Monetary supply and Inflation

Government of India can print any number of notes.
There are two ways of generating Currency Notes, some may take physical form and other in the form of book entry.
One is through 'Deficit Financing' where the government of India's total expenditure exceeds total income from all sources - Income Tax, Excise duty, Central Sales Tax, Value Added Tax, Import duty etc. Supposing Net Expenditure for 2008 is say -80,000 crores. Since the GOI does not have money, it gives credit or print notes to the extent of Rs 80000 crores.

Secondly through FOREX intervention. When the lot of dollars or other Forex currencies come to India, they need to be converted into rupees before they could buy stocks, bonds or make direct investment. The foreign investor has to buy Rupee from the market which will cause Rupee demand to exceed the demand, so the rupee appreciates. In this case, no currencies are printed. However, when RBI at the instance of GOI decides to intervene in the FOREX market to 'sterilize' Rupee currency's rise, it ask the Foreign Investor not to go to the market and buy the Rupee. Instead, RBI give special rate to the foreign investor to buy dollars in 'off market' and give him the credit to his current account with any bank (book entry). For instance, if Citibank approaches RBI to sell US$ 500 Millions on behalf of its Mutual fund customer, it will get better rate, say Rs 41 instead of market rate of Rs 40, so it saves about 2.5% on exchange. RBI then gives credit of Rs 2050 crores by buying US$ directly from the Citibank. This avoids selling of dollar and buying of rupee in the market, so rupee exchange rate remains same. Had Citibank sold $500 Millions in the market, rupee might have appreciated to say Rs 39 or it would have got 5% less than what it would have got by selling to RBI. In short, Money Supply (called M1) increases in the market. The book entry slowly gets converted into real money because when Citibank buys the stock, it has to pay in rupees, and that rupee will circulate in the marketplace. This is a suicidal policy; it does not increase the good, but merely increases money supply. The equilibrium between Goods and Currency in circulation is adversely affected as result of which 'Inflation' in the system increases.
This second type of practice is adopted by most Asian countries including Japan, which have highly inflationary effect.

One cannot pay Rupee to IMF to discharge the debt. The debt was contracted in US$, so you have to buy US$ by selling rupee in the marketplace to pay off the debt. If what you say was possible, practically every country will discharge its debt by printing more notes. USA is exception. Because it was used as Intervention Currency, or common currency, US government was encouraged to issue more notes and contract debts. Since the debt was issued in US$ or its own currency, it will pay off the creditors by printing more notes. This is what it is doing. It borrows from the world, and the President Bush go on giving Tax Rebates to its citizens at will, because he can afford to, because the world is foolish in giving more value to dollar.

Above should help you understand some basics of Monetary Management. Note there is no free market for currency in India.