My article “India’s Money” in the *Cayman Financial Review*, July 2012

India’s money

India was recognised and received the comity of nations when it signed the Treaty of Versailles as a victor, later becoming a Dominion and successor-state of British India in 1947, and a sovereign republic in 1950. Pakistan emerged as a new state created out of British India in 1947, remaining a Dominion until 1956 when it became an Islamic republic.

India was an original member of the League of Nations, a signatory to the UN’s San Francisco Declaration, a participant at Bretton Woods, and an original member of the IMF.

Yet some 65 years later, sovereign India has failed to develop a currency universally acceptable as a freely convertible world money. Nor do trade, monetary, fiscal or political conditions appear such that the rupee can become a hard currency of the world economy easily or very soon.

JM Keynes in his first book, a century ago, gave a masterly survey of the immediate monetary history. The rupee had been on a silver standard until 1893 when an attempt at bimetallism failed; instead India stumbled into the 20th century on a modified gold standard that chanced to fulfil desiderata known since Ricardo, namely “the currency media used in the internal circulation are confined to notes and cheap token coins, which are made to act precisely as if they were bits of gold by being made convertible into gold for foreign payment purposes”.

Ie, the rupee was legal tender at home and convertible into sterling for international payments in London, the price being set at 1s 4d. Gold at £3.17s.10½d until August 1914 meant a rupee price of Rs 31 per troy oz.- long-forgotten now when gold retails at Rs 90,000 per troy oz, measuring an average annual rate of inflation in the gold price of about 8.5 per cent for the century.

Until 1947 the rupee remained subservient to British policy. Sterling payments included paying for merchandise imports, dividends and repayments on British business, as well as iniquitous “home charges” imposed by Britain to rule India as an unfree imperial dependency. Britain “returned to gold” in 1925, and did so notoriously at the same price as before though the rupee was revalued to 1s 6d.; Indian businessmen complained to no avail that this hurt exports and worsened the large deflation caused by the Depression. The same continued after sterling became a paper money again in September 1931, backed only by London’s position as a financial capital.

India remained a major trading nation during 1870-1914 with a share of world manufactured exports as high as 4 per cent. Keynes found Britain (the world’s largest exporter), exporting most to India; while Germany (the world’s fastest growing economy) received 5 per cent of its imports from India and sent 1½ per cent of its exports to India, making India the sixth largest exporter to Germany (after the USA, Russia, Britain, Austria-Hungary, France) and eighth largest importer from it (after Britain, Austria-Hungary, Russia, France, the USA, Belgium, Italy).

As of 1917-1918, India’s macroeconomics appear idyllic: an export surplus of £61.42 million, official reserves of £66.53 million, total claims on the rest of the world of £127.5 million (32.85 million troy ozs of gold), and a 1916-17 budget surplus of £6,594,885. The rupee, though legal tender only on the subcontinent, became what we might call a “super convertible” currency in being widely accepted in markets and stock markets from the Middle East through South East Asia to Australia.

Even at mid-century, India (without Pakistan) was still a trading power with 2 per cent of world exports and a rank of 16 in the world economy after the USA, Britain, West Germany, France, Canada, Belgium, Holland, Japan, Italy, Australia, Sweden, Venezuela, Brazil, Malaya and Switzerland. But then a collapse occurred over several decades to near insignificance in world trade and payments, from which India has yet to recover.

Of world merchandise exports, the subcontinent’s share fell to less than 1 per cent, and of Asia’s to less than 6 per cent, India accounting for two thirds; Malaysia alone accounted for more. Among 11 major developing countries (Korea, Taiwan, Singapore, Hong Kong, Argentina, Brazil, Chile, Mexico, Israel, Yugoslavia), India’s share of manufactured exports fell from 65 per cent in 1953 to 51 percent in 1960 to 31 per cent in 1966 to 10 per cent by 1973. And this was before the entry of China.

