For his part, [RBI Governor] Deshmukh tried to play a constructive and bipartisan role to ensure the orderly transfer of monetary control to authorities in Pakistan. The initial plan called for the transfer of power to a civilian administration run by Indians by June 1948, but the timeline was abruptly shortened as communal violence erupted following the announcement of the Radcliffe line, which demarcated the boundaries of the two nations. Looking to cut their losses, the British government, led by the labour administration in Britain, brought forward the date of handover to August 15, 1947, throwing the Indian administration into a tizzy.

While there was a special cabinet committee within the interim government that was looking into the division of resources, it was replaced in a hurry by a “Partition Council” on July 1, 1947. One of the expert committees set up to divide resources and institutions between India and Pakistan was looking into matters of currency and coinage arrangements, the division of the central bank and its balance sheet, the formulation of an exchange rate mechanism, along with holdings at the International Monetary Fund and the World Bank.

The Reserve Bank was only present within this committee in an advisory role, providing data and technical expertise. Deshmukh had requested both sides to keep the RBI in an advisory role, and delegated staff to help the committee with its requirements.

The discussions had to be wrapped up within a limited time, but they were far from cordial. The committee submitted its report on July 28, 1947, and added supplementary notes in the first week of August.

The eventual conclusion was to keep a common currency within India and Pakistan until March 1948, after which, for the next six months, only overprinted notes would be issued in Pakistan, but the Indian rupee notes remaining in Pakistan would continue to be legal tender until September 1948.

This would be a period of transition, and the RBI would cease to be the monetary authority in Pakistan from October 1, 1948, transferring all liabilities of the overprinted Pakistani notes to the new authority. Before October, all profits of the central bank were to be divided between the two countries, and following the transfer, all RBI-related property would be transferred to the new monetary authority.

The RBI was also asked to make provisions for relocating staff from one side to another if they so desired, and it was also asked to recruit adequate staff in Pakistan. During the transition, RBI also agreed to depute staff as needed. Pakistan was split into two geographical halves by India in 1947. Dhaka did not have a central bank office, which the RBI set up. This branch in Dhaka would eventually become the Bangladesh Bank in 1971, at the same address.

While the administrative arrangements were largely agreeable to Deshmukh and his deputy governors, they took strong exception to Pakistan’s suggestion to nominate a Muslim deputy governor for the period when RBI would serve as the central bank to Pakistan. There was also disagreement over Pakistan’s proposal to nominate two directors to the central board, and its demand for giving the new government the authority to increase currency in circulation, if deemed necessary.

The RBI was agreeable to the last point, but only if limits were set on the increase for both countries, and if the temporary increase could be settled against the transfer of assets between the two nations through the Reserve Bank. This would later become a highly contentious issue, and would result in RBI’s premature withdrawal from the country.

The Reserve Bank of India took control of Pakistan’s monetary system under the Pakistan (Monetary System and Reserve Bank) Order 1947, issued on August 14, 1947, which provided for the RBI to operate as the currency and monetary manager for Pakistan until September 30, 1948.

As agreed, Pakistan was not allowed to nominate a deputy governor, but the Reserve Bank was open to nominated members on the board who could put forward Pakistan’s case, if needed. However, the names suggested by the new government in Pakistan ran into trouble.

While Sir Syed Maratib Ali, who was already a member of the board, was allowed to represent Pakistan, the nomination of John Turner, a Bank of England official working as an advisor to the government of Pakistan, was deemed inappropriate. Other nominations also ran into trouble; Pakistan wanted to nominate Nazir Ahmed Khan, who by his position in the constituent assembly of Pakistan, was unable to secure the position on RBI’s board for a long period, as he was disqualified in March 1948 from his directorship. Despite these hiccups and the flaring tempers on both sides, the Reserve Bank describes its time serving the government in Pakistan as “smooth” in the initial months. As Deshmukh highlights in his memoirs, the RBI tried to act in a fair and non-partisan manner, and provided adequate funds, as per the agreements, to the new country.


With regard to RBI’s employees, a large number of transfers between the two countries had been done by May 1948, and Deshmukh ensured that staff in Pakistan was adequate both in number and quality, while provisioning for training of new staff recruits. However, the relationship between the Reserve Bank and Pakistan’s government was becoming dysfunctional, and the trust deficit widened significantly after Pakistan’s invasion of Kashmir in late 1947.

In January 1948, Pakistan’s government requested the Reserve Bank to release advance funds, which could be offset later against transfers due from India to Pakistan. The RBI, however, declined to give advances against the government of India’s dues, but nonetheless agreed to provide a ways and means advance to support financing. This was agreeable to the Pakistanis, but when Deshmukh asked for information about the ability of Pakistan to repay the funds, the government took it as an affront and accused RBI of acting in a partisan manner. This allegation was vehemently opposed by Deshmukh, who decided to leave the decision to the central board, which had convened an emergency meeting on January 14, 1948.

