The problem of the rupee: its origin and its solution

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TABLE XXXVII

period II, 1900-1908
 Years Currency in Circulation Rupees + Notes Index Number of prices in India 1890-94 = 100 Index Number of prices in England 1890-94 = 100 Amount in Crores of Rs. Index Number 1890-94 = 100 (1) (2) (3) (4) (5) 1900 134 103 126 103 1901 150 115 120 98 1902 143 109 115 96 1903 147 113 111 97 1904 152 116 110 100 1905 164 126 120 100 1906 185 142 134 107 1907 190 145 138 113 1908 181 139 147 104

TABLE XXXVIII

period III, 1909-14[f15]
 Years Currency in Circulation Rupees + Notes Index Number of prices in India 1890-94 = 100 Index Number of prices in England 1890-94 = 100 Amount in Crores of Rs. index Number 1890-94 = 100 (1) (2) (3) (4) (5) 1909 198 152 138 105 1910 199 152 137 110 1911 209 160 139 114 1912 214 164 147 117 1913 238 182 152 124 1914 237 182 156 124

TABLE XXXIX

period IV, 1915-1921[f16]
 Years Currency in Circulation Rupees + Notes Index Number of prices in India 1913=100 index Number of prices in England 1913= 100 Amount in Crores of Rs. Index Number 1913 =100 (1) (2) (3) (4) (5) 1915 266 104 112 127.1 1916 297 116 125 159.5 1917 338 132 142 206.1 1918 407 155 178 226.5 1919 463 180 200 241.9 1920 411 160 209 295.3 1921 393 114 183 182.4

Now do these tables confirm, or do they not, the argument that the fail in the gold value of the rupee is coincident with a fall in the general purchasing power of the rupee ? What was the general purchasing power of the rupee when a fall in its gold value occurred ? if we scrutinise the facts given in the above tables in the light of this query there can be no doubt as to the validity of this argument. From the tables it will be seen that the gold value of the rupee improved between 1893-1898 because there was a steady, if not unbroken, improvement in its general purchasing power. Again, on the subsequent occasions when the exchange fell, as it did in 1908, 1914, and 1920, it will be observed that these were the years which marked the peaks in the rising price-level in India ; in other words, those were the years in which there was the greatest depreciation in the general purchasing power of the rupee. A further proof, if it be needed, of the argument that the exchange value of the rupee must ultimately be governed by its general purchasing power is afforded by the movements of the rupee-sterling exchange since 1920 (see Table XL).

But, although such is the theoretical view confirmed by statistical evidence of the causes which bring about these periodic falls in the gold value of the rupee (otherwise spoken of as the fall of exchange), it is not shared by the Government of India. The official explanation is that a fail in the gold value of the rupee is due to an adverse balance of trade. Such is also the view of eminent supporters of the exchange standard like Mr. Keynes[f17] and Mr. Shirras. [f18]

No doubt, some such line of reasoning is responsible for the currency fiasco of 1920. How is it possible otherwise to explain the policy of raising the exchange value of the rupee ? Both the Smith Committee on Indian Currency*[f19] and the Government of lndia[f20] were aware of the fact that the rupee was heavily depreciated, as evidenced by the rise of prices in India.