Even India’s legendary textiles lost ground steadily. As of 1962-71, India held an average annual market-share of almost 20 per cent of manufactured textile imports into the USA; this fell to 10 per cent by 1972-81 and less than 5 per cent by 1982-91. India’s share of Britain’s imports of textile manufactures fell from 16 per cent in the early 1960s to less than 4 per cent in the 1990s. India may not be among the top thirty merchandise exporters of the world today, although there has been new growth seen in areas like pharmaceuticals and computer-services.

Causes of the collapse include Western protectionism as well as emergence of new technologies and new competitors willing to use these. But it was largely policy-induced. Between 1939 and 1945/46, Britain clamped draconian exchange-controls on what remained of the Sterling Area (which, besides Eqypt and Iraq, included the Empire and Commonwealth without Canada, Newfoundland and Hong Kong). The controls were relative to currencies outside the Sterling area, principally the US dollar.

The new India and new Pakistan, far from ending these war-time controls of their respective rupees (as Britain would itself do gradually with the pound) instead made them more draconian to include the Sterling area as well. Hence the Ricardo-Keynes dictum was breached – the rupee remained an inexpensive medium for internal circulation but was no longer convertible externally, indeed it had become open to being debauched the more easily.

Milton Friedman in November 1955 argued to the government of India that the new sovereign country should remove exchange controls completely and have a freely convertible rupee at a floating market-determined price on the pattern of the Canadian dollar, along with a steady predictable monetary climate. Far from debating such a proposal, the government ignored his advice, and his document was suppressed until I published it 34 years later in May 1989 at the University of Hawaii.

Intricate barriers, subsidies and licensing (based on war-time “essentiality” and “actual user” criteria) continued, now in name of import-substitution and “planning”. Major industries were nationalised, which became leading consumers of imports obtained by administrative rationing of foreign exchange earned by export sectors. Domestic business predictably diverted to the large protected markets that resulted. Import restrictions of consumer goods and gold expectedly led to smuggling and open corruption in Customs.

A vast parallel or “black” economy arose with its thriving “hawala” sector. The exchange-rate was seen as yet another administered price, not a reflection of demand for foreign relative to domestic moneys. Foreign currency earnings from exports were confiscated in exchange for rupees at the administered rate, then rationed first to meet foreign debt repayments and government expenditures abroad like maintenance of embassies, military imports, official foreign travel, etc; then for import of food, fertilisers, petroleum and inputs required by government firms; then for import demands of those private firms successful in obtaining import licenses; lastly, to satisfy demands of the public at large for purposes like travel or study abroad.

Not only was extension of war-time exchange-controls seen as axiomatic, the massive war-time deficit finance via money creation that the British had indulged in with India’s public finances, came to be permanently institutionalised in the name of socialist planning.

On 7 December 1952 the planners said: “The raison d’ être of a planned economy is the fullest mobilisation of available resources and their allocation so as to secure optimum results. There is no doubt that the Reserve Bank, which is a nationalised institution, will play its appropriate part in furthering economic development along agreed lines”’; and on 14 May 1956: “Insofar as government expenditure is financed by central bank credit, there is a direct increase in currency in circulation”.

The fate of India’s paper money was sealed. Just as the Bank of England could “theoretically lend the full amount” the UK government was authorised to spend by Parliament, and the US government had assurance the Federal Reserve “could and would see that the Treasury was supplied with all the money that it needed for war finance beyond those secured by taxation and by borrowing from non-bank sources”, so government of India expenditure over seven decades has been for all practical purposes assured of automatic limitless financing via money creation. Since more than two dozen state governments have no money-creating powers, their debts also effectively accrue to the government of India.

The next mention of money supply was 43 years later on April 5 1999 in the “Ninth Plan” when it was said a “viable monetary posture” was “to accept an average inflation rate in the region of 7 per cent per annum, which would justify a growth rate of money supply (base money) of 16 per cent per annum”. Recent money supply growth has been near 19-21 per cent per annum, and inflation properly measured has been well above 10 per cent. Hidden in thousands of pages of the “Tenth Plan” dated 21 December, 2002, a half century after “planning” started, is found it being said it is “financed almost entirely by borrowing… India’s public finance inherits the consequence of fiscal mismanagement in the past”.

