This calculation makes no allowance for the general wastage through loss and various causes, or for the steady drain of rupees across the land frontiers. This last item is probably considerable and is not adequately accounted for in the trade returns. The recorded statistics of trade overland show a large annual balance against India, which is probably met by an unrecorded export of gold, silver bullion, and rupees. In the case of Nepal, for example, the recorded statistics show a considerable net balance of imports of treasure into India; and in the case of Tibet, Afghanistan and, in fact, all the land frontiers, the official statistics of the export of treasure do not tally with what we know of the circulation of the rupee beyond the frontiers. Taking all these causes of loss together, I do not think we should overestimate the wastage of rupees from the circulation in placing it between half a crore and a crore annually. For the twelve years 1900 to 1912, therefore, I propose to make an aggregate deduction of 941 lakhs.

This leaves us with a public circulation of 175 crores of rupees (£116,500,000) on March 31, 1912, and a total public circulation, including notes, of 228 crores[68] (£152,000,000), being an increase since 1900 of 46 per cent in the rupee circulation and of 58 per cent in the total circulation. If Mr. Atkinson’s estimate of the circulation in 1900 is nearer the truth than Mr. Harrison’s, then the public rupee circulation in 1912 may have been as much as 200 crores. In the course of 1912 there was a good deal of fresh coinage, of which, at the time of writing, accurate statistics are not yet available. For our present purpose it will be quite sufficiently cautious to think of the public rupee and note circulation together as amounting to not more than 250 crores.

21. How much of this could possibly be spared from circulation at a time of crisis? In 1908 the rupee circulation fell (at its lowest point) by somewhat less than 30 crores, or less than 20 per cent of the estimated rupee circulation at that time. The note circulation (see p. 55) fell much less seriously. It does not seem to me likely that the Government could be called on at the present time to redeem more than 25 per cent of the total circulation (notes and rupees together), or, on the basis of the foregoing calculations, 60 crores (say) of rupees (£40,000,000). If the Government were to keep in one way or another a reserve of this amount for purely currency purposes, I think they would have done as much as reasonable prudence could require. I do not say that it is impossible that they should be called on to redeem a greater amount than this. But it would be extravagant to maintain a reserve adequate for all conceivable emergencies, since there is a further resort of which use might fairly be made without great reluctance. Unless the London Money Market has collapsed as well as the Indian, it is always open to the Secretary of State to borrow by means of India Bills. There would be nothing shameful in this—though possibly some expense. But the expense, even if the Secretary of State had to pay a rate of interest appropriate to Turkey or China, would be much less than the expense of maintaining a very great reserve against unlikely emergencies.[69]

22. So much for the proper magnitude of the Reserve, regarded as a Currency Reserve. The question of its use as a Banking Reserve raises two problems—a problem of policy and a problem of statistics. Ought the Government to allow its Reserve to be used as a Banking Reserve? If so, how large ought this Reserve to be? Let us consider policy first.

23. There are three kinds of crises by which the Indian Money Market might be assailed—a purely internal crisis, in which the banks have difficulty in meeting a run on them by their Indian depositors; a purely external crisis, in which India owes, and is called on to pay, large sums in the London Market, but is free from serious banking trouble at home; and a general crisis, in which the features of an internal and an external crisis are combined.

A purely internal crisis of the first kind might require assistance from the resources of Government, but would involve no claims on their sterling resources specifically, as distinguished from their rupee resources. The trouble would probably begin with a boom of the usual type, heavy commitments on the part of the banks, large importations of foreign goods, and (in the future) a good deal of internal company promoting. If, early in the autumn, a serious failure of the monsoon became apparent, a widespread suspension on the part of the numerous bubble banks, which have been springing up lately all over India,[70] would be a probable consequence. Indian depositors generally might take alarm and hoard money in their own houses on a large scale. Exchange Banks have such large deposits in India and so little cash there[71] that they would probably require to import funds from London as fast as possible. The Indian Joint Stock Banks, however, are now so important that the part played by the Exchange Banks might not be adequate to save the situation. The Government would then be called on to make advances to the Presidency Banks. This has happened from time to time in the past, the last occasion being in April 1898, when the Bank of Bombay, whose bank rate was then at 13 per cent, asked the Government for an advance of 25 lakhs.[72]

This raises the first question of policy—whether the Government should help the bankers’ reserves on an occasion of internal crisis by making rupee advances to them. But it is hardly relevant to the question of the Government’s sterling resources; and, unless the Government Savings Banks were to be in trouble at the same time, it is not likely that there would be any difficulty in helping the bankers, if it were thought right to do so.

