Recently, the “Indian Rupee” depreciation to more than Rs. 70 a dollar.
In this context, it would be worthy to understand the context of how India achieved monetary independence, which was much later than 1947.
What is the history of the Indian rupee’s travails?
Pre-Independence
The association of Indian rupee with Britain was prolonged by factors beyond India’s control and continued even long after Independence.
From 1931 onwards, rupee was pegged to the “sterling standard” (Britain’s currency), which was a depreciating one at that time.
War - Because of this monetary dependence, when Britain (and France) declared war on Germany in 1939, it impacted the currency situation severely.
India’s economy was also geared up by the colonial government towards the war effort through imposition of production & money exchange restrictions.
Notably, the rupee, which was completely convertible into any currency before, was made inconvertible into any other currency from 1939.
Fund transfers outside British territory were severely restricted and dollar securities held by private individuals were also compulsorily acquired.
This was done to enhance Britain’s dollar reserves, and people were compensated in rupees at an arbitrary rate, resulting in losses to many.
Implications - Dollars for the war were also raised by selling silver bullion from India’s reserves to governments outside the sterling area.
Importantly, dollars were spent on imports of essential consumables as dictated by the war requirements, and not others.
India had accumulated a sizeable sterling balance of £1,300 million in 1946, as almost all forms of consumer imports were curtailed due to war.
Subsequently, the corresponding increase in rupee circulation which was stocked up during the war, caused inflation in India.
Partitioning the Pie
After the war ended, the transfer of the sterling balances was negotiated between India and Britain and later Pakistan also joined in.
Winston Churchill had been threatening to write off the sterling balances if not given a deal that is to his liking (which was an exorbitant ask).
But, with Churchill losing power in 1946, the new regime in Britain towed a more cordial tone towards India despite some tough negotiations.
India sought a commitment from Britain that “sterling (which was then over valued), won’t be devalued in the near future, but that was refused.
Further, the chaos of partition violence and other unsettled political questions sidelined the more mundane economic discussions to the margins.
The deal
Britain managed to secure restrictions on both India and Pakistan to judiciously use their Sterling reserves to secure its own “balance of payment”.
Stress - Britain had initially agreed to make the pound convertible under the terms of a loan from the U.S., which meant India could spend in dollars.
But Britain soon repudiated this convertibility clause, which in turn altering the character of the agreement entered into with India.
The pound convertibility pact was violated as Britain had to meet its massive imports from U.S. due enhanced consumer demand in the post war years.
A delegation was sent back to London to renegotiate the convertible portion of the sterling balances but that mission failed and the deal was never secured.
Results - The negotiations were finally concluded in the summer of 1949, after the completion of the bitter separation of Indian and Pakistani finances.
The Indian side agreed to deductions from the sterling balances for pensions of former British members of the ICS and for military equipment purchases.
The subtractions added to £100 million and limits were placed on how much could be drawn in a given period from the balances.
How did the valuations vary since then?
While the British side gave credible warnings of an imminent sterling devaluation, the Indian side failed to decipher and capitalise on them.
The sterling was devalued steeply in September 1949, which took India by surprise and literally wiped off a third of the value of India’s sterling reserves.
Subsequently, India too had to devalue its rupee proportionally, which had considerable economic implications as imports become costly.
The two currencies were delinked in 1975 and have functioned independent of each other in monetary terms ever since.
The sterling was floated against the major international currencies in the early 1970s, but rupee was floated only in 1993-1994, after liberalisation policies.
