case study questions on demonetisation

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Early Lessons from India’s Demonetization Experiment

• Bhaskar Chakravorti

A good narrative can override the data.

India’s government took drastic demonetization action in November 2016 to expose the so-called “black” market, fueled by money that is illegally gained and undeclared for tax purposes. Reactions to the move to demonetize 500- and 1,000-note rupee notes have been mixed, but Prime Minister Narendra Modi’s government was recently rewarded with victory in midterm state-level elections , seen as a referendum on its unprecedented action. There are some updated takeaways to consider from this risky political and monetary move: First, public policy for rooting out corruption calls for a systemic approach, with carrots and sticks to motivate cultural, institutional, and behavioral change in the long term. Silver bullets, such as drastic demonetization, don’t work. Second, innovation and creativity emerged around the digital payments ecosystem in the wake of the sudden voiding of some currencies. Next, data quality and context still matter. In India’s case, relying on official GDP growth figures may not be the best measure of monetary policy success. And finally, having a “big narrative” about a controversial policy move may still matter more to public opinion than having a data story to prove whether something is worthwhile.

Did India just pull off a monetary and political miracle?

• Bhaskar Chakravorti is the Dean of Global Business at The Fletcher School at Tufts University and founding Executive Director of Fletcher’s Institute for Business in the Global Context . He is the author of The Slow Pace of Fast Change .

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Demonetisation Verdict: Breakdown of the majority and minority opinions

While BR Gavai, J has written the majority opinion for himself and SA Nazeer, A.S. Bopanna, V. Ramasubramanian, JJ, to uphold the legality of the 2016 demonetization, BV Nagarathna, J is the lone dissenter who has held that though demonetisation was well-intentioned and well thought of, the manner in which it was carried out was improper and unlawful.

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Supreme Court : Six years after the country went through demonetisation, that was severely criticised for being poorly planned, unfair and unlawful, the Constitution Bench of S. Abdul Nazeer, B.R Gavai *, A.S. Bopanna, V. Ramasubramanian,  B.V. Nagarathna **, JJ. has upheld the Centre’s 2016 demonetisation scheme in a 4:1 majority and held that demonetisation was proportionate to the Union’s stated objectives and was implemented in a reasonable manner. While Gavai, J has written the majority opinion for himself and SA Nazeer, A.S. Bopanna, V. Ramasubramanian, JJ, Nagarathna, J is the lone dissenter who has held that though demonetisation was well-intentioned and well thought of, the manner in which it was carried out was improper and unlawful.

Here’s the breakdown of the 382-pages-long verdict:

While on 16.12.2016, the Supreme had framed 9 questions to be decided by a larger bench, the Constitution Bench reframed the questions into the following 6 issues:

• Whether the power available to Central Government under Section  26(2) of  Reserve Bank of India (‘RBI’) Act, 1934  can be restricted to mean that, it can be exercise for only one or some series of bank notes and not for all, because the word “any” appearing before the series in the sub- section, specifically so in the earlier two occasions the demonetisation exercise was done through the plenary legislations?
• In the event it is held that the power under Section  26(2) of the  RBI Act  is constituted to mean that it can be done in all series of bank notes, whether the power vested with Central Government will amount to conferring excessive delegation and hence needs be struck down?
• Whether the impugned notification dated 08-11-2016 is liable to be struck down on the ground of that the decision-making process is fraud in law?
• Whether the impugned notification dated 08-11-2016 is liable to be struck down applying the test of proportionality?
• Whether the period provided for the exchange of notes by the impugned notification can be said to be unreasonable?
• Whether RBI has independent power under Section  4(2) of the  Specified Bank Notes (Cessation of Liabilities) Act, 2017  (‘2017 Act’) in isolation of provision of Section 3 and Section 4 (1) thereof, to accept the demonitisation of notes beyond the period specified in notification issued under Section 4(1)?

Majority Opinion

Issue 1: ‘Any’ series of notes under Section 26(2) if the RBI Act – Interpreted

The policy underlining the provisions of Section 26 of the RBI Act is to enable the Central Government on the recommendation of the Central Board, to effect demonetization. The same can be done in respect of any series of bank notes of any denomination. The legislative policy is with regard to management and regulation of currency. Demonetization of notes would certainly be a part of management and regulation of currency. The legislature has empowered the Central Government to exercise such a power. The Central Government may take recourse to such a power when it finds necessary to do so taking into consideration myriad factors. No doubt that such factors must have reasonable nexus with the object sought to be achieved.

The Court observed that if the argument that the provisions of sub-section (2) of Section 26 of the RBI Act have to be interpreted in a restricted manner, is to be accepted, it may, at times, lead to an anomalous situation.

Explaining by way of an example, the Court said that if there are 20 series of a particular denomination, and if the argument of the petitioners is to be accepted, the Central Government would be empowered to demonetize 19 series of a particular denomination, leaving one series of the said denomination to continue to be a legal tender, which would lead to a chaotic situation.

“If the Central Government finds that fake notes of a particular denomination are widely in circulation or that they are being used to promote terrorism, can it be said, for instance, that out of 20 series of bank notes of a particular denomination, it can demonetize only 19 series of bank notes but not all 20 series? In our view, this will result in nothing else but absurdity and the very purpose for which the power is vested shall stand frustrated.”

On the argument that the power under subsection (2) of Section 26 of the RBI Act has to be construed to restricting it to “one” or “some” series of bank notes, is that the Parliament also meant the same inasmuch as on earlier two occasions i.e. in 1946 and 1978 the demonetisation exercise in respect of “all” series was done by resorting to plenary legislations, the Court has observed that, merely because on earlier two occasions the Government decided to take recourse to plenary power of legislation, this, by itself, cannot be a ground to give a restricted meaning to the word “any” in sub-section (2) of Section 26 of the RBI Act .

Hence, the word “any” would mean “all” under sub-section (2) of Section 26 of the RBI Act.

Issue 2: Excessive Delegation

The role assigned to the RBI in management and issuance of currency notes, so also in evolving monetary policy of the country, is well recognised. Insofar as the decision to be taken by the Central Government under sub-section (2) of Section 26 of the RBI Act is concerned, it is to be taken on the recommendation of the Central Board.

Hence, there is an inbuilt safeguard in sub-section (2) of Section 26 of the RBI Act inasmuch as the Central Government is required to take a decision on the recommendation of the RBI. Further, there is sufficient guidance to the delegatee when it exercises its powers under sub-section (2) of Section 26 of the RBI Act, from the subject matter of the statute, and the other provisions of the Act.

Issue 3: 08.11.2016 Notification – Flawed decision making

Relevant factors – If considered

After scrutinising the relevant record i.e. the communication dated 7th November 2016 addressed by the Secretary, Department of Economic Affairs, Ministry of Finance to the Governor, RBI, the Minutes of the Meeting of the Central Board dated 8th November 2016, the recommendations by the RBI dated 8th November 2016 and the Note for the Cabinet Meeting held on 8th November 2016, the Court noticed that the Central Board had taken into consideration the relevant factors while recommending withdrawal of legal tender of bank notes in the denomination of Rs.500/- and Rs.1000/- of existing and any older series in circulation . Similarly, all the relevant factors were placed for consideration before the Cabinet when it took the decision to demonetize.

