Rs. 500 and 1000 bank notes have ceased to be legal tender. This move has given rise to a lot of questions, including:  What is demonetisation, How is it carried out, The legality and Constitutionality of Demonetisation and its merits and demerits?  

This write–up is an attempt to clear the airs on it and provide students with a fair understanding of the issue, from both the law and policy perspective.

1. What is Demonetisation ?

Demonetisation is a radical step in monetary policy in which a currency unit’s status as a legal tender is declared invalid. This is usually done whenever there is a change of national currency, replacing the old unit with a new one. This is generally done in the times of Hyperinflation.

2. Demonetisation in India.

 We all know that bank notes of denominations of Rs. 500 and 1000 cease to be a legal tender w.e.f 9^th November, 2016. This has rendered 86 % of the Indian Currency redundant. Strictly speaking, the present move is not really demonetisation, as after demonetisation the very act of holding of the currency also becomes prohibited and the currency cannot be used for any purpose whatsoever. Under the present notification, the currency can still be used for certain purposes and can be exchanged within a specific time, therefore, it cannot be said that the currency has been demonetised totally. This step may more appropriately be called ‘de-legalisation’. (This is also the stand taken by the Government before the Hon’ble Supreme Court of India, through the Ld.Attorney General). However, for the purpose of convenience, the term ‘demonetisation’ is being used in the article. Students are advised to read the article subject to this caveat.

3. Past instances.

World–wide

There is huge precedent for such a step. Demonetisation, for example, was carried out when the European Monetary Union nations decided to adopt Euro as their currency. However, the old currencies were allowed to convert into Euros for a period of time in order to ensure a smooth transition through demonetisation. Zimbabwe, Fiji, Singapore and Philippines are other countries which have opted for currency demonetisation.

India

Previously, Demonetisation happened in India in 1978. The government’s move to demonetise, even then, was to tackle the issue of black money economy. In January 1978, the Indian government demonetised Rs 1,000, Rs 5,000 and Rs 10,000 notes.  The move was enacted under the High Denomination Bank Note (Demonetisation) Ordinance, followed by an Act in 1978. Under the law, all the above high denomination bank notes ceased to be legal tender after January 16, 1978. People who possessed these notes were given till January 24 the same year, that is, a week’s time, to exchange any high denomination bank notes.

The Constitutional Validity of the 1978 legislation was challenged before the Supreme Court of India in Jayantilal Ratanchad Shah v Reserve Bank of India (1997) on the basis that it was a violation of the right to carry out trade and commerce, and in addition, amounted to a compulsory acquisition of property without compensation by the Government.

Rejecting both these contentions, a Constitution Bench of the Supreme Court held that the such a demonetisation law was in public interest, given its purpose to control the problem of “unaccounted money” and did not, in any way, amount to a violation of the right of the petitioners. The Court also did not find the mechanism for return of the high denomination to be ‘unreasonable’ or in any way ‘arbitrary or unconstitutional’.

 

4. Distinction between Merit of the Scheme and its legality.

At the very outset, it is important to flag that the issue of legality of the scheme and its merit, as far as policy is concerned, are two different matters and should not be conflated. Let us deal with the legal basis of the scheme first:

 

5. Legal basis.

 The issuance of the currency is controlled by the Reserve Bank of India. The Reserve Bank manages currency in India and derives its role in currency management on the basis of the Reserve Bank of India Act, 1934

RBI has been constituted under the RBI Act to regulate the issue of bank notes and the keeping of reserves with a view to secure monetary stability in India and generally to operate the currency and credit system of the country to its advantage. Section 22 of that Act provides that the Bank shall have the sole right to issue bank notes. Section 24 prescribes the denomination of the notes.

Section 26 lays down that every bank note shall be legal tender at any place in India in payment or on account of the amount expressed therein and shall be guaranteed by the Central Government. It further lays down that on recommendation of the Central Board the Central Government may however by notification in the Gazette of India declare that with effect from such date as may be specified in the notification any series of bank notes of any denomination shall cease to be legal tender except at such office or agency of the Bank and to such extent as may be specified in the notification. The other Section of the RBI Act relevant for our purposes is Section 39 which imposes on the Bank an express obligation to issue, rupee coin or notes of lower values on demand, in exchange for bank notes and currency notes of the Government of India.

