2 January 2023

Table of Contents

Supreme Court upholds demonetization: What was the challenge about?

GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Recently, the Supreme Court upheld the government’s decision to demonetise currency notes of Rs 500 and Rs 1,000. Instead of the effect of the decision, the court had to determine whether the recommendation for the policy came from the government or the RBI. 

Demonetisation

• Demonetization is the process of eliminating any of the currency unit of its status as legal tender in the country.
• In the process, either the existing types of currency are withdrawn or swap with new one.
• Thus, a currency that is terminated will no longer be used for exchanges and have no financial value.
• For example, in India, on 8^th November 2016, the government announced a ban on then in circulation Rs.500 and Rs.1000 denomination bank notes with immediate effect.

• It was aimed at three purposes –

Reasons behind Demonetization

• The governments around the world use demonetization rarely under some exceptional situations such as –

• Hyperinflation: The government considers demonetization as a solution to take back control and minimize the adverse situation.
• Counterfeit currency, terror, and tax fraud: To prevent illicit use of legal tender of the country.
• To introduce new monetary system.

Impact of Demonetization in India

• Inflation declined: Due to less liquidity and currency movement into the economy.
• Reduced monetary supply: Due to decline in black or illegal money to some extent.
• Reduced terror and other crime activities for a period of time.

Why was demonetization challenged?

• The petition challenged that the procedure prescribed in Section 26(2) of RBI Act, 1934, was not followed.

• Section 26(2) of the Act states that “on recommendation of the [RBI] Central Board, the Central Government may, by notification in the Gazette of India, declare that, with effect from such date… any series of bank notes of any denomination shall cease to be legal tender save at such office or agency of the Bank and to such extent as may be specified in the notification”.

• According to the Preamble of the Reserve Bank of India Act, 1934, the right to regulate the issue of banknotes is entirely with RBI.
• Thus, the petitioners argued that the recommendation should have emanated from the RBI.

• But in this case, the government had advised the central bank, following which it made the recommendation. 

• In 1946 and 1978, the government had demonetized currency by way of a law made by Parliament.

The Government and RBI’s stance

• The RBI defended that Section 26(2) does not talk about the process of initiation. In addition, the RBI also accepted that it gave the recommendation to the government regarding demonetization.
• The government responded that the RBI had not agreed to the proposals of the previous governments regarding demonetization, following which they made the law.

• In this case the RBI was agreed so the process was done through executive notification rather than through legislation.

The Supreme Court’s verdict 

• The SC by a 4-1 majority held that the Centre’s notification dated November 8, 2016, was valid and satisfied the test of proportionality.
• It has also validated the three objectives of demonetization and observed a reasonable nexus between the objects and the means to achieve the objects.
• Based on the evidences, the SC iterated that there was a consultative process between central government and RBI for over 6 months before the decision was taken and the decision was taken after RBI board’s approval which shows in-built safeguard against centre’s powers.
• It stated that decision-making process cannot be faulted merely because the proposal emanated from the centre.
• The court also marked that it cannot supplant the wisdom of executive with its wisdom.

Justice B V Nagarathna view in her dissent

• No independent application of mind by RBI: The central bank did not apply its mind independently while recommending the cancellation of Rs 500 and Rs 1000 notes as proposed by the Centre.
• Interpretation of Section 26(2) of RBI Act: As per Section 26(2), the proposal for demonetisation is to emanate from the central board of the RBI.

• In addition, such a recommendation would be void also because the power under Section 26(2) is applicable only for a particular series of currency notes & not for the whole series of currency notes of a denomination.

• Executive order not enough for such a step: Since, the demonetisation of all series of notes at the instance of the central government is a far more serious issue than the demonetisation of particular series by the bank. Thus, it has to be done through legislation than through executive notification.
• Wonder whether RBI thought through implications: The objectives of the central board may have been sound, just and proper. But the manner in which the said objects were achieved and the procedure followed were not in accordance with law. 
• Unlawful on legalistic analysis, not on objects: The noble objectives of demonetisation are not under question but the measure has been regarded as unlawful only on a purely legalistic analysis.

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