Further, a draft scheme to implement the proposal for demonetisation in a non-disruptive manner with as little inconvenience to the public and business entities as possible was also prepared by the RBI along with the recommendation for demonetization. The same was also taken into consideration by the Cabinet.

Hence, the contention that the decision-making process suffers from non-consideration of relevant factors and eschewing of the irrelevant factors, was held to be without substance.

Want of Requisite Quorum

Insofar as the contention of the petitioners that there was no quorum as required under the 1949 Regulations is concerned, it was noticed that the requisite quorum of four directors of whom not less than three directors nominated under Section 8(1)(b) or 8(1)(c) were present for the meeting . Hence, the contention that the Meeting of the Central Board dated 8th November 2016 is not validly held for want of quorum, was also rejected.

RBI’s recommendation

The scheme mandates that before the Central Government takes a decision with regard to demonetisation, it would be required to consider the recommendation of the Central Board. Hence, in the context in which it is used, the word “recommendation” would mean a consultative process between the Central Board and the Central Government.

The matter was under active consideration for a period of six months between the RBI and the Central Government. The record would also reveal that all the relevant information was shared by both the Central Board as well as the Central Government with each other. As such, it cannot be said that there was no conscious, effective, meaningful and purposeful consultation.

Hence, merely because the Central Government has advised the Central Board to consider recommending demonetisation and that the Central Board, on the advice of the Central Government, has considered the proposal for demonetization and recommended it and, thereafter, the Central Government has taken a decision, cannot be a ground to hold that the procedure prescribed under Section 26 of the RBI Act was breached .

Objective not met

It was argued that the objective with which the impugned Notification was issued, i.e., to combat fake currency, black money and parallel financing are concerned, the same has utterly failed, as, immediately after demonetisation was effected, currency notes of new series have been seized. It is also submitted that the fake currency is also in vogue. New series of notes have been seized from terrorists. The Attorney General, on the other hand, submitted that the long term benefits of demonetization have been enormous, direct and indirect.

The Court, however, observed that, in any case, mere errors of judgment by the government seen in retrospect is not subject to judicial review. In such matters, legislative and quasi-legislative authorities are entitled to a free play, and unless the action suffers from patent illegality, manifest or palpable arbitrariness, the Court should be slow in interfering with the same.

Hasty decision

The Court observed that ‘hasty’ argument would be destructive of the very purpose of demonetisation. Such measures undisputedly are required to be taken with utmost confidentiality and speed. If the news of such a measure is leaked out, it is difficult to imagine how disastrous the consequences would be .

Hardships of citizens

On the contention that, on account of a hasty decision by the Central Government, citizens had to suffer at large, that many people were required to stand in the queues for hours, that many citizens were deprived of their meals, and that many citizens lost their jobs, the Court observed that the Central Government had advised the Central Board to draft a scheme to implement demonetisation in a non-disruptive manner with as little inconvenience to the public and business entities as possible. Accordingly, a draft scheme was also submitted by the Central Board along with its recommendations for demonetization. Further, the RBI has subsequently issued relaxations from time to time taking into consideration the difficulties of the people and availability of the new notes. No doubt that on account of demonetisation, the citizens were faced with various hardships, however, if the impugned Notification had a nexus with the objectives to be achieved, then, merely because some citizens have suffered through hardships would not be a ground to hold the impugned Notification to be bad in law .

Issue 4: 08.11.2016 Notification – Proportionality

The doctrine of proportionality was found to be fully satisfied based on the four-pronged test:

For the purpose of achieving three objectives, namely three purposes, i.e., elimination of fake currency, black money and terror financing, the Central Government, on the recommendations of the Central Board, took a decision to demonetize the bank notes of denominational value of Rs.500/- and Rs.1000/-. Assuming that holding bank notes is a right under Article 300-A of the Constitution of India, the limitation that is imposed is designated for a proper purpose. By no stretch of imagination could it be said that the aforesaid three purposes are not proper purposes.

Second test

Demonetisation of high denomination bank notes of Rs.500/- and Rs.1000/- has a reasonable nexus with the three purposes sought to be achieved.

What alternate measure could have been undertaken with a lesser degree of limitation is very difficult to define. Whether demonetization of only Rs.500/- denomination notes ought to have been done or the denomination of only the notes of Rs.1000/- ought to have been done or as to whether particular series of the bank notes ought to have been demonetised, are areas which are purely within the domain of the experts and beyond the arena of judicial review.

Fourth test

By demonetisation, the right vested in the notes was not taken away. The only restrictions were with regard to exchange of old notes with the new notes, which were also gradually relaxed from time to time. As such, the right to property in bank notes was not taken away. A full value of legitimate currency was entitled to be deposited in the bank account, however, up to a particular date.

Even if there were reasonable restrictions on the said right, the said restrictions were in the public interest of curbing evils of fake currency, black money, drug trafficking & terror financing.

Issue 5: Period for exchange of notes

The Court took note of the fact that under the 1978 Act, three days’ period was provided for exchanging the demonetised notes. If a person could not avail of the said period, five days’ grace period was made available during which period the money could be exchanged subject to the RBI being satisfied with the genuineness of the reasons for not submitting the same within three days.

However, in 2016 Demonetisation, the period for exchanging any amount of SBNs and depositing the same in the KYC compliant bank account without any limit or hindrance was 52 days. The Court, hence, failed to understand as to how the said period of 52 days could be construed to be unreasonable, unjust and violative of the petitioners’ fundamental rights.

Issue 6: RBI’s independent power

The RBI does not have independent power under sub-section (2) of Section 4 of the 2017 Act in isolation of the provisions of Sections 3 and 4(1) thereof to accept the demonetized notes beyond the period specified in notifications issued under sub-section (1) of Section 4 of the 2017 Act.

The purpose of the 2017 Act is to extinguish the liabilities of the SBNs which have ceased to be legal tender with effect from 9th November 2016 so as to give clarity and finality to the liabilities of the RBI and the Central Government arising from such bank notes which have ceased to be legal tender. However, in order to provide a grace period to genuine cases, Section 4 of the 2017 Act has been incorporated. Section 5 of the 2017 Act provides for prohibition on holding, transferring or receiving SBNs. Sections 6 and 7 of the 2017 Act are penal sections which provide for penalty for contravention of Sections 4 and 5 of the 2017 Act, respectively.

Under sub- section (2) thereof, the RBI is required to satisfy as to whether a person seeking to take benefit of grace period under sub-section (1) is entitled thereto after satisfying that the reasons for not depositing the SBNs prior to 30th December 2016, are genuine, and thereafter, credit the value of the said notes in his ‘KYC compliant bank account’. Sub-section (3) thereof provides for an appeal. Hence, subsection (2) of Section 4 of the 2017 Act cannot be read independently to provide power to the RBI in isolation of subsections (3) and (4) thereof. It is to be read as a part of the scheme of Section 4 of the 2017 Act.