A crisis of the second kind, due to general depression or bad harvests, in which India has to meet a heavy adverse balance in London, provided that, as in 1907, it is not accompanied by internal banking difficulties of the kind just described, causes, it is true, a drain on the Government’s sterling resources through the necessity of providing remittance on London, but only in proportion to the volume of notes and rupees which are brought to the Government for encashment or in payment of sterling drafts.

At first, therefore, in such a case, there is no question of the Government’s using its reserves otherwise than as currency reserves; and the banks will have plenty of notes and rupees with which to buy the Government’s sterling drafts. Only if the depression is very prolonged, and one bad harvest follows another, is the need likely to arise for sterling advances from Government, otherwise than against a corresponding face value of notes and rupees.

It is not very improbable, however, that in the future there might be a general crisis of the third kind—a heavy adverse balance against India, and an internal banking crisis at the same time. It is in these circumstances that the most difficult question of policy arises. The Indian Money Market would need to remit funds to London, but, on account of the internal banking crisis and an outbreak of hoarding amongst depositors, would not have even rupee resources with which to do it. Consequently the Government’s offer to sell sterling drafts in Calcutta, or to release gold from the Currency Reserve would not meet the case. If general distrust of banking was widely spread, and notes, gold, and rupees were being hoarded in the old–fashioned way on a large scale, the banks would not be able to put their hands on sufficient cash resources of any kind to enable them to pay for the Government’s drafts on a scale adequate to their necessities. The position would be that the Indian Money Market was on the verge of general insolvency with the Presidency Bank Rates at (say) 12 per cent, and that the Indian Government had (say) £40,000,000 sterling resources in hand with demands on only a modest scale for the encashment of notes and rupees. The Government would be vehemently urged to save the situation by making sterling advances, not simply in exchange for notes or rupees, but on some other non–monetary security.

24. We now have the possibilities before us. If in any of these sets of circumstances the Government were faced with demands for advances either in rupees or sterling, what line would it be proper to take?

On the one hand the policy of advances may introduce into the Indian Money Market a serious element of weakness,—an element, perhaps, inseparable from a system where there is no central banking authority and where the currency authority stands, normally, outside the money market. It is not the business of the Government to hold any of the reserves which the bankers ought to hold. But if the Government does, in fact, for another purpose hold large reserves in its hands, and if it is believed that it will in case of extreme necessity come to the market’s rescue, the bankers may tend to keep somewhat lower reserves than they ought, and than they otherwise would. We have over again the situation which has long existed, to its detriment, in the United States. There, as in India, the Government, with immense currency reserves of gold, is normally aloof from the money market. There also they have no central banking authority. The expectation that the Government will bring some of its gold to the rescue in extreme circumstances, has always been said to exert an enervating influence on the banks themselves in the matter of the precautions they take for times of crisis. The ultimate solution probably lies in the establishment of a Central Bank for India which shall be the Government Bank and shall hold the banking and currency reserves at the same time.[73]

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.

28. These are the relevant considerations. But any conclusion as to the possible magnitude of the adverse balance at which one can arrive on the basis of them is little better than a guess. I will give my guess for what it is worth. I think the £40,000,000, which I have fixed as the maximum figure of what is required for the redemption in sterling of such notes and rupees as may be presented, is more than sufficient to meet the adverse balance that is at all likely to emerge in any single year. But I do not think it certain that this sum would be adequate to the necessities of two successive bad years. On the other hand, it is necessary to bear in mind that by the second bad year there would have been time for a very great reduction in the volume of imports, on account of the greatly reduced purchasing power of the people, and that this might go a long way towards righting the balance; also that, if there was a considerable liquidation of short–period loans in the first year, it would not be necessary to repeat this to anything like the same extent in the second year. In short, the natural forces tending towards equilibrium would begin in the second year to show themselves more strongly. Nor is it necessary to accumulate reserves in advance for every eventuality. Two bad years in succession are not very likely; and, if they do come, the Secretary of State will have ample time to make his arrangements for borrowing.

I think it a sufficient concession, therefore, if the £40,000,000 be given as the proper limit, not as before of the aggregate sterling resources of all kinds, but of the Gold Standard Reserve and the sterling branch of the Paper Currency Reserve (i.e. excluding the Cash Balances).

