When India was divided in 1947, the RBI was placed in the unenviable position of serving as a central banker to Pakistan as well, a task that posed “several delicate problems”.
The RBI building in Chennai. Courtesy: BBJ Calcutta
The Wire’s #PartitionAt70 series brings a number of stories, through text and multimedia content, that will attempt to draw a comprehensive picture of those weeks and months when entire geographies and histories changed forever.
Although they rapidly evolved thereafter, the world’s first central banks were created, primarily, to enhance the financial power of the governments they served. The Sveriges Riksbank in Sweden set the template for financial management in 1668, a model that was later perfected by England’s William III who established the Bank of England as a method of reassuring creditors who had helped finance the Nine Years’ War against France.
As the Indian subcontinent was divided in 1947, the Reserve Bank of India (RBI) for a brief period of time served two countries and their respective governments. In this messy process, the central banks grappled with a number of tasks that, in its own words, “posed several delicate problems”.
Not only did the RBI have to assist in deciding how its profits, assets and liabilities would be divided up (an issue that the central bank acknowledges even today hasn’t been resolved properly), but was also placed in the unenviable position of being a common central banker to the dominions of India and Pakistan until September 1948 – the latter of which would eventually stretch the upper limits of its impartiality.
The RBI, however, didn’t decide how to go about this on its own. That task fell to, as with most issues that involved the transfer of power and administrative consequences of the Partition, to the Partition Council and its ten expert committees.
The affairs of the central bank fell primarily under the fifth expert committee. Following the internal logic of the Partition, each committee had an equal number of Muslim and non-Muslim members; each side expected to “represent the interests of the two future governments”
The fifth expert committee had six members: Ghulam Mohammad, Zahid Hussain, I. Quereshi, K.G. Ambegaokar, Sanjiva Row and M.V. Rangachari.
Mohammad and Hussain, who represented Pakistan’s interests, were extremely well-known financiers and government servants, with Mohammad eventually becoming the third governor-general of Pakistan and Hussain becoming the first governor of Pakistan’s central bank (the State Bank of Pakistan or SBP).
Their task was three-fold. One, they needed to make recommendations regarding the currency and coinage arrangements for the two governments. Two, they needed to formulate proposals for dividing up the RBI’s assets and liabilities, while deciding how the central bank’s employees and administrative machinery would be partitioned. And lastly, the committee needed to make recommendations regarding exchange control for the two states and decide how Pakistan would become a member of the IMF and International Bank for Reconstruction and Development.
Deshmukh and his decisions
The governor of the RBI at the time – Sir C.D. Deshmukh, who was the first Indian head of the central bank – was placed in an unique position. As an independent monetary authority, Deshmukh made it clear that the RBI should be “consulted only in an advisory and not in a partisan capacity”. And yet, the nature of the many issues that would come up for debate meant that Deshmukh and the RBI’s board couldn’t be wholly detached.
Internal RBI documentation offers up a number of amusing anecdotes in this regard, including how the central bank’s board of directors disagreed with Deshmukh and the RBI’s deputy governors over what extent they should be consulted and the RBI’s futile attempts at trying to persuade the Partition Council’s expert committee to come to Bombay (and not Delhi) for consultations.
Ultimately, the expert committee’s work needed to be completed within a month: their main report was submitted on July 28, 1947, and a supplementary report on August 5.
Much of the committee’s work laid the groundwork for the Pakistan (Monetary System and Reserve Bank) Order of 1947. The broad strokes were as follows:
- Both countries would have common currency and coinage until March 31, 1948, after which only Pakistani-printed notes would be issued in Pakistan. However, Indian notes would continue to remain legal tender in Pakistan for six months after March 31.
- The RBI would remain a common currency and monetary authority until October 1948. This date was eventually moved forward after relations between the RBI and Pakistan deteriorated.
- Pakistan would run its public debt office and run their exchange control from April 1, 1948. The Muslim members of the committee wanted the RBI to open a branch in Dhaka in this regard, with Deshmukh agreeing.
- With regard to the central bank’s employees and staff, the RBI curiously stated that all Muslim employees having their “places of domicile in Pakistan areas” would have to work for the future Pakistani central bank while the transfer of Muslim employees who lived in India and non-Muslim staff who served in Pakistan areas would be on a “voluntary basis”. Eventually, in line with the Indian government’s stance on all government staff, the RBI afforded all its employees an opportunity to select areas in which they desired to serve.
The expert committee’s transcripts also indicate there was a great deal of disagreement between the Muslim and non-Muslim members over two issues: the Muslim members felt that the Pakistan government should have the right to appoint a deputy governor of the RBI bank and that it should also directly nominate two out of the four nominated directors on the RBI’s central board. The Partition Council’s steering committee eventually agreed to only the second request, although this was never put into practice.
While it was agreed that the RBI’s physical assets would be transferred at book value to the new Pakistani central bank, the division of everything else went through numerous rounds of debates before being satisfactorily decided by the Partition Council’s steering committee.