Minority Opinion

Nagarathna, J expressed the following dissenting opinion on the first three issues and did not go into the last three issues:

i) The Central Government possesses the power to initiate and carry out the process of demonetisation of all series of bank notes, of all denominations. However, all series of bank notes, of all denominations could not be recommended to be demonetised, by the Central Board of the Bank under Section 26 (2) of the Act.

ii) Sub-section (2) of Section 26 of the Act applies only when a proposal for demonetisation is initiated by the Central Board of the Bank by way of a recommendation being made to the Central Government.

 iii) On receipt of a recommendation from the Central Board of the Bank for demonetisation under Section 26 (2) of the Act, the Central Government may accept the said recommendation or may not do so. If the Central Government accepts the recommendation, it may issue a notification in the Gazette in this regard.

iv) The Central Government may also initiate and carry out demonetisation, even in the absence of a recommendation by the Central Board of the Bank. However, this must be carried out only by enacting a plenary legislation or law in this regard, and not through issuance of a Notification under subsection (2) of Section 26 of the Act as this provision is not applicable in cases where the proposal for demonetisation is initiated by the Central Government.

• i) This question does not arise for consideration as it has been held that the power under sub-section (2) of Section 26 of the Act cannot be construed to mean “all” series or “all” denominations.
• ii) If the Central Board of the Bank is vested with the power to recommend demonetisation of “all” series or “all” denominations of bank notes, the same would amount to a case of excessive vesting of powers with the Bank.

i) That the measure of demonetisation ought to have been carried out by the Central Government by way of enacting an Act or plenary legislation.

ii) The proposal for demonetisation arose from the Central Government and therefore, could not be given effect to by way of issuance of a Notification as contemplated under sub-section (2) of Section 26 of the Act, as, such provision would not apply in cases where the proposal for demonetisation has originated from the Central Government, such as the instant case.

iii) That the decision-making process was also tainted with elements of “non-exercise of discretion” by the Central Board of the Bank in rendering its advise on the impugned measure. That the Bank acted at the behest of the Central Government and did not render an independent opinion to the Central Government.

iv) Therefore, the impugned Notification dated 8th November, 2016 issued under subsection (2) of Section 26 of the Act is unlawful. Further, the subsequent Ordinance of 2016 and Act of 2017 incorporating the terms of the impugned Notification are also unlawful.

Nagarathna, J did not answer the remaining questions in light of the answers to the first three issues.

She concluded by saying that d emonetisation was an initiative of the Central Government, targeted to address disparate evils, plaguing the Nation’s economy, including, practices of hoarding “black” money, counterfeiting, which in turn enable even greater evils, including terror funding, drug trafficking, emergence of a parallel economy, money laundering including Havala transactions . It is beyond the pale of doubt that the said measure, which was aimed at eliminating these depraved practices, was well-intentioned. However, the measure has been regarded as unlawful only on a purely legalistic analysis of the relevant provisions of the Act and not on the objects of demonetisation.

Considering that the impugned notification dated 8th November, 2016 and the Act have been acted upon, It has been clarified that the judgment would apply prospectively and would not affect any action taken by the Central Government or the Bank pursuant to the issuance of the Notification dated 8th November, 2016. Hence, no relief has been granted in the individual matters.

[Vivek Narayan Sharma v. Union of India, 2023 SCC OnLine SC 1 , decided on 02.01.2023]

Majority Opinion by: Justice BR Gavai

Know Thy Judge- Justice Bhushan Ramkrishna Gavai

Minority Opinion by: Justice BV Nagarathna

Justice BV Nagarathna: Igniting hope for the first ever woman Chief Justice of India

Appearances by:

For petitioners: Senior Advocate P. Chidambaram and Shyam Divan, Advocate Prashant Bhushan, and petitioner-in-person Viplav Sharma

For UOI: Attorney general R. Venkataramani

For RBI: Senior Advocate Jaideep Gupta

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Demonetisation: A year after India killed cash, here’s what we can learn

Bhaskar chakravorti bhaskar chakravorti nonresident senior fellow - governance studies , center for technology innovation.

November 7, 2017

Content from the Brookings Institution India Center is now archived . After seven years of an impactful partnership, as of September 11, 2020, Brookings India is now the Centre for Social and Economic Progress , an independent public policy institution based in India.

This article first appeared in the World Economic Forum . The views are of the author(s).

Almost a year ago, the Indian government rolled out an unprecedented policy move. Arguably, it was a time when the country was poised for economic success. With $9.49 trillion in purchasing power parity, it was the third-largest (in PPP terms) and the fastest-growing large economy in the world. On November 8, with no advance warning, India’s two highest-denomination banknotes, the 500-rupee and 1,000-rupee bills, were demonetized, rendering 86% of the country’s currency invalid overnight. The ostensible objective was a popular one: to root out corruption and illegitimate activity involving untraceable cash transactions. As the implications unfolded, I wrote two pieces (“India’s Botched War on Cash”and “Early Lessons from India’s Demonetization Experiment”) evaluating the policy and its impact. My assessment of the action was that the policy was poorly thought out and executed and that its net impact would be negative and particularly bad for the poor.

To read more, please click here .

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Two views on six issues: What the Supreme Court’s demonetisation verdict says

The supreme court identified six issues in the challenge to the government’s demonetisation decision. both the majority judgment and the dissent gave their views on each of these issues. we explain..

In the Supreme Court’s majority opinion upholding the government’s demonetisation order of November 8, 2016, Justice B R Gavai — writing for himself and Justices S Abdul Nazeer, A S Bopanna, and V Ramasubramanian — reframed the questions referred to the Constitution Bench into six issues. In her dissenting judgment, Justice B V Nagarathna disagreed with the reasoning and conclusions in the majority opinion.

1. 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 in view of the word “any” appearing before the word “series” in the said sub-section, specifically so, when on earlier two occasions, the demonetisation exercise was done through the plenary legislation?

Majority view: Section 26(2) of the RBI Act states that “on recommendation of the Central Board (of the RBI) the Central 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 petitioners argued that the word “any” would have to be given a restricted meaning to mean “some” and not “all” legal tender of a given denomination. Senior Advocate P Chidambaram 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, and held that the term has to be given a purposive interpretation and that any other meaning would lead to absurdity. Citing an example, the court said: “If there are 20 series of a particular denomination, and if the argument of the petitioners is to be accepted, the Central Government would be empowered to demonetise 19 series of a particular denomination, leaving one series of the said denomination to continue to be a legal tender, which would lead to a chaotic situation.”

Dissenting view: Justice Nagarathna held that if the word “any” could mean “all”, it would confer excessive and arbitrary powers on the RBI. In her view, “the contention of the Union of India that the Central Government has the power to demonetise “all” series of bank notes of “all” denominations which would mean that every Rs 1/-, Rs 5/-, Rs 10/-, Rs 20/-, Rs 50/-, Rs 100/-, Rs 500/-, Rs 1,000/-, Rs 5,000/-, Rs 10,000/-, could be demonetised. Since the same is possible theoretically, in my view, such an extensive power cannot be exercised by issuance of a simple gazette notification in exercise of an executive power of the Central Government as if it is one under sub-section (2) of Section 26 of the Act. The same can only be through a plenary legislation, by way of an enactment following a meaningful debate in Parliament, on the proposal of the Central Government.”

2. In the event it is held that the power under sub-section (2) of Section 26 of the RBI Act is construed to mean that it can be exercised in respect of “all” series of bank notes, whether the power vested with the Central Government under the said sub-section would amount to conferring excessive delegation and as such, liable to be struck down?