In a country such as India, where all available resources are required for capital expansion, and where it is not sound or humane policy to burden the present overmuch for the sake of the future, it is nearly as important to avoid extravagance in the reserve policy as to avoid undue parsimony. As the rupee and note circulation is increased, the proportion of reserves ought to grow, of course, pari passu. But in existing circumstances to hold much more than £40,000,000 in sterling in the Gold Standard Reserve and the Paper Currency Reserve together would border on extravagance. If the reserves were somewhat lower than this, I do not think it would necessarily be blameworthy to leave them so, provided it would prove a very burdensome thing to raise them. For the expedient of a loan is always available.[77] My conclusion, rather, is that the reserves should be allowed to reach some such figure as this by the natural processes of growth, before sums are diverted from them to other purposes.

A very few years ago hopes of reaching so secure a position as this would have seemed chimerical. But the details given on p. 131 show that in December 1912 the sterling reserves already amounted to somewhat more than this. It is not yet clear, however, that their present amount is normal. If it turns out to be so, then a position of adequate strength has been attained already. But the form in which these reserves are held is open to much criticism, and this must be my next topic.

29. The criticisms which have had most popular vogue have been mainly directed against the absolute amount of the Gold Standard Reserve, against the investment of a large part of this reserve in securities, and against the maintenance in London of some part of the gold in the Currency Reserve.

In regard to the amount of the Gold Standard Reserve, Lord Curzon, in 1904, was inclined to think that £10,000,000 would be a proper figure. In 1905 Sir E. Law, the Financial Member of the Viceroy’s Council, suggested £20,000,000. In 1906 Sir E. Baker thought £20,000,000 a suitable minimum. More recently, in 1912, £25,000,000 is the amount which responsible officials have announced that they are aiming at. Sir E. Law and Sir E. Baker both based their estimates on the amount which the Secretary of State would require for his Home Charges if he had to curtail his drawings of Council Bills by one–third or one–half for a considerable period. I do not think that this is the most useful point of view from which to approach the question, or that the proper magnitude of the Gold Standard Reserve can be discussed without reference to the magnitude of the other reserves.

30. The other two criticisms quoted above lead on to the general question of how the sterling resources should be held and how they should be divided between the several Reserves. The second of these questions is mainly a matter of book–keeping, but has nevertheless some importance. The Government of India’s present system has no logical basis, is exceedingly difficult to understand, and has often led, in consequence, to a good deal of misunderstanding. The ideal system should be as simple and logical as is compatible with leaving the authorities a free hand to shift and adjust as the necessities of the moment may require. The present system is the outcome partly of historical origins, partly of the authorities not having allowed themselves by law a perfectly free hand. The much criticised practice, for example, of holding six crores of coined rupees in the Gold Standard Reserve is probably due to the provision by which that portion of the Currency Reserve, which is held in London, can be held only in gold. If rupees have to be released hurriedly from the silver portion of the Gold Standard Reserve in India, the authorities have a completely free hand as to the form in which they make the corresponding addition to their sterling reserves in London; whereas, if they are released from the Currency Reserve, the corresponding transference in London must be made wholly in gold coin—a course which may sometimes be exceedingly inconvenient at the moment.

31. If the authorities allowed themselves more latitude as to the manner in which the Currency Reserve might be held, it would be a mere book–keeping transaction to transfer to this reserve the rupees now held in silver in the Gold Standard Reserve and to replace them by a corresponding transfer of gold; but such an arrangement would be more logical and easier to understand.

32. I think, therefore, that there might be considerable advantages in the adoption of some general scheme for the reserves such as the following:—

(1) While it would be legal to hold the Gold Standard Reserve in any form—gold, securities, bills of exchange, loans, or rupees—it should be normal in good times to hold, say, £11,000,000 in sterling securities and the rest in gold either in London or India, but preferably in London.

(2) Power should be taken to invest a larger amount of the Currency Reserve than at present (say £7,500,000 sterling securities in addition to the rupee securities instead of £2,500,000 as at present), and to hold a prescribed maximum proportion (say one–third) of it in bills of exchange or on loan at short notice either in India or London.

