The history of demonetisation continues to be fascinating. After posting about two episodes of Demonetisation in India in 1946 and 1978, one came across another one reading RBI history during Partition.
There are various economic history issues in Indo-Pak partition. The currency usage was one such issue. Before Partition, the Indian Rupee was used across the sub-continent. Post-partition, how did Pakistan move onto a new currency? How was Indian currency removed or in other words demonetised from Pakistan monetary system?What was the process?
In RBI’s first history volume (1935-51), there is some interesting discussion on these issues. (Let me warn upfront. This one is both a long and confusing post):
Just before Partition on July 1 1947, ten expert committees were floated to discuss on several issues related to partition. One of these was an expert committee was floated to discuss the issues related to money matters.
The Committee was required (i) to make
recommendations regarding currency and coinage arrangements for the two Governments,
(ii) to formulate proposals for the division of the assets and liabilities of the Reserve Bank
and the organisational consequences of partition in respect of ‘its administrative machinery,
(iii) to make recommendations regarding exchange control for the two States and (iv) to
report on the position of the two States in regard to the membership of the International
Monetary Fund and the International Bank for Reconstruction and Development.
The committee members were: (1) Ghulam Mohammad, (2) Zahid Hussain, (3) K. G. Ambegaokar, (4) Sanjiva Row, (5) I. Qureshi, (6) M. V. Rangachari Secretaries: H. S. Negi and Anwar Ali.
The committee submitted its report fairly quickly on 28 July 1947. On currency issue, following timeline was decided :
- From Partition to 31 March 1948: RBI will continue to be the central bank of India and Pakistan. The legal tender in both shall be Indian Rupees
- From 1 April 1948 to 30 Sep 1948: This was the transition period. RBI was to remain the central bank but all new issuance shall be in Pakistan overprinted note (these were issued by RBI but Government of Pakistan was inscribed). The existing Indian Rupees shall remain legal tender but no new issuance.
- From 1 Oct 1948 onwards: Pakistan central bank to start operations and take the entire liability of Pakistan overprinted notes. Against the liability of the Pakistan overprinted notes, RBI shall transfer the assets in proportion it held the total assets. There was no problem with these notes as they were of Government of Pakistan.On Indian Rupee notes, the thing was they had to be demonetised and eventually exchanged for Pakistan notes. They were liability of Pakistan and RBI was to transfer assets against these liabilities as well. This led to disagreement amidst Pakistan members. The Non-muslim members suggested a shorter time period for demonetisation whereas Muslim members wished for a longer transition.
In respect of the Issue Department, the only point of agreement was that the Pakistan Government should take over from the Reserve Bank, on October 1, 1948, the liability in respect of all the Pakistan overprinted notes of the Reserve Bank issued up to that date; against this currency liability, there was to be provisional allocation of assets to the Pakistan Government on September 30, 1948, in the ratio in which the various assets were held in the Issue Department on that day.
With regard to India notes in circulation in Pakistan areas, the liability for which also was required to be assumed by Pakistan, there was disagreement between the non-Muslim and Muslim members concerning the time that should be allowed for the final allocation of the assets to be made over to Pakistan against these India notes.
The non-Muslim members considered that this should be done on March 31, 1949, and should be equivalent to overprinted notes taken over by the Pakistan Government on September 30, 1948 and India notes returned from circulation in Pakistan between October 1, 1948 and March 31, 1949; the Muslim members considered that this period was not adequate and desired to have a provision leaving it open to the Pakistan Government to extend the date.
The non-Muslim members argued that since the notice regarding the demonetisation of India notes would have been given on April 1, 1948, a period of one year was more than sufficient for the withdrawal of India notes. India notes coming into the hands of the Pakistan Government after March 31, 1949 could be exchanged, they observed, in the normal manner as foreign exchange. The Bank’s representatives were in agreement with the non-Muslim members.
(emphasis is mine)
Based on this agreement, Pakistan (Monetary System and Reserve Bank) Order 1947 said following on currency (Bank mentioned here is RBI):
Currency and Coinage: The Bank was to have .the sole right to issue notes in Pakistan up to September 30, 1948. While India notes were to continue to remain legal tender in Pakistan up to September 30, 1948, the Order provided for the issue by the Bank, from April 1, 1948, of notes in Pakistan, carrying the inscription ‘Government of Pakistan’ in English and Urdu. The Government of India were not liable to pay the value of any notes so inscribed; the Bank’s liability in respect of such notes was to cease on September 30, 1948.
The Order did not specify the date on which the Government of Pakistan would issue their coins, but it provided that if any Pakistan coins had been issued, the Bank was not to issue India coins in Pakistan after March 31, 1948, except to the extent that Pakistan coins were not available in sufficient quantities. India one rupee notes were not to be legal tender in Pakistan after September 30, 1948; these were to be withdrawn in order to allocate the liability between the two Governments.
Division of Assets of the Issue deportment: The basic principle observed in the division of the Bank’s assets derived from the fact that in the case of every financial institution assets match liabilities. The transfer of assets had therefore necessarily to be balanced by a transfer of equivalent liabilities. Since the assets of the Issue Department were held against liability for note issue, the extent of assets transferred to Pakistan was equivalent to the note issue liability assumed by Pakistan.