TABLE XL
 Date Rupee Prices in India. 1913=100 Sterling Price in England (Statist). 1913=100 Average Rate of Exchange London on Calcutta Rupee-Sterling Purchasing Power Parity 16d x col.3/col.2 (1) (2) (3) (4) (5) d. d. 1920. January 202 289 27.81 22.89 February 203 306 32.05 24.12 March 194 301 29.66 25.40 April 193 300 27.88 25.95 May 190 298 25.91 25.77 June 192 293 23.63 25.08 July 196 282 22.63 24.49 August 193 263 22.75 24.70 September 188 244 22.31 24.94 October 188 232 19.88 24.00 November 186 215 19.69 22.62 December 179 209 17.44 21.81 1921. January 169 200 17.66 21.96 February 164 191 16.31 20.98 March 162 183 15.53 20.40 April 163 186 15.75 19.63 May 170 182 15.44 17.98 June 172 178 15.53 17.14 July 171 163 15.38 17.40 August 178 161 16.25 16.36 September 178 157 17.22 15.82 October 178 156 17.02 14.65 November 173 161 16.25 14.89 December 169 157 15.94 14.86 1922. January 162 156 15.88 15.41 February 159 156 15.59 16.70 March 160 157 15.34 15.70 April 160 159 15.19 15.90 May 162 159 15.59 15.70 June 169 160 15.63 15.14 July 170 158 15.69 14.87 August 166 153 15.66 14.74

Given this fact, any question of raising the gold value of the rupee to 2s. gold when the rupee had scarcely the power to purchase 1s. 4d. sterling was out of the question. The Committee indulged in loose talk about stabilising the Indian exchange. But even from this standpoint the Committee's insistence on linking the rupee to gold must be regarded as little grotesque. Stable exchange, to use Prof. Marshall's language, is something like bringing the railway gauges of the world in unison with the main line. If that is what is expected from a stable exchange, then what was the use of linking the rupee to gold which had ceased to be the " main line " ? What people wanted was a stable exchange in terms of the standard in which prices were measured. Linking to gold involved unlinking to sterling, and it is sterling which mattered and not gold. Given this importance of sterling over gold, was any policy of exchange stabilisation called for ? First of all it should have been grasped that such a policy could succeed only if it was possible to make sterling and rupee prices move in unison, for then alone could the ratio of interchange between them be the same. What control had the Government of India over the sterling ? They might have so controlled the rupee as to produce the effect desired, but all that might have been frustrated by an adverse move in the sterling. The success of the policy of linking to sterling would have been highly problematical although highly desirable. But was it called for ?

Now the problem of stabilisation is primarily a problem of controlling abnormal deviations from the purchasing-power parity between two currencies. In the case of India there were no abnormal deviations from the rupee-sterling purchasing-power parity. On the other hand, the Indian exchange was moving in a more or less close correspondence with it. There was therefore no ground for originating any policy of exchange stabilisation. But, supposing there were abnormal deviations and that, owing to some reasons known to it, the Committee believed that the exchange value of the rupee was not likely to return to the point justified by its general purchasing power, in that case the Committee should have fixed the exchange value well within the range of the purchasing power of the rupee. As it was, the value of the rupee fixed by the Committee the rupee never had. In giving a value to the rupee so much above its purchasing-power parity, it is obvious the Committee originated a solution for the simple problem of stabilising the rupee which involved the much bigger and quite a different problem of deflation or raising the absolute value of the rupee. How was the object to be attained ? The Committee never considered that problem. And why ? Was it because the price of silver had gone up ? May be. But it is doubtful whether the Committee could have believed firmly that the value of silver was going to be permanently so high as to require a modification of the gold par. Anyone who cared to scrutinise the rise in the price of silver could have found that the rise was largely speculative and could not have been permanent.

TABLE XLI

price oF silver IN sterling (pence)[f21]
 Year Highest Lowest Average Range of Variation 1913 29 3/8 25 15/16 27 9/16 3 7/16 1914 273/4 22 1/8 25 5/16 5 5/8 1915 27 1/4 22 5/16 23 11/16 4 15/16 1916 37 1/8 26 11/16 31 5/16 10 7/16 1917 55 35 11/16 40 7/8 19 11/16 1918 49 1/2 42 1/2 47 9/16 7 1919 79 1/8 47 3/4 57 1/16 31 3/8 1920 89 1/2 38 7/8 61 7/16 50 5/8 1921 43 3/8 30 5/8 37 12 ¾