All this, after the necessary change of law, could be effected by a change in book–keeping; and in December 1912 the account would have stood as follows (compare the actual state of affairs as given on p. 131):—

Gold—
Gold Standard Reserve in London	£7,500,000
Gold Standard Reserve in India	2,500,000
Currency Reserve in India	15,000,000
	—————–
	£25,000,000
	════════
Money at Short Notice—
Currency Reserve in London	£1,000,000
Cash Balances in London	7,500,000
	—————–
	£8,500,000
	════════
Sterling Securities—
Currency Reserve	£7,500,000
Gold Standard Reserve	11,000,000
	—————–
	£18,500,000
	════════
Rupees—
Currency Reserve	£13,750,000
	════════

33. Some changes of substance might be added to these changes in book–keeping and are naturally suggested by them. There is, first, the question whether the gold portion of the reserves ought to be held in India or in London. Readers of Chapter IV. will know that there are, in my opinion, no advantages in keeping gold in India, and that such a policy involves a direct money loss through the cost of originally carrying the gold to India and the cost of bringing it back again to London when, at a later date, it is required to support exchange. But Indian opinion views with suspicion the holding in London of the greater part of India’s gold reserve, and this opinion, though ill–founded, is likely to persist for some time to come. The amount of expense involved in keeping gold in the Indian reserves is, in relation to the issues involved, not great; and it might be well worth while to incur it in order to avoid the currency system’s falling under a suspicion, however ill–founded. It might be a satisfactory compromise, therefore, if, as a normal practice (but not as a legal requirement), the gold in the Gold Standard Reserve were held “ear–marked” at the Bank of England, but the gold in the Currency Reserve retained in India. It may be added that the authorities seem, in fact, to be moving somewhat in this direction; for it is understood to be their intention to accumulate £5,000,000 in gold “earmarked” for the Gold Standard Reserve.

If, however, a large part of the gold be held in India, it is of the utmost importance, in the event of a crisis, that the gold should be shipped by the Government to London and sterling drafts on London sold against it, or, if it were released in India, that the banks only should be allowed to get it, and on an undertaking to export it. Otherwise, if it were made freely available in India, a part might be lost and wasted (so far as the support of exchange is concerned) in hoards.

34. The suspicion which is felt with regard to the holding of Indian gold in London is exceedingly natural, and can be completely dissipated only by a fuller knowledge of the currency system and of the mechanism of the foreign exchanges, than the generality is likely to possess. It is natural to think that this gold is more at the disposal of the London Money Market than it would be if it were in India, and that the Secretary of State, under corrupt or interested pressure, can easily place it at the disposal of London financiers. Apart from the question how far the Secretary of State is really open to such pressure, it may be doubted whether he is likely to be exposed to it, because at a time of real stringency it will prove easy, I believe, for the London Market to get hold of some part of the Indian gold, whether held in London or in India, by perfectly legitimate means. India is normally in the position of owing London money; this debt is discharged partly by the consignment of goods, partly by the renewal at frequent intervals of short loans or credits made by the London Market to the Indian Market on bills of exchange or through the Exchange Banks, and partly by new permanent loans. If there is great stringency in the London Market and London is in urgent need of funds, the use of the last two methods can be so much restricted that India can be practically forced to pay what is owing in gold. It is, in fact, precisely because she is open to this pressure that it is necessary for a considerable gold reserve to be kept. So long, therefore, as the gold is freely available either in India or in London for the support of exchange, it is unlikely that it can be withheld from the London Money Market if this Market really wants it. If it is in London, India will be able, by the sale of telegraphic sterling transfers in Calcutta, to discharge her due obligations cheaply and without delay; if it is in Calcutta, additional charges and a loss of time must be incurred.

A feeling of jealousy on a country’s part, lest some other country should have a lien on its gold reserve, is frequently liable to arise at the present time, but is essentially opposed in spirit to the whole purpose and meaning of keeping gold reserves at all. Gold reserves are meant to be used in times of difficulty, and for the discharge of pressing obligations. It is absurd for a man with a large balance at his bank to default to his creditors, because a feeling of jealousy, in regard to any one in whose favour he draws a cheque, prevents him from ever drawing one. Mr. Bagehot certainly did England a great service in dissipating from the minds of her financiers this primitive prejudice;—for wonderfully few other countries have yet learnt that gold reserves, although no doubt they serve some purpose when they are held for show only, exist to much better purpose if they are held for use also.