Majority view: On the issue of whether the RBI Act delegates excessive power to make law to the Centre, and is therefore unconstitutional, the majority view disagreed with the petitioners. “Insofar as the decision to be taken by the Central Government under sub-section (2) of Section 26 of the RBI Act is concerned, it is to be taken on the recommendation of the Central Board. We, therefore, find that there is an inbuilt safeguard in sub-section (2) of Section 26 of the RBI Act inasmuch as the Central Government is required to take a decision on the recommendation of the RBI,” the court said. It also said that the delegation of power is in any case to the central government, which is answerable to Parliament.

Dissenting view: Since Justice Nagarathna held that Section 26(2) gives excessive powers to the Centre to demonetise currency by just issuing a gazette notification, it follows that the Centre’s 2016 decision was unconstitutional.

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3.  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.

On the merits and soundness of the decision, the majority stated that the court cannot determine the effectiveness of economic policy. However, it agreed with the Centre’s contention that the decision had to be made in secrecy and in haste for it to be effective.

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 use of the words/ phrases such as, “as desired” by the Central Government; Government had “recommended” the withdrawal of the legal tender of existing Rs 500/- and Rs 1,000/- notes; recommendation has been “obtained”; etc., are self-explanatory,” the dissenting opinion states.

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. For example, the August 2019 decision to remove the special status of Jammu and Kashmir was done through an Ordinance.

4. As to whether the impugned notification dated 8th November 2016 is liable to be struck down applying the 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.

5. As to whether the period provided for exchange of notes vide the impugned notification dated 8th November 2016 can be said to be unreasonable?

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, “we fail to understand as to how the said period of 52 days could be construed to be unreasonable, unjust and violative of the petitioners’ fundamental rights.”

Dissenting view: Since the dissent had already held the demonetisation decision unlawful, it did not answer this question.

6. As to whether the RBI has independent power under sub-section (2) of Section 4 of the 2017 Act in isolation of provisions of Section 3 and Section 4(1) thereof to accept the demonetised notes beyond the period specified in notifications issued under sub- section (1) of Section 4?

Majority view : The Specified Bank Notes (Cessation of Liabilities) Act, 2017 prohibits and penalises holding, transferring, or receiving demonetised currency. However, some earlier notifications allowed a grace period for certain individuals, like those who were abroad when demonetisation was notified, to exchange their old currency.

The petitioners argued that RBI had no independent powers to allow that when the 2017 Act had been passed by Parliament. The majority view stated that the earlier notifications have to be read as part of the 2017 law, giving it a “contextual and harmonious construction”.

Dissenting view: Same as 4, 5 above.

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Supreme Court’s Judgment on Demonetisation – Explained, pointwise

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• 1 Introduction
• 2 What is the Supreme Court’s Judgment regarding Demonetisation?
• 3 What questions were considered by the Supreme Court Judgment on Demonetisation?
• 4 Conclusion

Introduction

On 02 January, 2023, a 5-judge bench of the Supreme Court’s Constitution Bench ruled on a number of petitions challenging the legality of the Union Government’s decision in November 2016 to demonetise the currency notes of INR 500 and INR 1,000. The Supreme Court’s Judgment on Demonetisation has upheld the decision of the Government and dismissed the petitions.

What is the Supreme Court’s Judgment regarding Demonetisation?

In November 2016, the Union Government had demonetised the currency notes of denominations INR 500 and INR 1000. The Supreme Court has upheld the legal aspects of the decision of the Government by a majority vote of 4:1.

The Court adjudicated that the notification from the Government (November 8, 2016) is lawful and that it passes the proportionality test. One Judge (Justice V Nagarathna) has given a dissenting judgment noting that even though demonetization was well-intended and well-thought-out, it still needs to be declared unlawful on legal grounds and not on the basis of objects.

What questions were considered by the Supreme Court Judgment on Demonetisation?

The Supreme Court had identified six issues in the challenge to the government’s demonetisation decision.

A. Sub-section (2) of Section 26 of the RBI Act states that, “ On recommendation of the Central Board the Central Government may, by notification in the Gazette of India, declare that…..any series of bank notes of any denomination shall cease to be legal tender…specified in the notification “. The Supreme Court considered whether the power available under this clause can be restricted to mean that it can be exercised only for “one” or “some” series of bank notes and not “all” series? 

Majority view : The majority opinion held that Section 26(2) RBI Act, which empowers Centre to demonetize any series of bank notes of any denomination, can be used to demonetize the whole series of currency . It observed ‘restrictive meaning cannot be given to word “any’ in Section 26(2) of RBI Act’. The purposes of the Act must be considered while interpretation. The bench added that Section 26(2) cannot be struck down as unconstitutional on the ground of excessive delegation, adding that there are inbuilt safeguards.

Minority view : The Judge held that “Any series” under Section 26(2) RBI Act cannot mean “all series”. “All Series” would mean that the Government can demonetize all series of all denominations by gazette notification. Such an extensive power can be “exercised only through a plenary legislation, by way of an enactment following a meaningful debate in Parliament”.

Source: The Times of India

B . If the power under Section 26 (Question A above) means “all series” of bank notes, whether this power would amount to conferring excessive delegation and as such, liable to be struck down?

Majority view : The decision under sub-section (2) of Section 26 has to be taken by the Central Government on the recommendation of the Central Board. Thus there is an inbuilt safeguard in the RBI Act. It also said that the delegation of power is in any case to the Central Government, which is answerable to Parliament.

Minority view : The Judge held that RBI Act does not envisage initiation of demonetisation by the Central Government . As per Section 26(2), the proposal for demonetisation to emanate from the central board of the RBI . The Judge further held that if demonetisation is to be initiated by the Central Government, such power is to be through a legislation or an ordinance derived from Entry 36 of List I (Currency, Coinage, Legal Tender, and Foreign Exchange).

C . Is there a possibility that the Notification of Demonetisation (issued on November 8th, 2016) could be overturned on the ground of legal flaws in the decision-making process?

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 .

On the merits of the decision, the majority stated that the Court cannot determine the effectiveness of economic policy . However, it agreed with the Centre’s contention that the decision had to be made in secrecy and in haste for it to be effective .

Minority view : The Judge observed that the statement in the records submitted by the RBI “as desired by the Central Government” demonstrates that there was no independent application by the RBI and merely approved Centre’s decision. The entire exercise was carried out in 24 hours. The Judge held it in the violation of Section 26(2) of the RBI Act.

D . Does the Government Notification of Demonetisation (issued on November 8th, 2016) fail the Test of Proportionality and thus be subject to being overturned?

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: (a) Legitimate purpose; (b) Rational connection with the purpose; (c) Necessity; (d) 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 connection with demonetisation. On the question of necessity, the Court said that it is “ exclusively within the domain of the experts “, (RBI) to answer this question.

On the question of Proportionality, the Court said “what alternate measure could have been undertaken with a lesser degree of limitation is very difficult to define”.

Minority view : The Judge said that since she had already held the demonetisation decision unlawful , this question need not be answered.

E . Whether the period of exchange of notes (after demonetisation) can be said to be unreasonable?

Majority view : The Court cited an earlier instance of demonetisation in 1978 where a 3-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, “ we fail to understand as to how the said period of 52 days could be construed to be unreasonable, unjust and violative of the petitioners’ fundamental rights .”

Minority view : Since the dissent had already held the demonetisation decision unlawful, it did not answer this question.

F . Is the RBI authorised to continue accepting the demonetised notes beyond the period specified in notifications issued under sub-section (1) of Section 4 of the 2017 Act?