But supposing that the rise in the price of silver was not speculative, did it follow that the rupee was appreciated ? The diagnosis of the Committee was an egregious blunder. With the facts laid before the Committee it is difficult to understand how anyone with a mere smattering of the knowledge of price movements could have concluded that because silver had appreciated the rupee had therefore appreciated. On the other hand, what had happened was that the rupee had depreciated in terms of general commodities, including gold and silver. indeed, the appreciation of silver was a depreciation of the rupee. The following (Table XLII) is conclusive evidence of that fact —

TABLE XLII

depreciation oF THE rupee
 Date Price of Bar Gold in India (Bombay) per Tola of 180 grs. Price of Silver in India (Bombay) per 100 Tolas Index Number for Prices in India 1913=100 Rs. A. Rs. A. 1914 24 10 65 11 1915 24 14 61 2 112 1916 27 2 78 10 125 1917 27 11 94 10 142 1918 (July) 34 0 (May 16) 117 2 178 1918 (Nov. 28) 82 10 1918 August 30 0 1918 Sept. 32 4 1919 March 32 0 113 0 200

Thus, the rise in the price of silver was a part of the general rise of prices of the depreciation of the rupee. The Committee desired to raise the gold value of the rupee to 10 rupees per sovereign when it cost twice that number of rupees to purchase a sovereign in the market. So marked was the depreciation of the rupee in terms of gold that a few months before the Committee submitted its report the Statesman (a Calcutta paper) wrote —

" If you land in the country with a sovereign the Government will take it away from you and give you eleven rupees three annas in return. If you are in the country and happen to have a sovereign and take it to the currency office you will get fifteen rupees for it. On the other hand, if you take it to the bazar you will find purchasers at twenty-one rupees." These facts were admitted by the Finance Department of the Government of India to be substantially correct, [f22] and yet in the face of them the Committee recommended the 2s. gold parity for the rupee. The Committee confused the rupee with the silver, and thus failed to distinguish the problem of retaining the rupee in circulation and raising its exchange value in terms of gold. The latter solution was applicable only if the rupee had appreciated. But as it was silver that had appreciated in terms of the rupee, the only feasible solution was to have proposed the reduction of the fineness of the rupee. Had the Committee regarded silver as a commodity distinct from the rupee like any other commodity to be measured in terms of the rupee as a unit of account, probably it might have avoided committing the blunder which it did. But what is more than probable is that the Committee did not think that the general purchasing power of the rupee was a factor of any moment in the consideration of the matter it was asked to report upon. What was of prime importance in its eyes for the maintenance of the exchange value of the rupee was a favourable balance of trade, and that India had at the time the Committee drafted its Report. For the Committee, in the course of its general observations on the exchange standard, remarked:

" that the system had proved effectual in preventing the fall in the value of the rupee below 1s. 4d., and unless there should have been profound modifications in India's position as an exporting country with a favourable trade balance, there was no reason to apprehend any breakdown in this respect." [f23]

Proceeding on this view of the question it was quite natural for the Committee to have argued that if a favourable balance of trade sustained 1s. gold exchange, why should a similar balance of trade not sustain 2s. gold exchange?

" But for the rest they [i.e. the Government of India] can now only rely on the natural course of events and the return of favourable export conditions, combined with the reduction of imports... to strengthen the exchange. Experience has demonstrated that in the present condition of the world trade stability is at present unattainable, but the Government of India see no reason why the operation of natural conditions should not allow of the eventual fixation of exchange at the level advocated in the report of the Currency Committee."