Vague stirrings of the original sin of mercantilism always inherent in the mind of the natural man and urging him to regard gold as beyond everything essential wealth; jealousy of the too powerful magnates of the London Money Market obtaining what should belong to India’s Market for their own purposes; jealousy of the Secretary of State seeming, like a man who invests abroad, to seek in this way an independence of India in case of trouble; jealousy of Great Britain, who might use or regard India’s “ear–marked” gold as her own war–chest;—all combine to make a powerful, natural, and yet unfounded prejudice which it is exceedingly difficult to combat. Nothing is commoner than to read incitements against malevolent financiers who would seek to deprive India of her “fair share” of the world’s new gold. India must be allowed, I suppose, to hug her sterile favourite. In spite of the notorious fact that the Bank of England holds less gold than the Central Bank of any other first–class Power,—far less even than the Caja of the Argentine,—the belief will continue that the amount of gold a country holds at home, rather than the degree of promptness and certainty with which at all times it can meet its international engagements, is the measure of its financial strength.

35. What other changes of substance might be made usefully? By far the most important is connected with the proposed power to make advances from the Currency Reserve on bills of exchange and other approved security, as briefly described in Chapter III.

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.

Only under one or other of two conditions could loans from the Cash Balances be important: first, if the proceeds of taxation tended to accumulate in the Government Treasuries in the autumn and winter months so that the balances tended to be above their normal level at the busy season; and second, if the Government were to pursue the foolish policy of habitually keeping more ample balances than they really required. The first of these conditions is not fulfilled to any important extent. The land tax is collected, naturally, after the harvest has been sold, not during it; and at the end of the calendar year the surplus balances are small. The totals of the Indian Balances on August 1 and January 1 of recent years are shown below:—

(In Lakhs of Rupees)

	August 1.		January 1.
	Reserve Treasuries.	Total Balances in India.	Reserve Treasuries.	Total Balances in India.
1906–1907	5,26	17,18	1,60	10,46
1907–1908	5,18	17,14	3,20	11,84
1908–1909	7,41	19,54	,76	9,33
1909–1910	2,22	13,61	1,74	10,16
1910–1911	9,49	21,43	2,82	13,18
1911–1912	9,62	22,66	3,21	15,18
1912–1913	10,96	24,58	10,62	21,99

The total balances include the working balances in the innumerable District Treasuries all over India and the sums already deposited with the Presidency Banks. When, therefore, we are considering to what extent the Government could lend at the height of the busy season, we must chiefly pay attention to the sums in the Reserve Treasuries on January 1. The above figures show conclusively that, as a rule, the Indian Money Market cannot expect substantial assistance from this source at the time of year when it is most needed. Except in 1913,[82] the resources of the Reserve Treasuries on January 1 have been in recent years between £1,000,000 and £2,000,000.

After January 1, it is true, the revenue comes in rapidly.[83] But as a matter of fact, the funds which accumulate from the proceeds of revenue between January and April are quickly released and returned to the Money Market, as matters now are, through the encashment of the Council Bills which are generally sold in large quantities at this time of year. If this money were to be released by loan instead of by the encashment of Council Bills, the effect would be that less funds would be remitted to London; and unless we assume that more funds are being remitted to London than are really required, this would put the Secretary of State to inconvenience in meeting the Home Charges. Only in years when sufficient funds had been remitted to London earlier in the financial year, therefore, would surplus funds be available in the Indian Treasury to any important extent even in the latter half of the busy season.

I do not say that the Government should not lend from the Cash Balances in India whenever exceptional circumstances may lead to their being at an unnecessarily high level in the busy season. But the sums which could be lent in this way would not generally be important, and the amount of elasticity which the financial system could gain by these loans would be small compared with what it might acquire from a reform of the Paper Currency Reserve. I should prefer, therefore, that the Indian Cash Balances should be held, so far as possible, in notes, thus increasing the capacity of the Currency Reserve, and that all advances should be made in form from the Currency Reserve. The question of the use of funds in the Cash Balances would then lapse into the question of the use of funds in the Paper Currency Reserve. But if a different system of book–keeping be preferred, no substantial change is involved in what I propose. The method of loaning from the Currency Reserve is applicable mutatis mutandis to loans from the Cash Balances.

39. Of the Cash Balances in London no more than a working account is kept with the Bank of England. The manner in which the rest is dealt with is best described in the words of an official memorandum issued by the India Office in 1913 [Cd. 6619]:—