Deshmukh was in favour of the payments being made, on account of the promise that had been made to Pakistan by the government before the Kashmir conflict broke out. He advised the government along the same lines, but was shot down.

In a heated board meeting, the Pakistani representative put forth a memorandum for release of funds from the RBI, which was promptly voted down by the other members of the central board.

The Pakistani members were also reminded in a resolution that while the RBI was a banker to both India and Pakistan, it had no authority to transfer funds to one country on behalf of another, without requisite orders. Meanwhile, the issue was picked up by Sardar Patel in Delhi, who made it clear that without a resolution on Kashmir, no payments would be made to Pakistan. However, Mahatma Gandhi, who was unhappy over these events, undertook a fast to ensure Pakistan got what it was promised, forcing the government and Prime Minister Jawaharlal Nehru to honour the agreement on January 15 itself, despite objections from Patel. This gesture by Mahatma Gandhi probably aggravated communal sentiments, and may have had something to do with his assassination, but that question remains imponderable in our history, as Deshmukh noted later.

Even as the funds were provided, the relationship between the RBI and the government of Pakistan never recovered. A few days after the emergency board meeting, Pakistan decided to go ahead and float short and long-term loans, for which it asked RBI to make adequate preparations. The Pakistani government also wanted to understand whether these loans could be procured in India, but it quickly dropped the idea. However, despite RBI’s misgivings on the timing of the loans, the government went ahead. While the funds were being raised, Pakistan’s finance minister Ghulam Muhammad invited Deshmukh for talks on RBI’s support to the fundraising exercise, but Deshmukh declined on account of the recent accusations made by the Pakistani government. The government was taken aback, and sent a sharp retort through the finance secretary.

Amid this war of words, the Pakistani government, through its high commissioner in India, Zahid Hussain (who went on to become the first governor of Pakistan’s central bank, State Bank of Pakistan), asked RBI to stop issuing notes in Pakistan from March 31 instead of June 30, 1948, as previously agreed. While the decision came as a surprise, RBI was more concerned about the removal of India’s current surplus notes in Pakistan, which had not been appropriately destroyed or returned to India.

On receiving adequate assurances, RBI went ahead and signed an agreement with the government of Pakistan to terminate their relationship, and Pakistan assumed control of its finances from April 1948.

However, even in the midst of a premature departure, RBI was able to convince the governments of India and Pakistan to sign off on a payments agreement between the two countries, whereby both the Indian rupee and the Pakistani rupee would be treated at par, and no changes in the currency valuation would be undertaken without prior notice and consultations. On July 1, 1948, the State Bank of Pakistan was inaugurated. Its first governor, Zahid Hussain, was a respected figure, and was notably close to Mohammad Ali Jinnah. He was also a vice chancellor at the Aligarh Muslim University, and went on to serve the State Bank of Pakistan for five years.

The exchange control arrangement, however, proved to be short-lived, as Pakistan refused to devalue its currency in 1949, following the sterling devaluation. Indeed, even with the State Bank of Pakistan taking charge, there was to be no exchange control between the two countries for one year. The agreement was extended in June 1949 for another year, but in September, India decided to follow the sterling in devaluing its currency, a step Pakistan refused to take. India had promptly moved to devalue its exchange rate after Sir Stafford Cripps informed the commonwealth governments at the IMF meetings of 1949 that the sterling was going to be depreciated by 30%. Deshmukh, who had completed his term as governor, but was still the representative for India at the IMF, agreed with the proposed devaluation, and also advised Pakistan’s finance minister to follow suit, but the Pakistani government refused. For the payment system to be maintained, devaluation was necessary, but with Pakistan refusing to follow India’s 30.5% devaluation, the exchange rate was now skewed to 100 Pakistani rupees equalling 144 Indian rupees.

The Indian finance minister defended India’s actions, but trade relations were affected, with confusion over the prevailing exchange rate. RBI decided to suspend transactions in the Pakistani rupee. The government of Pakistan still wanted their sterling payments to be made under the earlier agreements, but the Indian government refused to comply. In the market rate, it took a while before the devaluation started being passed on, which led to a temporary disruption in the remittances market as well. The exchange controls were as such strictly enforced from September 1949 onwards, but it was only after Pakistan’s notification of its exchange rate in the IMF from mid-1950 that trade started to normalise between the two neighbours.

Excerpted with permission from The Story of the Reserve Bank of India, Rahul Bajoria, Rupa Publications.