Agency House Crises in India: What Role Did Indigo Play?

by Tehreem Husain

English, Dutch, and Danish factories at Mocha, 1680 ca. Public Domain picture


History provides us with many examples of asset bubbles which have led to systemic crises in the economy. Popular examples are that of the Tulip mania and the South Sea Bubble. This blog discusses the case of an indigo price bubble in nineteenth century India, perhaps the first of its kind, which lead to a contagion like crises in the economy.

 Almost 17.4% of Indian GDP was derived from the agricultural sector in 2015-16, with nearly half of the Indian population being dependent on agriculture and allied activities for livelihood. This makes smooth functioning of commodity markets of considerable importance to policymakers. Throughout time, there have been many episodes of commodity price surges and ensuing market volatility due to traditional demand-supply gaps, monetary stress and financialization of commodity markets inclusive of speculation (Varadi, 2012). What role did agriculture play in commodity market volatility during the late 18th/ early 19th century? Little is known about perhaps the first asset bubble of its kind in India – the indigo crisis, the reasons attributed to it and the cost it imposed on different sectors of the economy.

With the advent of the East India Company, India was a global trade destination for a number of commodities including cotton, silk, indigo, saltpetre and tea. In order to trade these commodities with global markets, European traders needed banks to finance foreign trade. Indigenous bankers in India did not provide this particular banking function and hence the East India Company diversified its business by introducing agency houses in Calcutta which amongst others also performed banking functions. These agency houses performed all the banking functions of receiving deposits, making advances and issuing paper money. Their responsibility of note circulation crucially helped them in carrying out their diversified lines of businesses as ship-owners, land owners, farmers, manufacturers, money lenders and bankers (Cooke, 1830). It was the agency house of Messrs. Alexander & Co. which started the first European bank in India, called the Bank of Hindostan, in 1770 (Singh, 1966).

In the early nineteenth century these agency houses were tested for their endurance and continuance due to three factors. Firstly and most importantly, during the early 1820s, agency houses borrowed money at low interest rates and invested it prodigally in indigo concerns-the crop being the only profitable means of remittance in Europe. The crisis multiplied when newly formed agency houses, besides investing capital in their own indigo concerns, fiercely competed with the old houses in making indiscriminate advances to indigo planters and paid little regard to the actual state of the market. Excessive demand of indigo fuelled the prices in the mid 1820s and encouraged increased production of the commodity which eventually led to a glut in the market and sharp decline in its price. This rise and fall in prices is evident from the fact that the indigo price shot up from Rs. 130/maund in 1813 to Rs. 300 in 1824, and then fell to Rs. 145/maund in 1832 (Singh, 1966).

The second challenge, along with indigo price volatility, was the start of the first Anglo Burmese war in 1825. This further led to stressed monetary conditions resulting in a scarcity of metal in Calcutta (Sinha, 1927).

Thirdly, in terms of the global landscape, this period marked the peak of investment boom in Britain, which characterized an explosion of company promotions and bond issues by foreign governments, mining companies, railways, utilities, docks and steamships. In total during 1824-25 some 624 companies hoping to raise £372 million were brought to the market. However, with the investment boom peaking out in 1825, market conditions had changed. Interest rates had risen making borrowing more expensive, investor sentiment had become more cautious which eventually led to a panic like situation resulting in bank failures and bankruptcies (Brunnermeier & Schnabel, 2015).

In such times of local and global economic stress, several minor agency houses failed in 1827 which shook investor confidence in the remaining agency houses. A notable case is that of the agency house of Messrs. Palmer and Co., known as the ‘indigo king of Bengal’, which faced heavy withdrawals from their partners and eventually led to the closure of their private bank and finally their own demise in 1830. This panicked the market and led to further withdrawals of capital investments.

During this period agency houses made desperate appeals to the government for financial relief and highlighted their importance in the Indian financial system at that time. In a minute dated 14th May 1830, Lord William Bentick, Governor General of India from 1828-35, accentuated systemic importance of agency houses. He highlighted that not only would there be a dislocation of trade in some staple commodities, any damage to the ‘conglomerate’ nature of the agency houses would cause severe disruptions in other industries, most notably shipping. Finally, loans were granted to these houses in the form of treasury notes bearing 6 percent interest.

Despite the monetary aids provided by the government, the wave of agency house failures could not be curbed. More agency houses failed in January 1832. In addition to this, the unexpected fall in the price of indigo created difficulties for one of the biggest agency houses Messrs. Alexander & Co. It is important to note that the relief package came under stringent conditions. They were obliged to withdraw their bank notes from circulation, and were given an extended period for the payment of their debts provided they end their banking operations (Savkar, 1938). This resulted in the demise of the Bank of Hindostan and the Commercial Bank.

Overall seven great Agency Houses of Calcutta failed within a short span of four years which had detrimental effects on the Indian economy at that time. It may be summarized that speculation in indigo and mixing of trading and agency business were the pivotal reasons behind the failure of these agency houses. More importantly, this episode of a commodity price bubble spreading its tentacles to the entire economy had a phenomenal impact on the structure of business. It is recoded that from a handful of firms in the year before 1850, there were 170 firms working as joint stock organizations in 1868. The first commercial register to identify firms with tradable stock was established in 1843 which listed eights firms (Aldous, 2015). Joint stock organizational form also entered banking. A key example is the rise of the Union Bank of Calcutta (Cooke, 1830). The crisis also led to the establishment of a number of private banks by the British expats (Jones, 1995).