The first period, from 1893-98 was comparatively speaking the only period marked by a rather halting and cautious policy in respect of currency expansion. The reason no doubt was the well-known fact that at the time the Mints were closed the currency was already redundant. Yet the period was not immune from currency expansion. [f32] At the time the Mints were closed the silver bullion then in the hands of the people was depreciated as a result of the fall in its value due to the closure. An agitation was set up by interested parties to compel the Government to make good the loss. Ultimately, the Government was prevailed upon by Sir James Mackay (now Lord Inchcape), the very man who forced Government to close the Mints, to take the silver from the banks. The Government proposed to the Secretary of State that they be allowed to sell the silver even at a loss rather than coin and add to the already redundant volume of currency. The Secretary of State having refused, the sliver was coined and added to the currency. The stoppage of Council Bills in 1893-94 had temporarily accumulated a large number of rupees in their Treasuries, a transaction which practically amounted to a contraction of currency. But the Government later decided to spend them on railway construction—a policy tantamount to an addition to currency. The resumption of Council Bills after 1894 had also the same effect, for a sale of bills involves an addition to currency. In view of the heavy cost of financing the Home Treasury by gold borrowings, the resumption of sale was a pardonable act. But what was absolutely unpardonable was the increase in the fiduciary portion of the paper-currency reserve from 8 to 10 crores. [f33] thereby putting 2 crores of coined rupees into circulation, particularly so because the Finance Minister refused to pay any heed to its incidence on the currency policy, arguing:—

" I am a little doubtful whether, in discussing the question of the investment of the currency reserve, we are at liberty to look at outside considerations of that kind." [f34] All told, the additions to the currency during the first period were negligible as compared to what took place in the second period, 1900-1908. This period was characterised by a phenomenal increase in the volume of currency poured by the Government into circulation. Speaking of the coinage of rupees during this period, Mr. Keynes, anything but an unfriendly critic of the Government's policy observed[f35]

"The coinage of rupees recommenced on a significant scale in 1900 a steady annual demand for fresh coinage (low in 1901-2, high in 1903-4, but at no time abnormal), and the Mints were able to meet it with time to spare, though there was some slight difficulty in 1903-4. In 1905-6 the demand quickened, and from July 1905 it quite outstripped the new supplies arising from the mintage of the uncoined silver... This slight scare, however, was more than sufficient to make the Government lose their heads. Having once started on a career of furious coinage, they continued to do so with little regard to considerations of ordinary prudence... without waiting to see how the busy seasons of 1906-7 would turn out, they coined heavily throughout the summer months... During the summer of 1907, as in the summer of 1908, they continued to coin without waiting until the prosperity of the season 1907-8 was assured."

Evidently, in this period the Government framed their policy "as though a community consumed currency with the same steady appetite with which some communities consume beer." The period also witnessed a material expansion of the paper currency. Up to 1903 the use of the currency notes was limited by reason of the fact that they were not only legal tender outside their circle of issue, but also because their encashability was restricted to the offices of the circles of their issue. This was a serious limitation on the extension of paper currency in India. by Act VI of 1903 the Rs. 5 was made universal in British India excepting Burma, i.e. was made legal tender in all circles, and also encashable at all offices of issue. Along with this the fiduciary portion of the paper-currency reserve was increased to Rs. 12 crores by Act III of 1905. The first event was only calculated to enlarge the circulation of the notes, but the second event had the direct effect of lowering the value of the rupee currency.

The third period (1909-14) was comparatively a, moderate but by no means a slack period from the standpoint of currency expansion in India. The first three years of the period were. so to say, years of subdued emotion with regard to the rupee coinace. With the exception of the year 1910, when there was no net addition to rupee coinage, and 1911, when the addition was a small one, the coinage in the years 1909 and 1912 ranged from 24 to 30 lakhs. But during the last two years of this period there was a sudden burst of rupee coinage, when the total reached 26 1/2 crores. The expansion of paper currency took place also on a great scale during this period. In 1909 the Rs. 5 were universalised in Burma as they had previously been in other parts of India. This process of universalisation was carried further during this period, when, under the authority granted by the Paper Currency Act (II of 1910), the Government universalised notes of Rs. 5 and Rs. 50 in 1910, of Rs. 100 in 1911. Along with the stimulus thus given to the increase of paper currency, the Government actually expanded the fiduciary portion of the issue from 12 to 14 crores by Act VII of 1911, thereby throwing into circulation 2 crores of additional rupees.