In 1939, World War II broke out and continued up to 1945. The major developments which took place in Indian monetary system during this period were as follows:
1. Exchange Control:
In order to regulate and control the foreign exchange resources of the country, the policy of exchange control was introduced in 1939. The main features of the policy were:
(i) Reserve Bank was given exclusive responsibility of managing the foreign exchange resources of the country.
(ii) Restrictions were imposed on the sale and purchase of foreign exchange.
(iii) Dealings in foreign exchange was allowed only through authorised dealers and banks.
(iv)The Indian exporters were obliged to use their earnings of scarce currencies with the prior permission of the Reserve Bank.
(v) No Indian citizen could buy and export foreign securities without the prior sanction of the Reserve Bank.
(vi)The exchange rate of the rupee was kept stable at Is. 6d.
2. Expansion of Currency and Credit:
During the World War II, was considerable expansion of currency and credit? Money supply increased by Rs. 1565 crores over the war period, which comprised note circulation (Rs. 906 crores), rupee coins (Rs.138 crores), small coins (Rs. 60 crores), and demand deposits (Rs. 461 crores). The main reasons for this expansion were as follows:
(i) Defence expenditure increased tremendously.
(ii) India supplied large quantities of goods to Britain and its allied countries during war, the payment for which was to be made in sterling. On the basis of these accumulated sterling balances, the Reserve Bank expanded the paper currency in the country.
(iii) Much money was spent in India on behalf of the British and allied government.
(iv) Although taxation and borrowing was increased to meet increased expenditure of the government, but still a large amount of fresh currency was needed and issued to fill the deficiency.
(v) Under various voluntary and compulsory repatriation schemes, sterling loans were converted into rupee loans.
3. Increase in Sterling Balances:
During the World War II, there was enormous increase in India’s sterling balances. These balances increased from Rs. 64 crores in 1939 to Rs. 1733 crores in 1945-46. The reasons for this increase were:
(i) India spent some money on behalf of the British Government. For this India was paid in terms of sterling’s.
(ii) Commodities supplied to Britain and the allied countries were paid in terms of sterling securities.
(iii) During the war period, India had favourable trade balances and became a creditor country to Britain. For this the payments were made in sterling securities.