In the first place, the function of note–issue is wholly dissociated in India from the function of banking. To discount bills is one of the functions of banks. Where there are Central Banks with the right of note issue, they are usually able, subject to various restrictions, to increase their note issue at certain seasons of the year in order to discount more bills.
In the second place, as there is no Central Bank in India, there is no Government Banker. It is true that the Government keep some funds (rather more than £2,000,000, as a rule) at the three Presidency Banks. But the bulk of their floating resources is held either in London or in cash in their own Treasuries in India. Thus, as in the United States, the Government maintains an independent Treasury system. This means, just as it does in the United States, that, at certain seasons of the year when taxes are flowing in fastest, funds may sometimes be withdrawn from the money market. The difficulty and inconvenience to which this system has given rise in the United States are well known to those who are acquainted with the recent financial history of that country. The ill effects of it are to a certain extent counteracted, in the case of India, by a transference of these funds to London and a release of the accumulating currency in India through the sale of Council Bills. But this is not a perfect solution.
The third and most important point arises out of the first two. The Indian currency is internally (i.e., apart from the import of funds from foreign countries) absolutely inelastic. There is no method whatever by which the volume of currency can be temporarily expanded by some credit device within the country to meet the regularly recurrent seasonal demands of trade. Cheque–using countries meet the difficulty by increasing the volume of credit created by the banks; most note–using countries meet it by the Central Bank’s discounting a greater volume of home bills than usual, and thus increasing its note circulation temporarily, without a corresponding increase in its metallic reserves. Except for a certain proportion of the business which is transacted by cheque (chiefly in the Presidency towns), there is nothing corresponding to this in India. Additional currency, whether notes or rupees, can be obtained in two ways only—by buying Council Bills in London or by bringing in sovereigns. Additional notes or rupees can be obtained in payment of Council Bills or in exchange for sovereigns, but not otherwise. The fact that a temporary increase in the media of exchange can only be obtained by bringing in funds from abroad partly explains the high rate of discount in India during the busy season. This question will be more fully dealt with in Chapter VIII. But the main point can be put briefly thus:—If funds are to be attracted from abroad for a short period (say three months), the rate of interest must be high enough to repay the cost of remittance both ways, which in the case of places so remote from one another as India and London is considerable. If there were some authority which could create credit money in India during the busy season, it would not be necessary for the rate of discount to rise so high.
17. The objections to the existing arrangements largely arise, therefore, out of the absence of a State Bank. This question is further discussed in Chapters VI. and VII. I feel little doubt that India ought to have a State Bank, associated in a greater or less degree with the Government. The Government is drifting year by year into doing more business of an essentially banking character; and as time goes on it will become increasingly objectionable to dissociate some of the functions of modern State Banking from others. But there is a considerable weight of opinion in favour of the view that the time for the establishment of a Central Indian Bank is not yet ripe. In the meantime is any partial remedy possible for the evils dealt with above?
18. I am inclined to think that such a remedy is possible. The manner in which the reserve against the note issue must be kept is needlessly restricted. Apart from that portion which is permanently invested, the whole must be kept in gold and silver. This is in imitation of the rules governing the Bank of England’s note–issue. But the note–issuing banks of Europe afford a better model. It might be proper to prescribe by law the holding of a certain proportion of the reserve (say one–third[30]) in gold or silver coin. A further amount might be held, as at present, permanently invested in Government of India securities. With regard to the rest the Government should, I think, permit itself much greater latitude. It should be free to lend it out on suitable security, either in India or London, for periods not exceeding three months. In London it should be lent out on the same conditions as the Cash Balances and the Gold–Exchange Standard (see Chapter VI.) are lent out at present. To lend in London would be technically convenient (for the reasons given on p. 172), but it would not cure the inelasticity of the Indian system. Part of the reserve should, therefore, be lent out in India. Suitable security for this purpose would be Government of India securities (which would have indirectly the effect of increasing the market for Rupee Paper) and Bills of Exchange of the highest class. It is not worth while to discuss here in detail the precise methods which it would be proper for the Government to adopt in lending out funds in India either from the Cash Balances or from the Paper Currency Reserve. Whether it were done through the Presidency Banks only, or whether an approved list of borrowers of Government funds were to be drawn up for India as is already the case for London, the effect on the Indian Money Market would be much the same. The needed element of elasticity would be obtained, and the present absolute dependence of India on London for an expansion of currency would be modified. I shall return to this proposal again in Chapters VI. and VIII. Its full force cannot be shown until we have discussed the question of the Secretary of State’s reserves as a whole, and have studied in detail the movements of the Indian bank rate.
A good deal of opinion has been expressed in India lately in favour of loans being made there from the Government’s Cash Balances. In so far as this opinion demands some new machinery by which on suitable occasions the Government can lend out funds in India herself, the evil which it seeks to remedy is a real one. And the method proposed above is, I believe, the right way in which to approach the problem’s solution.
19. The discussion of this question will be concluded in Chapters VI., VII., and VIII. But it will be well to say a few words at once with a view to avoiding misunderstandings on two points. It has been necessary in the immediate past to use the Paper Currency Reserve as a part of the general reserves held for ensuring the absolute stability of the rupee. I do not advocate the lending out in India of any part of this reserve, or of the Cash Balances, at the expense of the stability of the Gold Standard, or until adequate measures can be taken in other ways to ensure this. But I think the time has practically arrived when the whole of the liquid portion of the Paper Currency Reserve is not required, in addition to the Gold Standard Reserve proper, for this purpose. A busy season will soon come when the Government might lend some part of its reserves in India without endangering in the least the stability of its system and to the great advantage of Indian trade. It ought, at least, to have the power to do this.
20. The remaining point is this. A provision of the above kind for introducing some degree of elasticity into the Indian currency system would not be very useful in a season such as that of the autumn and winter of 1905–6 or of the autumn of 1912–13, when there was a demand for rupees on so great a scale that it could only be met from the Mint. Additions to the currency of this kind can only be made by importing funds from abroad. But these are permanent not temporary additions. Every such addition makes a similar demand for new coinage in succeeding seasons less likely. They are abnormal, and recent history seems to show that these permanent additions to the Indian currency are not made by slow and steady accretions year by year, but in great bursts of activity at considerable intervals. In years of normal activity, therefore, there may be considerable stores of rupees lying idle in the reserves beyond what is required for the safety of the currency. Indian bankers and merchants can only get at these rupees, so as to obtain a net addition to the currency, by buying sovereigns or Council Bills in London. If the use for the additional currency is only temporary, the cost of transport or remittance is great enough to make it not worth their while to get this addition until the Indian rate of discount has been forced up to a high level. If the Government were free on such occasions to lend out some part of the rupees, against high–class security, at 5 or even 6 per cent, this would be profitable to the Government, and would prevent the discount rate from reaching a level which is caused, not by anxiety, but merely by the expense arising out of the distance between London and Calcutta.