Indian Currency and Finance

by John Maynard Keynes

Experience accords with these expectations. When the Indian bank rate is high and the difference of ¹/₃₂d. between the two prices is in force, the demand is almost entirely for transfers. This is convenient to bankers, and, if he has the rupees waiting in India, profitable to the Secretary of State.

5. The bills and transfers are made payable at the option of the purchaser at Calcutta, Bombay, or Madras. The amount drawn on Madras is relatively small, and Calcutta comes first, with about 45 per cent of the whole.

6. Up to 1900 the volume of sales of Council Bills in any year was mainly governed by the amount required to defray the Home Charges, this amount partly depending on the volume of capital borrowings in the year. But the sales also fluctuated, though within comparatively narrow limits in most years, according to the Secretary of State’s opportunities (depending on the activity of business and the balance of trade) of selling his bills at a satisfactory rate. Since 1900, however, the functions of the Council Bill system have been enlarged, and it has now become a very important part of the general mechanism for the maintenance of the Gold Exchange Standard.

7. The way in which this has arisen is easily explained. On account of the provision by which rupees can always be obtained in India in exchange for sovereigns at the rate of 1s. 4d. per rupee, it can never be worth while for the banks to buy Council Bills at a price which exceeds 1s. 4d. by more than the cost of sending gold to India. This cost varies considerably from time to time, but it seldom exceeds ⅛d. If, therefore, the Secretary of State refuses to sell bills at less than 1s. 4⅛d., when the banks are requiring to remit to India, gold will flow. This gold will be presented at the Treasuries in India to be exchanged for rupees or notes. Thus the only effect of the Secretary of State’s refusing to sell remittances at a price which suits the banks is that sterling resources accumulate in his Treasuries in India instead of in England. This may not be convenient to him. For example, if the banks are sending gold to India on a large scale and are exchanging it for rupees, a time may come when this demand can only be met by minting more rupees; the silver for this must be purchased in London and the profit on the coinage must be credited to the Gold Standard Reserve which, for reasons to be discussed in the next chapter, is kept for the most part in London; thus the gold has eventually to be shipped back again to England to pay for the silver and to be credited to the Gold Standard Reserve. In this case a double loss is involved—the cost of sending the gold to India (for the Secretary of State could probably have got 1s. 4⅛d. per rupee if he had sold transfers, whereas if gold flows he gets only 1s. 4d.) and the cost of bringing it back again, say, ³/₃₂d.; thus a refusal to sell bills would mean an eventual loss of nearly ¼d. per rupee or about 1½ per cent. Or, again, the policy of holding some part of the gold in the Currency Reserve in London for possible use in emergency, may lead to the Secretary of State’s preferring gold to accumulate in London rather than in India; otherwise it will have to be sent back again, in pursuance of this policy, and a double loss incurred, as in the former case. Lastly, if the Secretary of State has considerable cash balances in India, it may be worth his while for a time to cash additional Council Bills out of these, thus in effect transferring his balances to London. The reasons that may make him inclined to do this are, first, that to increase the proportion of his cash balances held in sterling puts him in a stronger position in a case of emergency; second, that selling Council Bills at a good price now will enable him to meet the Home Charges later on when he might not be able to sell his Bills at so good a price (in this case the transference of cash balances from India to London is only temporary); third, that it may put him in a stronger position for carrying out impending loan transactions at the most favourable moment; and fourth, that cash balances held in London can be made to earn a small rate of interest.

All these considerations being taken into account, it can only be worth the Secretary of State’s while to refuse to sell bills within the gold export price, when he deliberately wishes either to increase his cash balances in India at the expense of his balances in London, or to replenish that part of the gold portion of the Currency Reserve which is kept in India.

Thus he will endeavour to make as certain as possible of selling within the year the amount budgeted for (i.e., the Home Charges adjusted with reference to the probable capital transactions of the year and the state of the cash balances); but he will sell more than this if the demand for remittance is so great that, on his refusal to sell, the price of remittance will rise to the gold export point In the words of the annual budget, “the estimate of Council drawings is for the amount necessary to provide for the Secretary of State’s requirements, but additional bills will be sold if needed to meet the demands of trade.”

8. Let us sum up the argument so far, and enforce at the same time the contention, brought up at the end of Chapter I., that the volume of currency circulating in India does not depend, as some critics have maintained, on the caprice of the India Office in the amount of Council Bills that it offers for sale. So far as Council Bills are sold for the ordinary purposes of remittance of Government funds from India to London, they are cashed in India out of the general balances of Government. But when they are sold in larger quantities, to obviate the necessity of sovereigns being sent, sufficient rupees are not forthcoming from this source. One expedient is to pay out some of the rupees in the Paper Currency Reserve or in the silver branch of the Gold Standard Reserve, and to pay an equivalent sum into the branches of these reserves which are held in London, “earmarked” at the Bank of England,[53] or in other sterling forms. If, on the other hand, the India Council had refused to sell bills freely, gold would have been exported to India, taken to the Paper Currency Department, and exchanged for rupees in notes or silver. In either case there is a similar increase in the volume of currency in India not held by the Government. The volume of currency which finds its way into circulation in India is, therefore, quite independent of the Secretary of State’s action. Exceptional amounts of Council Bills are only sold when exchange has reached a point at which it is nearly as profitable to remit gold; and if Council Bills were not sold sovereigns would go instead (the expense of sending them being lost), for which the Government of India would have to give rupees in exchange. This point is important, for it is often assumed in controversy regarding the currency and its relation to prices that the issue of rupees into circulation depends in some way upon the amount of Council Bills sold by the Government, and can, therefore, be expanded or contracted by them at will, according to the policy of the moment. Broadly speaking, this is false. Even if the Government were to hasten the flow of rupees into circulation by selling an exceptional quantity of bills at a relatively low rate (which would be equivalent to lowering by a fraction of a penny the normal value of the rupee as measured in sterling), and were to pursue this policy over a long period, the permanent effect could be no more than in proportion to the amount by which they had thus lowered the par value of the rupee in terms of sterling. This is the amount of their conceivable executive power, if the Government were to exercise it. In fact, it has not been exercised.

If, however, the stock of rupees in the reserves is running low (for a considerable quantity of rupees must always be kept there in order to ensure the ready convertibility of the notes in terms of rupees), and more Council Bills are sold in London than can be conveniently cashed in Calcutta in the above ways, more rupees must be issued from the Mint. The silver out of which they are minted is purchased in England out of the proceeds of selling the additional Council Bills, and the surplus due to the fact that rupees are worth more than the silver they contain, is credited to the Gold Standard Reserve. According to the present practice the process in these circumstances also is, therefore, automatic, and the amount of new rupees put into circulation does not depend on the arbitrary action of the Secretary of State in selling or withholding Council Bills. If he did not sell bills, sovereigns would be sent to India, new rupees would have to be coined to meet the obligation under which the Government of India has placed itself of giving rupees in exchange for sovereigns on demand, and a great part of the sovereigns would have to be credited in some form or other to the Gold Standard Reserve or shipped back to England again to pay for the silver.

It is true that, if a different practice were adopted (a practice which was adopted in part in 1907), and if the profits on the coinage of rupees, instead of being credited to the Gold Standard Reserve, were turned into rupees and spent by the Government in India on goods and services (whether for capital or any other purpose), more rupees would be in circulation for the time being than would have been the case otherwise. But even in this case the effect on the volume of circulation must be temporary, so long as the provisions for the maintenance of the rupee at 1s. 4d. are in operation. For this additional issue of rupees would, eventually, have the effect of delaying additional demands for coinage in the future or of precipitating an occasion for the withdrawal of rupees from circulation.