On a conspectus of the above provisions of the RBI Act, it is patently clear that Bank is the sole note issuing authority and has the obligation to exchange those notes when demanded except when, and to the extent, it is relieved of that obligation by the Central Government.

In the present move, demonetisation has been effected through a notification under the RBI Act, 1934, Section 26: Under sub-section (2) of this Section, the Union Government is given the power to declare that any notes issued by the Reserve Bank will no longer be legal tender.

The only procedural requirement is that the Board of the RBI recommends the same to the Union Government. This power is what has been exercised by the Government in the present notification.

 

6. Some of the legal arguments relating to the present ‘Demonetisation’ :

•  Demonetisation cannot be done via Notification – Section 26(2) of the RBI reads : “Government may, by notification in the Gazette of India, declare that, with effect from such date as may be specified in the notification, any series of bank notes of any denomination shall cease to be legal tender. The first objection is the meaning to be ascribed to the term “any series” in the above section. It is argued that the term “series” does not connote the entire denomination. It can, therefore, be argued that Section 26(2) of the RBI Act was never intended by the lawmakers to be used for wholesale withdrawal of black money from the economy, nor was it meant to withdraw legal tender, in one fell swoop, from all bank notes of a particular denomination, especially when it constitutes roughly 86 % of currency in circulation. Therefore, it may be argued that the ‘Act of De-legalisation of the entire denomination’ is not permissible u/s 26(2) of the RBI Act and can only be accomplished via legislative route and not by way of a notification.
• Such a move is possible only via Legislation/Ordinance : In view of the apparent limitations of S.26(2) of the RBI Act, it may be argued that ‘Demonetisation’ can only be by way of an ordinance/legislation. A note is a legal tender; a debt guaranteed by the Government. Article 300A of the Constitution states that “No person can be deprived of his property except by authority of law”. Demonetisation, it is argued, amounts to extinguishment of public debt owed by the Government to the holder of the demonetised note. A currency note is ‘property’ in the hands of the holder. In Jayantilal Shah v. RBI (AIR 1997 SC 370) while upholding the validity of High Denomination Bank Notes (Demonetisation) Act, 1978, held that demonetisation results in extinguishment of a public debt which amounts to deprivation of property and, therefore, can be done only by law. Would a notification qualify as ‘Law’ remains to be seen. In this regard Article 13 of the Constitution may become relevant.
• It is also argued, placing reliance on Madan Mohan Pathak v Union of India, 1978, that wiping out of a public debt amounts to ‘acquisition’, which can be done only by an Act of Parliament and only after payment of reasonable compensation. To buttress this contention, it may be argued that in 1978 also, demonetisation was done by way of an Ordinance, which was later adopted in the form of a law. It is also argued that the imperatives of secrecy can be well served by way of an ordinance also. Article 300A of the Constitution may be worth examining here.
• Another legal issue worth discussing is that whether the government can withdraw, alter or restrict the promise made by the RBI governor on the bank notes to the effect, “I promise to pay the bearer the sum of five hundred/one thousand rupees”, thereby seeking to go back on the guarantee. It has to be seen whether this general proposition survives in view of specific power with the Government under the RBI Act, 1934.
• Constitutionality of Section 26(2) of RBI Act under challenge on grounds of excessive delegation – The very Constitutionality of Section 26(2) of the RBI Act has also been challenged by petitioners in the SC (in the ongoing litigation before the Hon’ble Supreme Court of India) on the grounds of being a case of ‘excessive delegation’. According to the petition, fixing the date from which the demonetisation would come into force is the substratum of power under section 26(2) and constitutes an “essential law making function” which cannot be delegated to be fixed by the central government on its own determination. It has also been argued that the only way to save section 26(2) from being held ultra-vires the constitution is to regard that the power to fix such a date contemplates a reasonable notice to the people at large, the petition suggests.