Majority view : The Specified Bank Notes (Cessation of Liabilities) Act, 2017 prohibits and penalises holding, transferring, or receiving demonetised currency. However, some earlier notifications allowed a grace period for certain individuals , like those who were abroad when demonetisation was notified, to exchange their old currency. The petitioners argued that RBI had no independent powers to allow that when the 2017 Act had been passed by Parliament. The majority view stated that the earlier notifications have to be read as part of the 2017 law, giving it a “contextual and harmonious construction” .

During the hearing in November-December 2022, the Supreme Court indicated that demonetization might not be scrapped because “the clock cannot be turned back” . After six years, the economy and society have finally recovered from the shock of the demonetisation decision. However, the Supreme Court’s Judgment on Demonetisation and arguments may lead it to establish guidelines for future such exercises.

Syllabus : GS II, Government policies and interventions for development in various sectors and issues arising out of their design and implementation; GS III, Indian Economy.

Source : Indian Express , Indian Express , The Times of India

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Supreme Court upholds demonetisation: What was the challenge about?

Syllabus: Government Policies and Interventions for Development in various sectors and Issues arising out of their Design and Implementation

  Direction: The article highlights the background in which the issue of demonetisation reached the SC, arguments in favour and against demonetisation and the recent SC verdict.

Context: The Supreme Court upheld the government’s decision to demonetise currency notes of Rs 500 and Rs 1,000 by a 4:1 majority.

Background:

• Introduced new notes of Rs 2,000 and Rs 500 for public circulation.
• Two primary reasons: to curb fake currency notes and reduce black money stored as cash.
• Though supported by many, 58 petitions have been filed in the SC challenging various aspects.
• The petitioners accused that Section 26(2) of RBI Act, 1934 , was not followed: On the recommendation of the [RBI] Central Board , the Central Government may, by notification in the Gazette of India, declare that any series of bank notes of any denomination shall cease to be legal tender.
• The court was to consider whether the recommendation for the policy came from the government or the RBI.

Arguments for and against demonetisation presented in the SC:

The SC’s (4:1) verdict on demonetisation:

• The Centre’s notification was valid and satisfied the test of proportionality – a reasonable nexus between the objectives and the means to achieve the objectives.
• From the record, it appears that there was a consultative process between the central government and RBI for over 6 months before the decision was taken.
• The Decision-making process cannot be faulted merely because the proposal emanated from the centre (as the government and RBI are not in ‘isolated boxes’) and the court cannot replace the wisdom of the executive with its wisdom.
• The action taken by the Central Government has been validated by the Specified Bank Notes (Cessation of liabilities) Act, 2017 , which prohibited and penalised the holding or transferring or receiving of demonetised currency.

The dissenting judgement:

• While the measure was “ well-intentioned ”, it was to be declared unlawful purely on legal grounds as the record demonstrates that there was no independent application of mind by RBI.
• Violation of Section 26(2), as the proposal for demonetisation, is to emanate from the central board of the RBI and the demonetisation has to be done through legislation rather than through executive notification.

Conclusion: Most policy decisions carry the risk of unintended consequences, which must be carefully balanced against the potential benefits of such decisions.

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Demonetisation

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• Topical Analysis

ECONOMIC SURVEY ANALYSIS ON DEMONETISATION

• Published 12th Jul, 2019

Supplementary Reading A. Experience of demonetization around world 1. Ghana 1982 - • Measures: Demonetisation of 50 cedi notes in 1982; no exchange facility for long; freeze on bank deposits • Rationale: Excess liquidity and inflation • Effect: Loss of confidence in the banking system 2. Brazil 1990 • Measures: Collor Plan: monetary contraction by freezing all deposits above certain limit .Deposits upto a ceiling denominated in the old currency (cruzado novo) were converted to the new currency (cruzeiro) at parity. • Rationale: To fight hyperinflation • Effect: Contraction of output; price moderation only very gradual due to uncontrolled re- injection of liquidity 3. Australia (1988, 2015) • Measures: Introduction of next generation notes with tactile features. • Rationale: Prevent counterfeit • Impact: The first country to have a full series of circulating polymer bank notes 4. Singapore (1999, 2004) • Measures: The Portrait notes, the fourth series of currency notes, were launched in September 1999 with sophisticated security features (1999). Discontinued issuance of S$10,000note and instructed banks to stop re- circulating it since October 2014; but still remained legal tender (2004). • Rationale: Mitigate higher money- laundering risks associated with large-value cash transactions.

IMPACT OF DEMONETIZATION ON BANKING SECTOR

Demonetisation and its impact on microfinance sector.

