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The Genesis of the Rupee as Modern Money

One of the key tenets of Modern Money Theory (MMT) is that taxes drive money.  The state can introduce any object as money so long as it makes it mandatory (and enforceable) that all obligations due to it can be settled in that object or money-thing only.  In other words, if a piece of paper denominated as a rupee is introduced as legal tender, it will make that piece of paper valuable as money even though it does not have any intrinsic (market) value like a silver or gold coin.  However, legal tender is only one of the two critical features of modern money.  The other, fiat currency, i.e. currency by order, decree, regulation or law, refers to money that is not convertible into precious metals (or commodities), or foreign currencies at a fixed rate

It is interesting to see how modern money took root in colonial India in the second half of the nineteenth century.  As the British began consolidating political power over India, the government became aware of the benefits that could accrue to itself and society-at-large from introducing a paper currency.  Quite like the argument made by MMT, the importance of money as legal tender was emphasized.  In spite of being in a position to enforce tax collections, the British still found it challenging to surmount the obstacles in issuing an inconvertible paper rupee or, in other words, a fiat currency.  The reason for this can be understood when we go back further in time and look at the legacy of the silver rupee.

The rupee or rupyā, which means silver, was introduced as currency in the year AD 1542 during the reign of Sher Shah Suri.  The rupee coin weighed approximately 11.4 grams with purity of close to 96 percent.  It was a standard coin and its purchasing power fluctuated with the price of silver bullion in the market.  It can therefore be conceived as a commodity except that it (as coin) served as the unit of account as well as the single legal tender.  This monometallic silver standard with the rupee as standard coin, with few modifications in its weight, continued throughout the Mughal period and then under the rule of the English East India Company except for short intervals of time when the latter, unsuccessfully and with tumultuous consequences, experimented with bimetallism.  Obligations to the state had to be settled in these coins (objects) only so that the government could earn brassage in the process of minting coins from bullion.  Exchanges within the private sector also benefited from coinage as a coin’s weight and purity was certified by the mint thereby avoiding the need to assay pieces of metal.  

The boom in Indian cotton exports which began in the 1850s had led to a severe international shortage of silver and consequently, the rupee.  Two options were explored to overcome the shortages in silver; the first, a gold currency for India which never materialized and second, the introduction of paper currency.  A plan for the latter was proposed in 1859 by James Wilson, a financier and economist, soon after the transfer of power from the Company to the British Crown.  While a complete transition to an inconvertible fiat currency was not in the reckoning at that point in time given that the British government’s legitimacy was low, post-the 1857 mutiny, Wilson nonetheless proposed a leverage ratio of one is to four or as Nassau Lees put it, “… [Wilson] proposed suddenly to create about £51,000,000 in currency notes, £17,000,000 only of which were to represent actual coin or bullion …”.

Implicit in Wilson’s scheme was the belief that an increased supply of money would bring benefits to the real economy by saving precious capital from being wasted in the production of precious metals and its transport as well as stimulating trade and investment, resulting in higher output.  While debate broke over Wilson’s scheme over issues like inflation and asset bubbles, the key apprehension was whether or not people would accept paper (with no intrinsic value) as currency.  For this Wilson emphasized that the government must ensure convertibility as absolutely certain, especially in the interior parts of the country.

However, more than this assurance of convertibility with just one-fourth of the value of paper currency held as silver reserves, Wilson realized that it was paper currency as legal tender which would ultimately create a demand for it.  Consider the following remarks made by him:

“… in order for that a Paper currency shall fulfill all the purposes of coin, it is necessary that it should be a legal tender everywhere … and it should be received by the Government in payment of revenue and for all other purposes.”

“… let us bear in mind that the proposal is, and we think that essential, that the notes to be issued are to be legal tender in all transactions between man and man, that they are to be received at Government Treasury for all the demands of the Government for revenue or other purposes, and that the system is to be general and to extend over the whole of India.”

In fact, it was an ardent critic of Wilson’s plan, Nassau Lees, who articulated the importance of legal tender in driving the paper rupee:

“… it is impossible to examine his [Wilson’s] scheme closely, and in detail, without arriving at the conclusion … that he depended more on the ‘legal tender’ than on the principles that he himself laid down.  The edicts of kings and the laws of nations can certainly constitute paper, leather, shells, beads, and other things money.  Emperors and kings have ere now done so.  And any of these things once made what is called “legal tender”, all within the limits of the kingdom being compelled to receive them in liquidation of debts, they necessarily come into circulation.”

In spite of Wilson’s understanding of the essence of modern money, the plan was ultimately not adopted.  Instead, a far more conservative scheme based on complete backing of all paper currency issued with silver reserves was implemented in 1862.

Nonetheless, in Wilson’s plan, the seeds for the rupee as modern money had been sown.

Sashi Sivramkrishna
Sashi Sivramkrishna is the author of two books, In Search of Stability: Economics of Money, History of the Rupee and Maximum Government, Maximum Governance: Reframing India’s Macroeconomic Discourse. He is also an avid documentary filmmaker. He is presently Director of the Foundation to Aid Industrial Recovery (FAIR)