Had the rupee been a hard currency, the vast amounts of government debt that have accumulated today could have been evaluated at world prices. As things stand, the value at world prices of the asset-sides of banks becomes an unknown, making profitability uncertain of the domestic securities’ market in general. This compounds myriad problems of the mostly nationalised banking system, candidly surveyed over years by James A. Hanson and summarised in his sentence: “The Ministry of Finance continues to run the public sector banks”. AC Harberger a decade ago called for “thorough understanding of the facts” and a “serious study of India’s fiscal deficits”.

“Where are they being parked? At what cost? And how much vacant parking space remains to be occupied before major problems emerge?” “… the authorities appear to have little sense of alarm about these deficits. Does this represent a myopic and irresponsible vision, aimed at surviving the moment while passing an ever greater burden to future governments and later generations? Or does it mean the authorities have studied the problem well, and that today’s deficits are being placed in convenient parking lots that still have plenty of unused capacity?”

As no such study has taken place, the possibility of “a myopic and irresponsible vision” takes credence. Besides, foreign lines of credit have become squeezed or closed by separate crises in the USA, Europe and Japan. India is far from being a creditor country able to help out with any world problems at present.

The last 20 years have seen liberalisation in consumer goods imports and travel and study abroad, and the rupee is no longer an administrative price for current account purposes. Indian firms have been permitted to do business abroad, Indian residents to send large cash gifts to relatives abroad, as well as relative liberalisation of gold imports. A natural technological revolution has been underway inducing real growth in India as in the rest of Asia, where populations are large and families stable: even small increases in capital-per-head, combined with modern communication technologies making travel or migration unnecessary, may explain rapid growth in productivity and output.

To move towards a currency of integrity today that befits the real growth requires comprehensive candid study of the structure of government liabilities and expenditures, systematic cleaning of government accounts at their roots, seeking to raise productivity of government investments and expenditures by better use of the audit function, as well as bringing coherence to fiscal and monetary policy through institutional changes in the processes of public decision-making, specifically, separating the banking and central banking functions from the Treasury function, while bringing the planning function to be one serving the Treasury function rather than pretending to be above it.

Waste or ostentation in public expenditure itself creates incentives for evasion of taxes; indeed, the untaxed economy may even have caused an underestimation of real growth being made. The road exists to be taken though it may be one that demands excessive political courage.

The author thanks Dr Warren Coats for constructive comments on earlier versions of this article.


  1. Friedman, Milton “A Memorandum to the Government of India 1955”, in Roy & James (1989).

  2. Friedman, Milton & Rose, Two Lucky People, 1998.

  3. Hanson, James A. “Indian Banking: Market Liberalization and the Pressures for Institutional and Market Framework Reform” in Krueger & Chinoy (2004).

  4. Harberger, Arnold C “Parking the Deficit – The Uncertain Link between Fiscal Deficits and Inflation-cum-Devaluation”, in Krueger & Chinoy (2004).

  5. Keynes, John Maynard, Indian Currency and Finance, 1913.

  6. Krueger, Anne O. & Sajjid Z. Chinoy (eds) Reforming India’s External, Financial and Fiscal Policies, 2004.

  7. Roy, Subroto, Pricing, Planning and Politics: A Study of Economic Distrtions in India, 1984.

  8. Roy, Subroto & WE James (eds), Foundations of India’s Political Economy: Towards an Agenda for the 1990s, 1989, 1992


My article “India’s Money” in the *Cayman Financial Review*, July 2012, is linked here.

Of related interest:

Monetary Integrity and the Rupee

Towards Making the Indian Rupee a Hard Currency of the World Economy: An analysis from British times until the present day