Introduction Microfinance Institutions (MFIs), irrespective of legal form, seek to promote financial inclusion by providing financial services to clients of financially un-served and under-served households. Over time, the microfinance sector has become an integral part of the financial infrastructure catering to the vulnerable sections of society in India. In the Indian microfinance industry NBFC-MFIs hold a significant share and are regulated by RBI. As on date, there are 71 NBFC-MFIs registered with the RBI. Demonetisation and micro-finance sector • In November 2016, the Indian government launched a huge demonetisation drive when they banned 500 and 1000 Rupees notes. In a country where 69% of the population lived in rural areas and 90% of the transactions are cash based, the move was paralysing. • For the Micro Finance industry this came as a blow too. Most of the borrowers of the MFIs are based in rural areas; they borrow in cash and repay in cash. Typically, MFIs that have had a repayment rate of 99% have had a fall of upto 12% in repayment rates. For many MFIs the non-performing assets (NPA) have risen by 7-10%. • ICRA’s estimates show that MFIs (including some erstwhile ones that have now become small finance banks) raised nearly Rs.5, 500 crore through the securitisation route in the first six months of FY17. However, they raised only around Rs.1,650 crore in the second-half of the fiscal, resulting in total securitisation volumes of around Rs.7,150 crore for the full year. • In comparison, MFI securitisation volumes had increased by 80 per cent to around Rs.9,000 crore in FY16. Securitisation involves pooling of assets such as micro loans, and creation and issuance of securities backed by cash flows from the underlying assets. • The dip in micro loan securitisation volumes is primarily due to the impact of the demonetisation event on the portfolio of most MFIs. Negative impacts have been discussed below: • Impact on collections: a) Microfinance entities traditionally use cash in their lending and recovery operations. The installments on microfinance loans have weekly / fortnightly / monthly collections of small denominations. On account of non-availability of cash post demonetization, the borrowers were not in a position to service their loans which led to delay and drop in collection rates. • Impact on lending: a) Despite the efforts to increase cashless disbursement, majority of the disbursements were still cash based. Because of the withdrawal limits imposed on current accounts, MFIs were not able to withdraw cash for further disbursement and the incremental disbursements were restricted to the collections. b) The main reason for this significant drop in disbursements was due to the focus of MFIs shifting from disbursements to collections and they also adopted a wait and watch approach in order to comprehend the position. • Impacts on farmers: a) Particularly farmers and SMEs that make up most of the customers are affected in a big way. The drying up of liquidity that the demonetisation drive has caused has affected cash dependent rural communities in a big way. b) In Tamil Nadu, farmers-suicide due to debt issues is almost a daily occurrence. There have been several cases where farmers have had to borrow from local lenders at higher rates, to pay off the MFIs, as MFIs tend to be stricter on their debt collection dates. • Interruption in economic activities in rural economy: a) Inability in the repayment of dues and hence lack of new credit will hinder the business of small farmer and entrepreneurs. This have drastically affect the blossoming rural economy. • Delay in loan repayment: a) Repayment of loans to MFIs has dropped as it is unable to accept cash in older denominations from the poor people which has affected its ability to repay the banks. Banks would block the process of financial support to MFIs, which would lead to shutting down of many NBFC MFIs. This would also have an adverse impact on SMEs. • Threat to existence of small MFIs : a) Outstanding dues of these institutions will further hinder the availability of term loan from the lending institutions imposing a threat to their survival. Despite 60 days extension by RBI in due repayment, political interference is making the prospect of recovery less optimistic. b) MFIs with high financial leverage and low collections efficiencies are expected to face deterioration in their credit profile. Positive impacts have been discussed below: • While these are certainly tragic incidents, there are various avenues the government and the MFIs have explored and continue to explore. One positive outcome of it all is that, the top 8 MFIs in India that hold about 40% of the market share, have now been provided the small finance bank licenses. This would mean they can have their own cash out points and the demonetisation drive is very likely to increase usage of their accounts. • MFIs have also been lobbying with the Reserve Bank of India (RBI) to extend deadlines for the usage of the banned currency notes and farmers have had some special exemptions to this extent. • RBI has also provided MFIs with a further 90 days extension before classifying loans as NPAs, if payments were due in November and December 2016. • There have been some signs of recovery in certain parts of the country where repayments had fallen immediately after demonetisation. • Due to demonetisation and the push for a cashless economy, awareness has been created regarding use of technology like e-wallets, PAytm, USSD, AEPS, etc which would drive the people towards financial inclusion. • Though this demonetization has brought adverse impact on the rural economy, it should be taken a step to connect the rural people with the banking sector directly. • More focus on opening accounts under PMJDY which would promote financial inclusion. • This move is expected to ‘break the ice’ between marginalized, illiterate and ignorant rural people and banks and hence providing them to approach the main stream avenue of credit. • MFIs are increasingly looking for cashless disbursement and collection through Jan-Dhan accounts and by leveraging technology. With 8 NBFC-MFIs converting into Small Finance Banks (SFBs) by March 2017, the competitive environment is bound to undergo a major shift within the microfinance industry as a whole. As these entities are expected to remain focused on microfinance, cashless disbursement and collection of loans is bound to increase in the future. • Even though the collections are less, many MFIs are conducting center / group meetings to make borrowers aware of the impact on their credit profile due to default on repayment and the role credit bureaus. These meetings are also used to educate the borrowers to overcome any kind of slowdown in their business activities and to encourage banking habits in order to move towards non-cash based model. Way Forward According to a December, 2015 Reserve Bank of India report titled “ Report of the Committee on Medium-term Path on Financial Inclusion ”, the number of branches per 1, 00,000 of population in rural and semi-urban areas is less than half of that in urban and metropolitan areas. • The presence of ATMs is also very low in rural areas. However, NBFC-MFIs have a very strong reach in rural areas and semi-urban areas where banks have a considerably lower penetration. • Therefore, with a view to mitigate the hardship and financial crunch currently being faced by NBFC-MFIs and the rural and semi-urban community, the government / RBI may consider the following: 1. Exchange of SBNs: a. The Government may take advantage of the extensive infrastructure and reach that NBFC-MFIs have in rural and semi-urban areas by allowing them to be eligible to exchange SBNs against valid compliance documents and by putting in place other checks and balances. 2. Acceptance of SBNs: a. NBFC-MFIs may be allowed to act as facilitators and collect repayment of loans from their customers through SBNs until December 30, 2016 while complying with all other control and KYC requirements stipulated by the RBI in this regard. b. This would help reduce cases of unintentional defaults in loans and also ensure that the overall asset quality of the NBFC-MFI sector does not get eroded. 3. Enhance the withdrawal limits: a. In order to provide necessary operational flexibility and at the same time being mindful of the growing business needs, the Government/ RBI may consider relaxing the daily / weekly withdrawal limits for companies involved in the micro-financing sector. Conclusion If MFIs, particularly the smaller MFIs, continue to experience worsening repayment rates and defaults, their sustainability is questionable. Bearing in mind the importance of microfinance for financial inclusion and livelihoods of a client-base of around 40 million, demonetisation has dealt a severe blow to the microfinance sector in more ways than one. It has considerably damaged the repayment behaviour and credit discipline that is central to the success of the microfinance model. Even if there is recovery in sight in the coming quarters, the report highlight the tremendous stress that the sector has borne following demonetisation.

DEMONETIZATION IMPACT ON DOMESTIC REMITTANCES

Domestic Remittance Market The domestic remittance market is growing at a faster pace with the help of organised money transfer channels, mobile money transfer and business correspondents (BCs) of banks. Nearly 100 million migrants have travelled to Tier-I cities in search of jobs. This results in the overall domestic remittance market growing at an average rate of 10.3 per cent during 2007-13. Remittances from migrant workers contribute more than 50 per cent to the overall domestic remittances market. Traditionally, a migrant worker can transfer money by visiting a post office, or depositing the money in bank branches, or handing over the money to friends/families who are travelling back home. At present, migrant labours prefer to send money through instant money transfer products compared to the bank route, NEFT (National Electronic Funds Transfer), because of the efficiency and convenience the products offer. Through these channels, a migrant labour can make transactions at his convenience at an agent located near his home. The Domestic Money Transfer is a service launched by the Reserve Bank of India. The RBI allows banks to create their own merchant outlets or enable their partner company’s merchants to facilitate general public with money transfer service. The service offers to transfer or deposit money in bank accounts by simply visiting the local mobile shop, kirana stores, and chemist outlets etc. These merchants are registered either with a master bank correspondent or prepaid instrument issuer company. Customers can deposit or transfer Rs. 25000 in a month to their own or others accounts. This service is widely used by the migrants working in the metro cities and those who send money to their families and businesses on regular basis. The service felicitates the customers and eases the banks in terms of managing their customers in the decentralized way and giving the liberty to perform transactions even after “bank timings”. Benefits of Domestic Remittances • Increased domestic remittances have a positive impact on the nation’s economic growth. • Domestic remittances also eliminate difficulties associated with credit rationing. • These remittances finance needs for consumption or capital expenditures. • On a macroeconomic level, raising the total capacity of financing of investments through domestic remittances will improve the local economic situation. • Domestic remittances can also provide support in counter-cyclic conditions when when local market situations are not favourable. Demonetisation and Domestic Remittance Market On 8 November 2016, the Government of India announced the demonetisation of all Rs.500 and Rs.1,000 banknotes of the Mahatma Gandhi Series. The government claimed that the action would curtail the shadow economy and crack down on the use of illicit and counterfeit cash to fund illegal activity and terrorism. The sudden nature of the announcement and the prolonged cash shortages in the weeks that followed created significant disruption throughout the economy, threatening economic output. The Specified Bank Notes (Cessation of Liabilities) Ordinance, 2016 was issued by the Government of India on 28 December 2016, ceasing the liability of the government for the banned bank notes. This has impacted the firms associated with movement of domestic remittances. Effects of demonetization on remittance business: • Firms related to remittance movement have a Prepaid Payments Instruments (PPI) licence from the Reserve Bank of India (RBI) and act as business correspondents (BCs) for banks. • They set up their “money transfer counters” in kirana stores, medical shops, and mobile recharge outlets. • Their software platforms and logistics systems for cash collection facilitate domestic remittances that are paid in the form of cash by the remitter and deposited in the bank account of the beneficiary. • Operating with relaxed KYC (know your customer) norms, they channelize small-value remittances with a limit of Rs.5,000 per transaction and a monthly cap of Rs.25,000 per remitter. • Thus, these firms belong to an intermediate zone between the fully cash-based courier system and the entirely digital systems of a bank-to-bank transfer or a mobile-wallet transaction. • Before demonetisation, Rs.4,000 crore per month was remitted through this channel. After demonetization, a big drop in the business numbers has been recognized across the country. The current trend shows a downfall of 60% of total business. • Shortfall of valid currency notes in the market has stopped remittance transactions. • RBIs instructions to the industry of not accepting the Old Currency Notes. • There could be some regular people enjoying the service to convert their illegal money into white. After demonetization, it has been stopped. • Businesses with cash transactions are almost stopped; people are not paying each others, not accepting payments. • The number of “Wallet to bank transfer” transactions using multiple mobile apps has increased. • Banks have started promoting UPI and other modes and mobilizing public to do fund transfer using their mobiles. • To enjoy the high session, some wallet companies have waived off the transaction changes on money transfer. • “Switching” charges are officially waived off. Conclusion The failure of incomes in the informal sector to recover to the levels they would have reached without demonetisation appears to be an important factor for the weakness in the business correspondents (BC) remittances market. Steps need to be taken to reduce the impact of demonetization on remittance sector.