 (There are bunch of petitions currently pending before the Hon’ble Supreme Court of India relating to this issue. Writ Petition (Civil) 906 of 2016 and 916 of 2016, being two of them)

• Another legal objection can relate to the procedural requirements under Section 26(2) of the RBI Act, under which demonetisation can be done only on the basis of a recommendation of the RBI. The recommendation of the RBI has not been made public in the present case. Section 26 of the RBI Act, clearly contemplates a distinction between the central board of the RBI and the central government, and implies that the decision making process of the RBI has to be independent. It is to be examined whether the central board has considered all the relevant materials and the likely consequences prior to making its recommendation to the central government.

 

7. The arguments above give rise to certain legal issues that may be worth examining :

• Jurisdiction and Authority of the ‘Executive’ to bring a notification of this kind;
• Whether the notification qualifies as ‘Delegated Legislation’ and if yes, whether this is a case of excessive delegation of essential legislative policy, or whether the delegation is within legally-permissible limits?
• Whether a particular denomination of bank notes ceasing to be a legal tender constitutes ‘confiscation’ or ‘acquisition’ of ‘property’, and if yes, what is the manner in which the same can be done, in order to be constitutionally compatible?
• Distinction between Central Board of RBI and Central Government and the dynamics of the decision making process;
• Whether examination as to ‘reasonableness’ and ‘constitutionality’ of the move, and violation of fundamental rights can be examined? The inter-play of Article 19(1)(g) and 19(2) is also at issue here, amongst other Fundamental Rights; and finally –
• The scope and extent of Court’s scrutiny and intervention in matters of economic and monetary policy, or in other words, wisdom and advisability of judicial review of economic decisions.

 These are the broad legal/constitutional questions before the Hon’ble Supreme Court, where the demonetisation move has been challenged. It would be interesting for a student of law to see – Whether the Hon’ble Court embarks on a discussion as to the legality of the Scheme and its substantive content, or conversely refuses to interfere on the ground of it being an economic-policy issue and, therefore, beyond judicial review. The Hon’ble Court may also adopt a middle path and pass continuing orders with respect to the implementation aspect and supervise the scheme, in order to ensure a smooth transition.

The Hon’ble Supreme Court judgment on this is eagerly awaited.

 

That aside, the merits and demerits of the Scheme, may be outlined as follows :-

8. Let us start with the shortcomings:

• Inconvenience – Operational/transitional issues such as:
  • Cash Crunch;
  • Limit of Withdrawal being on the lower side;
  • Overcrowding in banks;
• Loss of time and work-hours in standing in queues for cash withdrawals;
• Disruption of the economy and shrinking of immediate purchasing power;
• Cost/expenditure incurred in operationalisation of the scheme (printing new currency/recalibration of ATMs/law and order etc);
• A lot of black money is not in liquid cash form, but in the form of gold and properties, therefore, unless this scheme is complemented with a robust implementation of Benami Property Law, and monitoring of Gold transactions – the move may not yield extraordinary and desired results.
• Farmers worst hit : It is the harvest (Rabi) season and farmers are facing difficulties, they might be constrained to take usurious loans from local moneylenders, in order to make ends meet. Many regions are also drought hit and cash crunch may hit them adversely, especially since the move has brought the functioning of many co-operative banks to a halt;
• Prices of vegetables, crops etc. crashing down, thus aggravating the suffering of the farmers;
• Unorganised Sector (which as per different estimates is 80 to 90% of the total workforce)/Labour/Small Trader/Shopkeeper/Farmer are the worst affected as almost all transactions take place in cash and banking penetration is still not as pervasive as desired. Many people still don’t have an Aadhar Card and no access to formal banking.
• It has been questioned by many quarters as to whether this scheme would have better implemented after the present sowing season.
• The onset of wedding season has compounded the problems of those having a marriage in the family;
• A general sense of anxiety prevailing in the society; resulting in a temporary setback to people’s legitimate expectations and on-going transactions, causing stress and tension.

