Indian Currency and Finance

by John Maynard Keynes

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.[74] 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.[75] 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,[76] 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.