly disputed. The official view was that, allowing for a certain proportion of distress sales, the bulk represented profit maximisation on an asset hoarded for capital appreciation.”
But this currency arrangement aroused deep resentment in this country. Such outflow of gold was regarded as “distress sales” by the Indian public. But it would have made justice had the proceeds from such sales been absorbed by the Government to augment the country’s metallic reserves for capital formation and economic development of the country.
Unrestricted gold outflow was an alarming one as it represented wastage of gold resources of India, the wreckage of the indigenous banking system, and a drain on the accumulated savings of generations. In view of this, there was a persistent demand for the prohibition of exports of gold. Undaunted by the mounting public criticism, the Government of India followed a non-interventionist policy—gold exports went unabated. Gold export was used mainly, if not wholly, to support an overvalued rupee and to give relief to an embarrassed government.
The year 1935 saw the birth of the Reserve Bank of India as the central bank of the country. The government was rigid to have a rupee-sterling rate at Re 1 = 1s. 6d, The RBI was advised by the Government of India to maintain this ratio. But the old ratio controversy again flared up. Indian people advocated devaluation to tide over the difficult balance of payments situation as well as to give relief to cultivators.
With the devaluation of franc and other gold bloc currencies, demand for devaluation of rupee received another stimulus. The issue of devaluation was raised in the Legislative Assembly. The Government remained calm in the midst of violent criticisms and agitations. The Government said that it would be no party to any ‘monkeying’ with the present ratio. The Indian National Congress took up the cudgel when the exchange value of rupee showed signs of weaknesses following the recession of 1937-38.
The outbreak of the Second World War produced some favourable effects on the Indian economy. At the same time, it precluded a phenomenal expansion of money supply thereby fuelling inflationary conditions. Export trade also received a strong stimulus as a result of the War. This led to a massive accumulation of sterling balances.
Thus the currency system during the War years displayed two important features:
(i) Huge expansion of paper currency in circulation, and
(ii) Large scale accumulation of sterling balances with the RBI.
Sterling balances accumulated largely when the British Government and Allied Nations made payment in terms of sterling for buying goods and services in India through the Government of India. This was credited to the account of the RBI in London. An agreement was made between the two Governments. It was agreed that these sterling balances were to remain blocked during the War. The sterling balances accumulated during the War period stood at £ 1,250 million or Rs. 1,700 crore approximately.
Accumulation of sterling balances had two aspects. On the one hand, it led to a phenomenal expansion in currency circulation. This is because of the fact that the accumulated sterling balances were transferred by the Government of India to the RBI which used them as a backing for the issuing of paper currency.
On the other hand, “…the sterling balances represented the deprivation of goods and services caused to the Indian consumers and producers in order to meet the requirements of war”. All these suggest that India had to pay a very heavy price —high dose of inflation and repatriation of sterling balances for the accumulation of these sterling balances.