Role of RBI as Currency Authority!
The RBI is the sole authority for the issue of currency in India other than one-rupee notes and coins and small coins which are issued by the Government of India. The bulk of the currency (about 93 per cent of it) is in the form of Reserve Bank notes, which are currently issued in the denominations of rupees two, five, ten, twenty, fifty, one hundred, and 500. Earlier, notes of higher denominations of rupees one thousand, five thousand, and ten thousand were also issued. But they were demonetized to discourage black-market operations through them.
The issue of notes by the RBI is kept separate from the rest of its banking operations. For this, the RBI is organized under two separate departments, the Issue Department and the Banking Department, the former being solely responsible for the issue of notes. All the currency issued by the RBI (i.e., its Issue Department) is its monetary liability. Under the law, it must be backed by assets of equal value (held in the Issue Department). These assets consist of gold coin and bullion, foreign securities, rupee coins, and Government of India rupee securities.
Whenever the Issue Department acquires any of these assets, it does so by issuing its currency. The conditions governing the composition of these assets determine largely the nature of the ‘currency standard’ prevailing in the country.
For example, for the period 1935-56, India had ‘proportional reserve system’ under which the RBI was required to hold against notes issued at least 40 per cent assets in its Issue Department in the form of gold (coin or bullion) and sterling (later foreign) securities, and only the balance in the form of rupee securities, with the further provision that gold (coin or bullion) at any time was not less than worth Rs. 40 crores.
In October 1956 this system was replaced by a ‘minimum of foreign reserves system’, which required the RBI to hold as assets in its Issue Department only a minimum of Rs. 515 crores worth of foreign reserves (Rs. 115 crores of gold and Rs. 400 crores of foreign securities) and all the rest in rupee securities, whatever the amount of its currency outstanding. Even this was diluted further a year after. Since then the only binding requirement has been to hold at least Rs. 115 crores worth of gold as backing against the currency issued the rest of the backing being in the form of rupee securities.
This has placed India on ‘managed paper currency standard’. At the end of March 1995, the amount of Reserve Bank currency outstanding was about Rs. 1, 00,000 crore. In comparison, the minimum gold-reserve requirement of Rs. 115 crores, fixed for all times, is truly paltry. It does not put any constraint on the future expansion of currency, all of which can be fully supported by rupee securities. This is, then, simply a method of ‘monetising’ a part of the public debt the debt of the Government of India.
The public debt itself is a non-monetary liability, i.e., it is not money. But when a part of the public debt is placed with the RBI, it serves as the basis for the issue of Reserve Bank currency, which is money. Hence, this is monetisation of public debt with the RBI.
Historically, the Central Government could borrow any amount of money from the RBI through the issue of ad-hoc treasury bills to it. The RBI, in turn, used to finance its credit to the government by the issue of its currency and hold the treasury bills in its Issue Department. (The same still holds true for the government securities acquired by the RBI.).
To check the automatic monetisation of the government’s budget deficit, an agreement was made between the GOI and the RBI in September 1994. This has put serious restrictions on the government’s ad hoc borrowings from the RBI.
The issue of currency into circulation and its withdrawal from circulation (i.e., expansion and contraction of currency respectively) take place through the Banking Department of the RBI. The mechanics is best explained with the help of an example. When the Central Government incurs a deficit in its budget and borrows from the RBI by selling treasury bills to the Banks’ Banking Department, the latter pays cash by either drawing down its stock of currency and/or by getting currency from the Issue Department against equivalent transfer of eligible assets. The government by spending new currency puts it into circulation.
Though the one-rupee notes and coins and small coins are issued by the Central Government, their distribution to the public is the sole responsibility of the RBI. For conversion of notes and coins of various denominations for the public and banks, the RBI maintains currency chests and small-coin depots as distribution centres throughout the country. Such facilities are made available at all offices of the RBI and a large number of other centres in the country, mainly by agency arrangements with the State Bank of India and its associate banks, most other nationalised banks, and government treasuries and sub-treasuries.