The following is the brief account of early history of Indian currency system before World War II:
1. Early Monetary System (before 1835):
At the time when the East Indian Company came to India, there was no properly organised monetary system in India. Theoretically speaking, India before 1935 has a kind of bimetallic standard because both gold and silver coins were in existence. But there was no uniformity in coins.
It is said that 944 types of coins of gold and silver with different weights and fineness were in circulation in the country. This created utter confusion because the conversion of one coin into another was very difficult.
2. Silver Standard (1835 to 1893):
To bring about uniform monetary system, the East India Company enacted the Currency Act of 1835, according to which the silver rupee was declared as the standard coin in the country.
This ushered in the era of silver monometallism in India. Under the silver standard, (a) there was free and unrestricted minting of silver rupee; (b) the weight of the silver rupee was 180 grains and its fineness was 11/12; and (c) the silver was unilimited legal tender.
From 1873 onwards, the silver standard ran into difficulties. Due to the discovery of new silver mines, the production of silver increased and the gold price of silver began to fall.
As a result of this, exchange value of silver rupee fell and Indian foreign trade received a setback thus, the government, on the recommendations of the Herschel Committee, abandoned the silver standard in 1893.
3. Silver Exchange Standard (1899 to 1917):
From 1893 to 1898 was a period of transition which preceded the adoption of gold exchange standard in the country. In 1898, the British Government appointed the Fowler Committee to draw up a suitable gold standard for India. The Fowler Committee recommended the traditional gold standard with a few modifications.
The government, under the Currency Act of 1899, introduced gold exchange standard (and not gold currency standard as recommended by the Fowler Committee) in India. The main features of gold exchange standard were:
(i) Silver rupees, half rupees and currency notes were unlimited legal tender for all internal transactions in India.
(ii) For external purposes, the rupee was convertible into gold at the rate: 1 rupee = Is 4- d.
(iii) The sterling value of the rupee was regulated between Is 4 ~ d. and Is d. through the sale of Council Bills and Reverse Council Bills respectively.
(iv) The Secretary of State used to sell Council Bills in London for payment in India, while Reverse Council Bills were sold in India for payment in London.
(v) For smooth working of the system, two reserves were maintained, one in India in rupees, and the other in London in sterling.
The Chamberlin Committee of 1913 approved the working and suitability of gold exchange standard in India. But, in 1916, due to shortage of silver the price of silver started rising and the people started melting silver rupee and selling it as silver.
This made it almost impossible for the government to purchase silver at a higher rate and supplying silver rupee at a lower rate of Is. 4d. Consequently, in August 1917, the silver rupee ceased to be standard coin and the gold exchange standard was abandoned.
4. Period of Unstable Exchange Rate (1917 to 1920):
The period between 1917 and 1920 was marked by unstable exchange rates. During this period, the government tried to restore gold exchange standard by allowing the exchange rate to vary with the price of silver.
In 1920, on the recommendations of the Babington- Smith committee, exchange was fixed at 1 Rupee = 2s. This was a very high rate and the attempt to maintain it cost the Indian exchequer Rs. 40 crores.
5. Period of Masterly inactivity (1917 to 1927):
After 1920, the government gave up all attempts to maintain a particular exchange rate. This policy, which was known as the policy of Masterly Inactivity, continued till 1927.
6. Hilton-Young Commission (1925):
In 1925, the government appointed Hilton-Young Commission to investigate into the monetary system in the country. The commission made far-reaching recon emendations for remodeling and renovating the Indian monetary system. The important recommendations were:
(i) The Commission recommended the abolition of the gold exchange standard and its replacement by the gold bullion standard. Under the gold bullion standard, the currency consisting of token coins and the paper notes could be converted into gold in the form of bullion at fixed rates.
(ii) The Commission also recommended to fix the rate of exchange at 1 Rupee = Is. 6d. Sir Purshottam Dass, the only Indian member of the Commission, was in favour if Is. 4d. as the exchange rate.
(iii) Another recommendation of the Commission was that a Reserve Bank should be established as the central bank of Indian.
7. Gold Bullion-cum-Sterling Exchange (1927-1931):
Under the Currency Act of 1927, a mixture of gold bullion and sterling exchange standards was adopted. According to this system, the rupee was linked to gold, but its value was fixed at 8.47 grains of fine gold, which is equivalent to Is. 6d. in terms of sterling.
Rupee and notes were made convertible into gold or to sterling at the option of the government for making foreign payments. This ‘hybrid’ system continued up to September 1931.
8. Pure Sterling Exchange Standard (1931-1939):
When England went off the gold standard in September 1931, India also abandoned the gold-bullion-cum-sterling exchange standard and directly linked the rupee with British pound sterling at the rate of 1 Rupee = Is. 6d. Once again, Indian monetary system became highly dependent on the monetary policy of Great Britain.
During Great Depression, Indian exports declined sharply and India had to export gold considerably to pay for her imports and ‘home charges’.
In January 1935, the Reserve Bank of India was established as the central bank of India it considerably strengthened the currency and banking system of the country.