Baba’s Explainer – Demonetisation Verdict

  • IASbaba
  • January 7, 2023
  • 0
Economics, Governance
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  • GS-3: Economy and issues relating to planning, mobilization, of resources, growth, development and employment.
  • GS-3: Money Laundering
  • GS-2: Governance

Context: Recently, Supreme Court in the majority opinion (4-1) upheld the government’s demonetisation order of November 8, 2016. However, Justice B V Nagarathna disagreed with the reasoning and conclusions in the majority opinion.

What is Demonetisation?
  • Demonetisation is referred to as the process of stripping a currency unit of its status to be used as a legal tender. In simple words, demonetisation is the process by which the demonetised notes cease to be accepted as legal currency for any kind of transaction.
  • After demonetisation is done, the old currency is replaced by a new currency, which may be of the same denomination or may be of a higher denomination.
  • Demonetisation in India has taken place three times till now, namely in the years of 1946, 1978 and 2016
  • The first demonetisation event happened in 1946, at that time the denominations of Rs.1000 and Rs.10000 were removed from circulation.
    • There was a visibly low impact of the demonetisation as the higher denomination currencies were not available to the common people.
    • In 1954, these notes were again introduced with an additional denomination of 5000.
  • The second demonetisation in India took place in 1978, at that time the Prime Minister was Morarji Desai. During the second demonetisation the denominations of 1000, 5000 and 10000 were taken out of circulation.
    • The whole purpose of demonetisation was to reduce the circulation of black money in the country. The announcement was made by Morarji Desai over the radio.
  • The latest demonetisation was announced on 8th of November, 2016 by Prime Minister Narendra Modi.
    • During this demonetisation the notes that were taken out of circulation were the denominations of 500 and 1000.
    • PM Modi also introduced new currency of denominations 500 and 2000 after demonetisation.
What were the objectives of 2016 demonetisation?

The objectives of demonetisation are as follows:

  • To stop the circulation of black money in the market.
  • To help in creation of cashless economy
  • To formalise the informal Indian Economy.
  • To remove counterfeit/fake notes from the market.
  • To help reduce anti-social activities who use black money and money laundering techniques.
  • To help in reducing the interest rates of the prevalent banking system
What was the popular narrative with Demonetisation?

Narratives are often intertwined in the cultural belief systems of the society. They create myths which endure despite rational appeal to facts.

  • The Weimar hyperinflation of 1921-24 is so deeply embedded in the German consciousness, that even now, nearly 100 years after the event, German society treasures financial stability and distrusts public debt.
  • Fiscal conservatism remains the dominant narrative and has inhibited the post-2008 recovery in Europe.

The demonetisation of high-value currency in India in 2016 is a classic case of policy based on faulty narratives.

