The relationship between note issue and its reserve backing is usually done on the basis of a reserve system by central banks across the world. The reserve system provides guidelines for the issue of new currencies. In India, currencies are issued by the RBI with the backing of reserves comprised of gold and foreign exchange (foreign currencies). For the issue of currencies, the RBI follows Minimum Reserve System at present. The Minimum Reserve System (MRS) is followed from 1956 onwards.
How RBI issues new currencies?
For every year, RBI makes a money supply expansion target based on the expected economic growth. Higher the economic growth, higher will be the expansion of newly issued money by the RBI. This strategy helps RBI to contain inflation as well as enabling people to meet their transaction needs.
Similarly, the RBI secures assets while issuing new currency into the economy. These assets are foreign currencies or government bonds. Every unit of new currency is a liability of the RBI. To match this liability, there should be equal volume of assets as well. The procured foreign currency and government bonds constitute to the assets of the RBI whereas the newly issued currency is its liability. Foreign currencies purchased by the RBI are kept at Banking Department whereas the resaves used for issuing new currency (under MRS) is kept at Issue Department.