Thus, the Order provided for the transfer to the Government of Pakistan from the Issue Department of the Bank, as soon after September 30, 1948 as practicable, assets equivalent in value to the total liability in respect of Pakistan overprinted notes outstanding on that day. India notes in circulation in Pakistan on September 30, 1948 were to be accepted by the Government of Pakistan at par up to March 31, 1949, or if the two Governments considered it necessary, up to September 30, 1949, and assets from the Issue Department equivalent in value to such India notes retired were to be transferred to the Pakistan Government on demand.
The Bank’s holdings of Pakistan’s rupee securities and advances, if any, taken by the Pakistan Government from the Bank were to be first set off against the liability for Pakistan notes and India notes returned from circulation in Pakistan and only in respect of the balance, the other assets of the Issue Department, consisting of gold, sterling securities, India rupee coin, Pakistan rupee coin and Government of India securities, were to be transferred in the proportions in which they were held in the Issue Department on September 30, 1948. Pakistan rupee coins remaining with the Bank after the division of assets were to be made over to the Government of India for disposal otherwise than as coin.
So basically Balance sheet of RBI Issue Department was to look like this on 30 Sep 1948:
Indian Rupees in India Govt Securites
Indian Rupees in Pakistan –Indian Govt
Pakistan Overprinted notes –Pakistan Govt
The last para in Monetary Order talks about this netting only. The Liabilities owed by the RBI to Pakistan Govt were to be netted against the assets owed by Pakistan Govt to RBI. Then whatever RBI owed as net liability was to be transferred to Pakistan along with assets held in the same proportion.
What eventually happened was due to differences between Pakistan and RBI, the initial arrangement had to be scrapped. RBI ceased being central bank to Pakistan 3 months earlier on June 30,1948.
Based on this Monetary Order was amended:
Division of Issue Department’s Assets: Pakistan’s share in the Issue Department assets was to be equivalent to the value of Pakistan notes outstanding on June 30, 1948, plus the total value of India notes which were legal tender in Pakistan on June 30, 1948, or in
respect of which the rights of encashment in Pakistan existed on that date, and which were retired thereafter and delivered by the Government of Pakistan to the Reserve Bank till the end of June 1949.
Transfer of Assets: The Bank was required to transfer from its Issue Department to the Government of Pakistan, as soon after June 30,
1948, as practicable, assets of a total value equivalent to the total liability in respect of Pakistan notes outstanding on that day. India notes which might be legal tender in Pakistan on June 30, 1948, or in respect of which the rights of encashment in Pakistan existed on that date, were to be accepted by the Government of Pakistan at par until June 30, 1949. On the delivery of such notes to the Bank from time to time in instalments of not less than Rs. 5 crores each, assets of equivalent value were to be transferred from the Issue Department to the Government of Pakistan.
The Order, however, provided that no assets of the Issue Department of the Bank were to be transferred to the Government of
Pakistan, until that Government returned to the Reserve Bank, India notes and India and Pakistan rupee coins held in the currency chests in Pakistan on June 30, 1948, at least to the extent the value of these notes and coins exceeded the value of Pakistan notes in
circulation on June 30, 1948. The Bank was entitled to withhold from the value of all or any of the assets to be transferred to the Government of Pakistan from the Issue Department of the Bank an amount equal to the value of India notes and coins which
were, for the time being, held in Pakistan.
The transfer of Banking department was easy as deposits of central and state Govts of Pakistan were netted against opening balance. This was Rs 100.7 cr.
The problem as expected was on account of Issue department. India was only accountable to return assets equivalent to Indian rupee in circulation in Pakistan till June 30 1948. So there was some expectations about the amount. However, Pakistan returned far higher volume of notes than expected. This was because Indian Rupees kept coming in Pakistan due to leaky borders. Pakistan also continued to take Indian Rupee as legal tender after 1 Jul 1948 leading to import of Indian Rupee. This led to Pakistan demanding much higher share in Assets of RBI which was not agreed by Indian Govt:
Difficulties arose in respect of India notes transferred to Pakistan after June 30, 1948. It was estimated at the time of the partition that total note circulation in Pakistan would be Rs.120 to Rs. 130 crores. Inscribed Pakistan notes on June 30, 1948 were of the value of Rs. 51.57 crores, Therefore, on the basis of the above estimate, about Rs. 80 crores of India notes were due to return from circulation after June 30, 1948. As against this, the actual value of India notes delivered to the Reserve Bank by the State Bank of Pakistan in the first six months July-December 1948 came to as much as Rs. 103 crores, while even thereafter, the weekly remittances continued to be
sizeable. Investigations revealed that a fair percentage of remittances received from Pakistan contained notes issued in India after March 31, 1948. Enquiries instituted by the Bank also revealed that substantial quantities of India notes did pass over to Pakistan, the main leakage having occurred on the eastern border. The transfer was mainly for payment of goods, e.g., jute, purchased from Pakistan. The results of the investigations were conveyed by the Bank to the Government of India in February 1949.
Apparently the matter remained unresolved at the time of writing of the RBI History in 1970.
This is obviously the Indian side of the story. Reading Pakistan side would be interesting as well. Also, how did the eventual transition to Pakistani Rupee would make it a more complete analysis.