Eventually, when the dust settled, the last settlement to be decided was the distribution of cash balances: The Indian government’s cash balance at the time of the Partition were a little under Rs 400 crore and Pakistan’s share was fixed at Rs 75 crore, which was inclusive of Rs 20 crore made available to Pakistan as working balance on August 15, 1947.
Deshmukh versus Pakistan
The remaining Rs 55 crore owed to Pakistan would go on to become a divisive and controversial issue that would strain relations between the RBI and Pakistan.
“The bank’s functioning as banker to the Pakistan Government was smooth in the first four-and-a-half months, but in early January 1948 serious trouble arose on two very important issues raised by the Pakistan Government. The two issues were: (i) grant of accommodation to the Pakistan Government and (ii) transfer of Rs. 55 crores of cash from the Government of India’s cash balances with the Bank to Pakistan Government’s account,” the RBI notes in its history.
What had happened was that soon after the Partition, Kashmir started becoming a focal point of controversy, worsened after Pakistan’s invasion.
C.D. Deshmukh on an Indian postal stamp. Courtesy: eBay
Much before the Pakistan government wrote asking for its due, the RBI governor tentatively reached out to the finance ministry in late 1947 over the question of transferring the remaining Rs 55 crore. In a telegram that reminded the Indian government that the cash balance could be transferred in lots of Rs 3 crore, Deshmukh prefaced his message by saying: “While recognising decision influenced by political considerations, I feel it is my duty to draw attention to considerations of currency which may not appear clearly to Government…”
The finance secretary’s reply was short and curt: the Indian government did not propose releasing any part of the cash balance at present.
Being put in a rather tricky situation, the RBI hesitantly pointed out to the Pakistani government while it would be possible to effect a ways and means advance of Rs 5 crore, payment of the remaining cash balance “appeared to be very uncertain in the light of pronouncements made on both sides”.
Believing that the RBI was trying to both apply limits on the ways and means advance and angered over being denied the remaining cash balance, Pakistan’s finance secretary sent off sharp reply to the RBI and Deshmukh:
“The Pakistan Government find it difficult to believe that a responsible institution like the Reserve Bank would wish to risk its reputation for fair dealing were it not for the interference of the India Government who are determined to strangle Pakistan financially and economically. In the circumstances the straightforward course for the Reserve Bank would be to inform the Government of Pakistan that it finds itself unable to continue as its Banker and currency authority, and to effect a division of the assets of the Bank forthwith.”
In a separate memorandum, Pakistan’s finance secretary also demanded that the RBI should transfer Rs 55 crore of cash balance to the account of the Pakistan government; otherwise, the central bank should not allow the government of India to operate their account without the Pakistan government’s consent. “We hereby demand that the Reserve Bank should treat both Dominions on an equal footing in this respect”, the memorandum concluded.
What explains India’s stance? As Gopalkrishna Gandhi has pointed out, the government was worried. “Nehru and Patel favoured holding the amount back. Would Pakistan not use the money to purchase arms to use against India?” Gopalkrishna noted back in 2014.
Deputy prime minister Sardar Vallabhbhai Patel defended the decision in January 1948 by saying he had made it clear to Pakistani authorities that the Indian government would not “regard the settlement of these issues as final until agreement has been reached on all outstanding issues”.
Eventually, Mahatma Gandhi’s stance on the issue prevailed. According to RBI history, the Mahatma’s stance was that the balances should be released to Pakistan and he even undertook a fast for the cause. The Indian government quickly backtracked after this and agreed to release the funds.
Removing RBI as Pakistani central banker
These events eventually soured Deshmukh’s relationship with the Pakistani government. In February 1948, the RBI governor declined an invitation extended by Pakistan’s finance minister to visit Karachi, saying, “I am not prepared to risk lack of consideration and courtesy which wholly unwarranted accusation led me to fear”.
When Pakistan’s finance secretary told Deshmukh that this attitude was “deplorable”, the central bank governor sharply responded:
“You could not deplore my attitude more than I deplore your Government’s action in dragging Reserve Bank unnecessarily into a public controversy. The Bank has always recognised its responsibility to your Government and discharged it to the best of its ability.”
A little later, things started heading towards a conclusion. During a round of exploratory talks between Deshmukh and Zahid Hussain (who sat on the fifth expert committee and was high commissioner for Pakistan in India at the time) in Delhi, the Pakistan government decided that it would take over the responsibility of currency and banking arrangements earlier than originally agreed – on April 1, 1948. The original arrangement had the RBI continuing until October 1948.
After this, the remaining details were quickly worked out. Indian currency notes in chests located in Pakistan would be returned to the RBI quicker than the date originally agreed upon and Pakistan’s currency and banking arrangements were handed off to the SBP.
Quibbles over the division of various assets continue to this very day. The SBP’s accounts every year lists unsettled claims on the RBI among its “assets” and has done so for the last 66 years. The Pakistani central bank believes it was denied roughly Rs 480.8 million through “Indian notes representing assets receivable from the RBI” and assets that were “held with the RBI pending transfer to Pakistan”. The SBP adjusts this for inflation, exchange rate revisions and appreciation of securities over the last 60 years and still claims that India owes it a little over Rs 5.6 billion.