EMPLOYMENT AND DEMONETIZATION

Introduction • The labour market in India has been witnessing numerous uncertainties including the problem of world recession, and growing ‘automation’ particularly in the manufacturing sector. Today major policy change like ‘demonetization’ is likely to make the employment scenario further volatile by causing uncertainties to rise in labour market. • Demonetization is the act of stripping a currency unit of its status as legal tender. It occurs whenever there is a change of national currency: The current form or forms of money is pulled from circulation and retired, often to be replaced with new notes or coins. • The opposite of demonetization is remonetisation, in which a form of payment is restored as legal tender. • On 8th November 2016, the Government of India has announced the demonetization of all 500 and 1000 banknotes of Mahatma Gandhi Series. • The move was taken to curb the menace of black money, fake notes and corruption by reducing the amount of cash available in the system. Effect of Demonetization on Employment: • The Centre for Monitoring Indian Economy has estimated that 1.5 million jobs were lost after demonetization. Alongside this loss of jobs, there has been a decline in the labour force participation rate (LPR). • For a developing economy like India, a drop in labour participation rate is a sign of an economic slowdown. • The All India Manufacturers’ Organization (AIMO), which represents traders and small-, medium- and large-scale industries, conducted survey and has found a drop in employment of 60 per cent and loss in revenue of 55 after demonetization last year. • Effect on Medium and large scale industries: a) Medium and large scale industries engaged in infrastructure projects, such as big-ticket road construction, reported a 35% cut in employment and 45% revenue loss. The industries like foreign companies, engaged in export-oriented activities reported 30% job losses and 40% revenue fall. b) In the manufacturing sector, medium and large scale industries reported the least job-losses are 5% and took a revenue hit of 20%. c) It is further found that labour intensive units such as food and beverage, tobacco, textile, leather, wood and jewelry employ nearly half of the total workers in the organized manufacturing sector of the economy. Given that nearly 84 percent of total factories have employment in the range of 0 to 99 are affected by the recent move of the government. • Effect on Informal Sector: a. The informal sector presently employs more than 80% of India’s workforce. It includes workers in small and medium industries, grocers, barbers, maids and others. b. More than 95% of total transactions in informal sector are in cash form. The decision of sudden ‘demonetization’ therefore led the labor market dynamics changed significantly by rendering millions of informal workers exposed to increased uncertainty in employment; they resorted to ‘reverse migration’. c. Within manufacturing, labour intensive sectors such as textiles, leather and gems and jewelry have already reported considerable job losses due to supply chain and market disruptions. d. Demonetization is considered as a means of increasing formality in informal sector. But a 2009 OECD study on informal economies concluded that enforcing formality can be counterproductive and lead to an increase in poverty. e. Many daily wage workers or contract workers were rendered jobless due to paucity of cash in the system. But even after re-monetization the number of new recruits has been reduced considerably as compared to pre demonetization. f. The 2016-17 economic survey also point out the decrease in demand for MGNREGA work in the aftermath of demonetization. • Effect on Agriculture: a. Agriculture was expected to grow at 4% this year according to, but demonetization is likely to dent that forecast. The impact is visible in different sub-segments. Winter crops such as wheat, mustard, chickpeas are due for sowing in a fortnight. Wheat prices were already up due to low stocks and anticipated shortfall in 2015-16 output and have firmed up further as demonetization. b. The vulnerability of the small farmers in agriculture is best exemplified by the predominance of marginal and small holdings in the country. Marginal and small holdings account for 85 per cent of the landholdings. Farmers failed to find buyers or due to dearth of cash ended up getting low prices. • Effect on Self-Employment: a. Most of the self-employed workers lose their employment during the months of cash crunch. They don’t able to sell their products because of cash crunch and lack of digital transactions facilities. Concerns: • The drop in labour participation is in line with CMIE’s observation that new investments have been falling. For a developing economy like India, a drop in labour participation rate is a sign of an economic slowdown. • Unlike in developed countries where labour participation is falling because of structural (ageing) reasons, India is a growing economy with a young population. • A slowdown hurts the younger new labour force. This is already evident. During January-April 2017, job losses were concentrated in the younger age brackets. Way Forward The decline in the Labour Participation Ratio should be a matter of deep concern for the Indian economy. Persons may drop out of the labour force due to discouragement, the inability to find a job. In the meantime, they may take up part-time jobs to make ends meet or may be compelled to start a small business (“forced entrepreneurship”) as a desperate move for their very survival. A remedy for this dismal state of affairs will not be forthcoming until the government recognizes the reasons behind this phenomenon. Government should focus on ensuring growth, job creation and investment. The urgent need is to get the private sector to start investing. One way to avoid winds of deflation is to kick-start private investments. There is a concerted attempt to improve ease of doing business, and technology is being used to deliver public services without leakages.

