Indian Currency and Finance

by John Maynard Keynes

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.[78] 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.[79]

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.[80]

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[81] 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.