Speculative Bubbles in History

by William Quinn and John Turner (Queen’s University Belfast)

Unknown, 1720ca. Tree caricature from South Sea bubble cards. Public domain, available here

Although the “speculative bubble” is one of few financial concepts to regularly show up in popular culture, in academic financial economics it is a remarkably controversial topic. There are unresolved debates surrounding what constitutes a bubble, whether bubbles actually exist, whether central banks should take action in order to ‘prick’ bubbles, and why, exactly, bubbles often lead to economic recessions. Even the use of the word “bubble” can provoke the ire of economists: Peter Garber describes it as “a fuzzy word filled with import but lacking any solid operational definition”, whereas Eugene Fama simply states that “the word ‘bubble’ drives me nuts”.

Assuming that bubbles actually exist as a recurring phenomenon, how should they be defined? Charles Kindleberger defined a bubble as any substantial upward price movement followed by a crash. This, however, feels incomplete: if an industry grew due to unforeseeable good news, before shrinking due to unforeseeable bad news, it would not seem accurate to describe the event as a bubble. Peter Garber therefore proposes defining a bubble as “a price movement that is inexplicable based on fundamentals”, which seems more consistent with the popular understanding of the word.

A problem with Garber’s definition is that, although it is more precise, it renders bubbles impossible to identify with certainty. This is because testing for market efficiency always invokes a ‘double hypothesis’ problem: one can never tell whether prices were truly inconsistent with fundamentals, or they just appear to have been because the pricing model used for the test was incomplete. One solution is to avoid using the word ‘bubble’ at all. But given how frequently the concept appears outside of academia, it would be absurd if academic finance had nothing to say on the subject at all. In practice, the most sensible solution is often to revert to Kindleberger’s definition.

Why are economic historians interested in bubbles? There are purely historical reasons to be interested in these events: they have often played a central role in the development of financial markets and corporate law, most notably with the Bubble Act of 1720. However, this is also a field in which the past can directly inform the present. The potentially severe economic consequences of bubbles makes their study essential, but they are also rare events, and acquiring an overview of the subject is almost impossible without a historical perspective. Economic history has therefore recently contributed to three areas of contemporary, policy-relevant debates surrounding bubbles.

The first area is the central question of whether bubbles represent examples of market irrationality. The historical evidence on this point is somewhat mixed. Qualitative evidence has been used to suggest that bubbles result from mass irrationality, or, as Charles Mackay put it, the ‘madness of crowds’. However, closely analysing share prices during famous episodes often contradicts these stories. This is not to say that the price at the peak of a bubble is necessarily “correct”, but there is generally a sense in which it is justifiable. For example, Gareth Campbell has shown how prices during the British Railway Mania, although inaccurate in hindsight, were generally consistent with the pricing models widely used at the time. In practice, these models overestimated the sustainability of high initial dividends. But this is a long way from the ‘madness’ described by Mackay. The evidence from historical bubbles suggest that, while prices might not always have perfectly reflected underlying fundamentals, the popular characterisation of bubble investors as naïve fools absorbed by a speculative frenzy is inaccurate.

The second area is the question of whether central banks should raise interest rates in order to ‘prick’ a bubble, thereby preventing adverse economic consequences if it is allowed to grow. There are strong economic arguments for and against this point, but historical evidence generally suggests that it is a bad idea. Ben Bernanke, amongst others, has argued that the attempts of the Federal Reserve to burst the asset price bubble on the eve of the Wall Street Crash were partly responsible for the Great Depression. Hans-Joachim Voth has convincingly shown that a similar mistake was made in Germany in 1927, with even more severe political consequences. The counter-argument put forward by Nouriel Roubini is that these particular examples involve monetary policy which was ‘botched’, and more well-informed efforts to influence asset prices could be effective. This is theoretically possible, but any historical examples seem insignificant in comparison to the severe consequences of the aforementioned attempts to burst bubbles in the 1920s.

The final area is the question of why financial bubbles are often followed by a recession. Here there are two plausible mechanisms: the ‘wealth effect’ and the ‘debt effect’. The wealth effect argument is that the bursting of the bubble inflicts heavy losses on investors, who respond by decreasing spending, thus reducing aggregate demand. The debt effect argument is that, after the bubble bursts, demand is reduced because the public are less inclined to borrow, and banks are less inclined to lend. A 140-year study by Óscar Jordá, Moritz Schularick, and Alan Taylor finds that, while both of these mechanisms seemingly occur, recessions are much more severe when the bubble was accompanied by a high level of leverage. John Turner in his book Banking in Crisis, has suggested that bubbles which are driven by indebtedness, such as the housing bubble of 2006-07, are particularly dangerous for banking systems and economies.

Real estate bubbles leading to bank troubles — 2008? Not exactly — LSE Business Review

The recent financial crisis suggested an important connection between real estate investments and bank trouble, especially in the U.S. In fact, this is nothing new. Although financial crises can have multiple and varied causes, real estate investment booms are likely to bode particularly ill for the stability of the financial system. Indeed, in a new…

via Real estate bubbles leading to bank troubles — 2008? Not exactly — LSE Business Review