 

9. Merits :

• Removal of Counterfeit Notes, which is rampant in the economy;
• Checks black money premised illegal activities like Terrorism/Naxalite funding, gambling, money laundering, narcotics etc.
• Would check corruption : corrupt officials would not be able to accept bribes by way of cash; existing bribe money will also be rendered useless;
• Checks illicit political funding, and thereby serves the larger cause of electoral reforms and check malpractices like gratification to voters. This will go on to strengthen our democracy.
• Would check black money based Real Estate and Gold Transactions, which keep money outside the purview of formal economy. This will also result in long term decline in Sale of Gold/Diamond, and may help in reduction in imports of Gold and help the ‘balance of payment’ situation;
• Almost 50 % of amount in sale/purchase of immoveable properties was paid in Cash. Now, with no cash component, real estate would become affordable to the honest tax-payer and stamp duty and income tax collections will go up;
• Phasing out of Black money will lead to decrease in RBI liabilities and Fiscal deficit will gradually come down, thereby easing financial burden;
• Checks parallel black economy – Increases tax base (higher tax – GDP ratio), which might lead to lower tax rates for legitimate tax payers and increases State Revenue, which may be used for a more extensive social spending, which is the mandate of a ‘welfare state’;
• More money with the Banks may result in reduction of interest rates; this might provide a boost to investment activities, creation of employment and reinvigorate demand and supply;
• Move towards cashless economy; which is more efficient, cost effective and better for the environment (insofar as trees are required to be cut for printing of currency);
• This might reduce inflation in the longer run and lead to more inclusive growth.

On a balance of the pros and cons of the scheme, it clearly appears that the move is for the greater good, in the longer run. The problems, though undeniable, appear to be of, more or less, transient nature and the long term benefits of the move far outweigh the immediate problems, which are in the nature of teething issues. The hardships faced by people can be mitigated by some of these post–operative care steps:

10. Suggestions:

• Positive debate in the Parliament on this issue, and constructive suggestions to make the transition less painful. India is a co-operative federal structure and each State and political party ought to act in the larger interests of the nation.
• ‘Demonetisation’ is a curative step; the problem also has to be nipped in its very bud, that is to say, the very creation of Black Money and storage in other forms like Real Estate, Gold or funds parked in tax havens also need to be chased, therefore, monitoring of Real Estate Transactions, Gold Purchase and discovery of funds parked in tax havens, is extremely crucial;
• Immediate ad-hoc Mobile/Micro Banking facilities and Recalibration of ATMs;
• Progressive taxation for big firms;
• Check use of poor people as mules by rich for disingenuous deposits and withdrawal later;
• War footing measures to provide cash liquidity in the existing setup, to ensure people’s basic needs at least are met, and organic demand once again regenerates, which acts as lifeblood of the economy;
• Strict Punishment for tax evaders and stringent enforcement of tax laws;
• Concerted Action against wrongdoers under:
  • Benami Property Act;
  • Income Declaration Schemes;
  • Whistleblowers Act;
  • Prevention of Corruption, Prevent of Money Laundering Act, shall go a long way to check the black money menace.

 

11. Conclusion

We have to remember that there is a certain amount of resistance whenever any status quo is sought to be changed. This is especially true when the status quo is convenient to many people. We all are hardwired to be change-averse.  Now, just because there are some immediate difficulties in the implementation of the move does not mean that the entire scheme should be shelved. We cannot throw the proverbial baby away with the bath water. The solution, therefore, is not in the rollback of the scheme, but effective and committed implementation of the same and ironing out of the practical difficulties. The Government of India, being the custodian and trustee of the Fundamental Rights of the people, is expected to be, and is seemingly fully aware of the sufferings of the people and it will be worthwhile to wait and watch as to what positive steps the committed government takes in order to do away with the immediate problems faced by the people and how in the long-run apprehensions and anxieties of the people are allayed.

After an analysis of the pros and cons, it can safely be concluded that : for the greater good of the nation, demonetisation is, without doubt, a trade-off worth taking, provided the immediate issues arising out of it are tackled deftly. It is indeed a well-intentioned move that will help us check the scourge of black money and lead to a more inclusive and equitable growth in the future, which is also the mandate of our Constitution.