  • The demonetisation story in India is based on popular myth that ill-gotten wealth is stored in stacks of currency notes and gold, hoarded in safes, boxes, or concealed cupboards. The dramatic action of demonetisation was considered powerful blow against this wealth because it was believed that this money was now rendered useless.
  • Such an action on black money was deeply satisfying psychologically as the narrative of black money is almost always in deeply moral terms.
  • The narrative ignores the fact black money is not really kept in cash except in small quantities but mostly accumulated through real estate and other assets.
  • Although income from corruption or criminal activities is by definition black money, most black money is earned through perfectly legal activities though not declared to the tax authorities.
  • Also, the narrative included that such a measure will solve terrorism by stopping terror financing (old notes no more valid & terrorists cannot exchange it)
  • The way the narrative was framed made it hard for critics to explain their opposition. To denounce it outright would suggest that they have a vested interest in defending black money and corruption.
  • The narrative started to change the focus from black money and fake currency to digital/cashless payments, as time passes and it was realised that it was a failure.
  • Appeals to nationalism and patriotism was also invoked to sustain the narrative.
  • The act (of demonetisation) was considered as an act of collective sacrifice. The people in long queues were reminded of the sacrifices of the soldiers guarding the nation’s borders and not to think of their own suffering.
  • The moral high ground claimed by the demonetisation narrative overshadowed the economic criticism of the policy and the observed reality.
  • Paradoxically, the failure of demonetisation policy does not appear to alter the narrative and, consequently, there is very little price to pay for its failure
Why is demonetisation considered as failure?
  • Demonetisation was done on two previous occasions, in 1946 and 1978, with poor results. But, unlike the limited impact of the previous events, the demonetisation in 2016 caused widespread disruption in the economy.
  • Very little of 2016 demonetisation’s declared objectives — of eliminating black money, corruption, moving towards a “less cash and more digital economy”, or increased tax compliance — were achieved
  • Expectations of windfall gains of some ₹2 trillion-3 trillion failed to materialise as more than 3% of the cancelled notes returned to the banks.
  • According to RBI report, after verification and reconciliation, the total value of the ₹ 500 and ₹,1000 as on November 8, 2016,  the day before note ban came into effect, was R₹15,417.93 lakh crore. The total value of the such notes returned from circulation was ₹15,310.73 lakh crore by August 2018.
  • If black money had existed as stockpiles of illegal cash, clearly all of it was very efficiently laundered.
  • By every measure, demonetisation as economic policy was a gross failure. But, as a narrative, it succeeded in creating a favourable or positive view of the policy.
  • Despite personal hardship, long queues, and the loss of income and savings, there was a degree of ambiguity in criticising the decision.
  • Most tended to distinguish the intention from the reality. That the policy was good but perhaps not implemented well seemed to be the main theme.
What were the legal questions regarding Demonetisation that was resolved by Supreme Court?
  1. Extent of Powers of Central Government
  • Whether the power available to the Central Government under sub-section (2) of Section 26 of the RBI Act can be restricted to mean that it can be exercised only for “one” or “some” series of bank notes and not “all” series.
  • The petitioner argued that RBI has power only to recommend “a particular series” of notes, but to demonetise “all series” of a particular denomination, it was considered necessary to do so by way of a separate enactment of Parliament.
  • The majority view disagreed with the petitioner’s argument, and held that the term has to be given a purposive interpretation and that any other meaning would lead to absurdity.
  • The majority view contended that the Central Government has the power to demonetise “all” series of bank notes of “all” denominations
  • Dissenting judgement: Such an extensive power to demonetise cannot be exercised by issuance of a simple gazette notification but through a plenary legislation.
  1. Decision making process
  • There was question raised as to whether the impugned Notification dated 8th November 2016 is liable to be struck down on the ground that the decision making process is flawed in law?
  • Majority view: The majority view relied on the government’s argument that merely because the process was initiated by the Centre, it could not be struck down.
  • The ruling notes that the minutes of the RBI Central Board meeting that recommended demonetisation on November 8, 2016 itself stated that the RBI and the Centre had discussed the idea for over six months before it was notified.
  • Dissenting view: Justice Nagarathna held that it is in violation of Section 26(2) RBI Act that the recommendation for demonetisation originated from the Centre and not the RBI’s Central Board.
    • The dissenting view also states that if the Centre indeed initiated the proposal, then it ought to have brought in legislation in Parliament.
    • If urgency and haste were needed, the dissent asks why an Ordinance could not have been brought which could have been subsequently ratified by Parliament.
  1. Test of Proportionality
  • Majority view: The majority decision applies a four-pronged test of proportionality to the constitutionality of the decision.
  • The four ingredients of the test to be satisfied are: i) legitimate purpose (ii) rational connection with the purpose (iii) necessity (iv) whether the action taken is proportional or balanced.
  • The majority verdict states that curbing fake currency, black money and terror funding are legitimate interests of the state and have a rational nexus with demonetisation.
  • For the third aspect, the court has to determine if the decision was necessary, and that there were no alternative measures that could have achieved a similar purpose with a lesser degree of harm for citizens. Here, the court said that it is “exclusively within the domain of the experts”, that is the RBI, to answer this question.
  • On the fourth aspect, the court said “what alternate measure could have been undertaken with a lesser degree of limitation is very difficult to define”.
  • Dissenting view: Justice Nagarathna said that since she had already held the demonetisation decision unlawful, this question need not be answered.
  1. Reasonable Period for exchange of notes
  • Majority view: The court cited an earlier instance of demonetisation in 1978 where a three-day period was provided for exchanging the demonetised notes. This was upheld by a Constitution Bench of the court.
  • Relying on this decision, the majority view said that the period of 52 days provided for exchange was reasonable.
  • Dissenting view: Since the dissent had already held the demonetisation decision unlawful, it did not answer this question.

Main Practice Question: What is demonetisation and why it is done? Do you think the 2016 Demonetisation exercise has served its purpose?

Note: Write answer his question in the comment section.

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