Biography: How John Matthai, India's second finance minister, handled the devaluation of the rupee

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13-05-2025

John Matthai told the House that he had informed Ceylon and Pakistan about the devaluation of the Indian rupee but had received no response from the latter. Matthai released an announcement in the press on 19 September, a Monday, about the devaluation and the concurrence was received from the IMF by the finance ministry on the same day. However, since Monday to Wednesday were all bank holidays, the new rate became effective only on 22 September 1949.
Matthai said that while he appreciated the difficulties faced by the British government, he found it strange that there was no mention of devaluation at the commonwealth ministers conference which was convened for discussing the dollar situation. 'I cannot help thinking that in a matter which so vitally affects the whole economy of every country in the sterling area, steps should have been taken to arrange for a secret meeting of the Finance Ministers of the Commonwealth countries before this decision was sprung upon them …'
Matthai told the House that there existed a case based on economic facts for the devaluation of both the pound and the rupee, but he would have liked to have more time for deliberation on the subject. It was a decision not born out of logic but thrust upon him by the compulsion of events. He said that there was no other option open to India but to devalue since 75 per cent of exports was with the soft currency areas and in case they did not devalue, Indian exports would have been hard hit. Since the sterling balance was not an infinite source, the only way India could maintain a healthy trade balance was by promoting exports. 'That then is the main reason. May I put it like this? We took this decision in the main as a defensive measure.'
He then went on to explain that India was a member of what was called the sterling area, and as long as India was part of the sterling area, it had to honour the objective of that area, which as he understood it, was to 'achieve a balance of trade at the highest possible level, partly by expanding exports and partly as a temporary measure – if that was necessary in order to restore equilibrium – by reducing imports also'. The essence of the sterling area was that all the hard currency resources earned by the members of the sterling area were pooled and all the members of the sterling area had the right to draw upon the central reserves for meeting their deficits in respect of dollar resources. It was in India's interest to remain in the sterling area, since unlike in the past when it was a net contributor to the pool, it was in the present day, a net beneficiary. After the UK, it was India who made the biggest demand upon the central reserves. Hence, it was in India's interest to remain in the sterling area.
Matthai warned that it was quite possible that India would not have access to the resources represented by the central reserves of the sterling area. He said it was time that the country 'marshalled its resources and put its whole pattern of trade on a basis which would enable it to go without this adventitious aid'. If the need for devaluation was accepted, then there was an equal ground for suggesting that there should be devaluation in equal measure. As it is, he said, the level of prices was higher in India, and if added to that there was an appreciation of the rupee, it would seriously handicap India's exports.
India devalued to the extent Britain did, but curiously Pakistan did not. The price of their exports was inelastic, and devaluation would have reduced their incomes. Matthai told the House that he thought that Pakistan's decision lacked economic justification. Pakistan's economic condition was not fundamentally different from that of other countries in the sterling area to justify what was in effect an appreciation of their currency.
Pakistan's favourable balance of payments was due largely to two factors: first, the export of raw cotton and jute to India and, second, its low capital imports given the fact that its industrialisation programme had yet to take off. Given the appreciation, Indian manufacturers would be compelled as a matter of self-preservation to refuse to buy raw jute and cotton from Pakistan. According to BK Nehru, Pakistan's failure to devalue started a trade war (with India being the aggressor), which lasted well over a year. He narrates how when a year after the devaluation he met Sir George Bolton again and in the course of the conversation, asked him if he had not given the Pakistanis the same information he had given the Indians. Bolton responded with a categorical 'no' saying that he could not think of any Pakistani who would not have made money if he was privy to such information. BK Nehru observes, 'This I thought was a most unfair remark. There was no difference then in the standards of integrity between civil servants of India and Pakistan.'
Analysing what he thought would be the future trend in Pakistan's balance of payments, given the fall in the export in cotton and jute and the impending industrialisation which would involve the import of capital goods, Matthai argued that Pakistan's decision not to devalue was the result of not economic, but other, considerations. Matthai approvingly quoted The Economist of London in this regard. The magazine had called it a 'temporary aberration' attributing it to psychological causes that included a sense of injured pride. Also, the temptation to demonstrate the superiority of their currency over the Indian currency had been too strong to resist. Matthai also said that economic forces would make it increasingly difficult for Pakistan to maintain the new ratio.
Matthai told the House that since the question of the exchange rate was linked with certain issues arising out of the payments agreement between the two countries, there was no decision to announce a new rate or to alter in any way the Indian decision on the devaluation. Referring to the effects of the devaluation on the Indian economy, Matthai said that the position was still obscure. 'There are far too many uncertain factors and I hesitate to lay down any dogmatic or categorical proposition.' However, he did venture to state a few broad conclusions which were necessarily of a tentative character.
