Q.What is the Minimum Reserve System of note issue followed by the RBI? Why was it adopted in place of the earlier Proportional Reserve System?

The Minimum Reserve System replaced an older, more rigid reserve rule specifically to let currency issue keep pace with a growing economy's genuine transaction needs. …

Under the Minimum Reserve System, the RBI's Issue Department is required to maintain only a stipulated minimum value of gold coin, gold bullion and foreign securities against the total note issue — there is no requirement that reserves rise in fixed proportion to every additional note issued. Once this minimum is maintained, the RBI may issue any further amount of currency the economy genuinely requires.

This replaced the earlier Proportional Reserve System, under which a fixed percentage (commonly two-fifths) of the total note issue had to be backed by gold and foreign securities at all times. As India's economy and its currency needs grew rapidly, this rigid proportional rule would have forced the RBI to hold ever-larger foreign exchange/gold reserves purely to issue more notes — even where the country's real reserves were better used for development and import needs. The Minimum Reserve System frees currency is …

Describing the Minimum Reserve System as requiring 'no reserves at all' — a stipulated minimum is still legally required, it simply does …