Analysing the balance of payments with the US, Matthai said that India's exports mainly comprised jute and tea, both commodities being demand and supply inelastic. Thus, devaluation was unlikely to lead to any quantitative increase. On the import side, he wanted to stop the import of food grains as early as possible, reduce the imports of motor vehicles, and to divert the purchase of machinery and other industrial products as far as possible to soft currency areas.
As far as the balance of payments position with the UK was concerned, he said that the goods exported to India by the UK using US material would necessarily show some increase. With the increasing demand, which was going to be placed upon the soft currency areas because of the higher dollar prices of these goods, there was 'likely to be an increased pressure of demand upon soft currency areas which could raise to some extent the prices of goods imported from soft currency areas'.
Matthai also discussed the effect of the devaluation on the convertible portion of India's sterling balance. While he admitted that there would be some loss, the loss was not likely to be as large as a straightforward application of arithmetical percentages would suggest. The loss would depend on the extent to which India could divert purchases to the sterling area, on the difference in prices, and on the money value that they set upon the difference in quality and periods of delivery. He observed, 'The real test in these matters is not currency, but the things currency buys.'
There had been fears about an attempt to scale down the sterling balances, something which was stoutly resisted by Purshotamdas Thakurdas and others. Matthai, during the course of his speech, adverted to Sir Winston Churchill's speech to the British Parliament regarding the scaling down of the sterling balances. He said that the demand for scaling down the balances was based on the plea that India owed a good deal more than it had contributed so far towards the war expenses of the allied countries. Matthai said that India's share of the war expenditure was a matter of definite and deliberate agreement between the two countries made at a time when Churchill was the prime minister. 'Every penny due from us under the present agreement has been paid … I maintain therefore in fairness, there is no justification for the demand which is being repeatedly made by certain sections of public opinion in the United Kingdom.'
The sterling balances, Matthai said, were a result of an improper use of the provisions of the RBI Act, which linked the rupee with the sterling, sterling securities being used to that extent as reserves for Indian currency. It was the sterling balances that were at the root of the inflation in India. He said that if there had been an Indian government at the time of the war, then the cost of goods supplied by India to the UK would have been met by goods supplied to India, especially capital goods, by rupee loans raised in India or by gold. If these did not meet the cost of supplies required, the supplies would have had to be restricted to that extent. This, he said, would have spared India the terrific inflation it inherited. India was not a party to the declaration of the war, whatever its merits, and it was unfair to now saddle a national government with additional expenses.
After briefly touching upon the price level, he told the House about the various steps taken, and proposed to be taken, after devaluation. He ended with a word of warning: He said that devaluation should be viewed as a timely warning about the fact that India had been living beyond its means, both internally and externally.
KT Shah, in the course of the debate, spoke of the betrayal by the British and how Matthai had been led into a trap by Sir Stafford, who till the very end said there would be no devaluation and then suddenly did what he had been denying all along. He accused Matthai of underestimating the injury that had occurred and said that nothing in the finance minister's statement had shown that the import of either food grains or capital goods could be curtailed. Speaking about the link with sterling, he said that even though technically there was no connection with sterling since the relevant RBI Act had been amended, the psychological link still remained, and this was affecting the behaviour of those in authority. He said that the decision to devalue would benefit only the British in their standard of living or in their industry.
Using strong language he observed, 'It has no concern with us … if anybody lives in the hope … the belief that we are going to benefit from it. I should regard him a candidate for an asylum and not for an Assembly.' He added that devaluation was of little use if there were competitive devaluations. Referring to Britain's difficult position he observed, 'Here is a country which must necessarily depend upon trade and depend upon Empire. While the Empire was there it was able to levy an unseen invisible tribute from that Empire in one way or the other.' Referring to the sterling balances, he bemoaned the reduction in the purchasing power of the balances and wanted a third-party guarantee for conversion into gold or dollar equivalent, and wanted no more contact with the British.
Pandit Thakur Das Bhargava from East Punjab believed that devaluation was the only option open to the government. He believed that Matthai had done the only thing possible at the time and that devaluation was done not to placate Britain but as a sovereign act by the government in the interest of the country. 'Our government, in self-interest alone agreed to this course. There was no other course open to government, and I want that this assembly should approve of this action of the government.'
Prof NG Ranga from Madras wanted to know what steps Matthai had taken to reduce imports and increase exports if, as he said he had had had an inkling of the devaluation. He wanted to know about the probability of converting the sterling balances into dollar exchange. T Prakasam, also from Madras, said that even though India was free, it was still 'tied down in the currency business to Great Britain.' He asked why India had devalued to the same extent as Britain and wanted the extent of devaluation to be reduced.
Pandit Nehru said that the country could not continue living beyond its means and that to that extent the devaluation had been a wake-up call. He wanted the country to concentrate on capital goods and the machine-making industry which would facilitate industrialisation. He wanted the members of the House to confer with the finance minister so that ideas could be shared by both parties. 'Now the members in this house are important not only as being members of Parliament, but as links with the people in the country, and it is quite essential that the house should cooperate fully in all the steps that we may take.'