DEMONETISATION AND BLACK MONEY

Demonetization of the notes of higher denomination has also been one of the recent step of the Government to unearth black-money. Demonetisation is a radical monetary step in which a currency unit is declared as an invalid legal tender. This is usually done whenever there is a change in the national currency of a nation. On November 8, 2016 Prime Minister announced that Rs 500 and Rs 1000 denomination notes will become invalid and all notes in lower denomination of Rs 100, Rs 50, Rs 20, Rs 10, Rs 5, Rs 2 and Re 1 and all coins will continue to be a valid legal tender. He also added that new notes of Rs 2,000 and Rs 500 will be introduced. There was also no change effected in any other form of currency exchange like cheque, Demand draft (DD), payments made through credit cards and debit cards. Why the government has banned Rs 500 and Rs 1000 notes particularly? • Some 68% of all transactions in the country are cash-based, and the Reserve Bank of India has estimated that the banned currency notes formed over 86% of all currency in circulation. • As per the data provided by the RBI, there are 16.5 billion (45% of currency stock in 2014-15) ‘500 rupee’ note and 6.7 billion (39% of currency stock in 2014-15) ‘1000 rupee’ notes are in circulation at present. It has been pointed out that any economic cost in printing these notes is likely to outweigh in terms of benefit it would bring to India and Indian economy. • In India, the rationale behind banning Rs 500 and Rs 1000 notes is that unaccounted money used in corruption or any deals takes place in the form of high-value notes of Rs 500 and Rs 1000 bills. These higher denomination notes are often found to be used for funding terrorism and corruption. • The Financial Action Task Force (FATF), a global body that monitors the criminal use of the international financial system has observed that high-value currency units are often used in money laundering schemes, racketeering, and drug and people trafficking. • In addition, these notes constitute a huge percentage of money spent during general elections by political parties, candidates in India. Impact of demonetisation on black money • Better tax compliance: This move is likely to lead to better tax compliance, raise the Tax to GDP ratio and improved tax collection. This could lead to lower borrowing and better fiscal management. Also with lower cash transactions in the near term, inflation may see downtrend in the near term. Also with higher tax to GDP ratio, the government may also get enough headroom to reduce the income tax rates, which can lead to higher disposable income with people and can improve consumption demand in the medium to long term. • Real Estate Check: Demonetisation is seen as a check on the real estate sector where prices get pushed up artificially, reducing the availability of affordable housing for the poor and the middle class. Claiming that removal of high denomination currency notes of Rs 1,000 and Rs 500 would lead to decline in real estate prices making affordable housing available to all. At present, there is excessive use of cash in real estate sector due to large cash transactions in areas such as purchase of land and housing property. The real estate prices get pushed up artificially. This reduces the availability of affordable housing for the poor and middle class. So now, greater over-the-board transaction will lead to a decline in real estate prices making affordable housing available to all. • Parallel economy burst: The move is expected to curb the parallel economy as the owners of black money will not be in a position to deposit the money with them in the banks. It is likely to temporarily stall the circulation of large volume of counterfeit currency and prevent funding for anti-social activities like smuggling, terrorism, espionage etc. The Income Tax department will be benefited with the move, as there will be more specific data gathered in the process which could help in catching the defaulters. • Check Terror Funding: It will put a stop to the neighbouring countries drug cartels and terrorists of supplying high value currency into India. • Check Fake notes: The move will also reduce the flow of fake currency in Indian markets as data shows that most of the counterfeit currency in circulation exists in high-denomination notes of Rs 500 and Rs 1000. According to the Reserve Bank of India’s annual report published this year, more than 2.61 lakh counterfeit notes in the denomination of Rs 500 were detected by banks in the year 2015-2016 while another 1.43 lakh fake notes of Rs 1000 were detected. By value, counterfeit notes of Rs 500 and Rs 1000 accounted for more than 92% of all the fake currency detected by banks across the country. • SOFT MONEY surge – Online transactions and other modes of payment: There is a massive surge in the online transactions and other modes of payment. E-wallets, digital transaction systems, e-banking, usage of plastic money are expected to see increase in demand. Eventually this should lead to strengthening of these systems and the concerned infrastructure. Under the cash crunch situation in Banks, the role played by Automated Teller Machines (ATMs) in dispensing cash is hugely important and their success in disbursing the cash effectively is, to a great extent, going to decide the fate of the demonetisation scheme. With the demonetisation move resulting in a drop in donations, some of the famous temples in Gujarat have started introducing e-wallets, ATMs with deposit facility and swipe machines to accept cashless donations. Recent data Number of Suspicious Transaction Reports filed by banks during 2016-17 has gone up from 61,361 in 2015-16 to 3,61,214; the increase during the same period for Financial Institutions is from 40,333 to 94,836 and for intermediaries registered with SEBI the increase is from 4,579 to 16,953. Based on big data analytics, cash seizure by Income Tax Department has more than doubled in 2016-17 when compared to 2015-16; during search and seizure by the Department Rs.15,497 crore of undisclosed income has been admitted which is 38% higher than the undisclosed amount admitted during 2015-16; and undisclosed income detected during surveys in 2016-17 is Rs.13,716 crore which is 41% higher than the detection made in 2015-16. Undisclosed income admitted and undisclosed income detected taken together amounts to Rs.29,213 crore; which is close to 18% of the amount involved in suspicious transactions. This process will gain momentum under ”Operation Clean Money” launched on January 31, 2017. The exercise to remove the anonymity with currency has further yielded results in the form of • 56 lakh new individual tax payers filing their returns till August 5, 2017 which was the last date for filing return for this category; last year this number was about 22 lakh; • Self-Assessment Tax (voluntary payment by tax payers at the time of filing return) paid by non-corporate tax payers increasing by 34.25% during April 1 to August 5 in 2017 when compared to the same period in 2016. With increase in tax base and bringing back undisclosed income into the formal economy, the amount of Advance Tax paid by non-corporate tax payers during the current year has also increased by about 42% during 1st April to 5th August. Further actions were taken under the law to stop operation of bank accounts of these struck off companies. Actions are also being taken for freezing their bank accounts and debarring their directors from being on board of any company. In the initial analysis of bank accounts of such companies following information has come out which are worth mentioning: • Of 2.97 lakh struck off companies, information pertaining to 28,088 companies involving 49,910 bank accounts show that these companies have deposited and withdrawn Rs.10,200 crore from 9th November 2016 till the date of strike off from RoC; • Many of these companies are found to have more than 100 bank accounts – one company even reaching a figure of 2,134 accounts; Simultaneously, Income Tax Department has taken action against more than 1150 shell companies which were used as conduits by over 22,000 beneficiaries to launder more than Rs.13,300 crore. Post demonetization, SEBI has introduced a Graded Surveillance Measure in stock exchanges. This measure has been introduced in over 800 securities by the exchanges. Inactive and suspended companies many a time are used as harbours of manipulative minds. In order to ensure that such suspicious companies do not languish in the exchanges, over 450 such companies have been delisted and demat accounts of their promoters have been frozen; they have also been barred to be directors of listed companies. Around 800 companies listed on erstwhile regional exchanges are not traceable and a process has been initiated to declare them as vanishing companies. Demonetization appears to have led to acceleration in the financialisation of savings. Criticisms The decision to demonetize Rs 500 and Rs 1000 notes is misconceived and will not address the problem of black money for the following reasons: • Demonetisation will only affect those who conduct transactions in cash, are not a part of the formal banking system or have not converted their cash into assets. • Black money is generated through evasion of taxes on income from lawful activities and money generated from illegal activities. In the absence of steps to curb the generation of black money, demonetization is a futile exercise, as it proved to be in 1978. • As per the Indian Statistical Institute, Kolkata study done on behalf of the National Investigation Agency (NIA), Rs 400 crores worth of fake currency is in circulation in the Indian economy. This is only .028% of Rs 14,180 billion worth currency demonetised in Rs 500 and Rs 1000 notes. • Two of the most vulnerable sectors that have traditionally been exploited for parking crime proceeds and black money is the property, and gems and jewellery market. These sectors have also been used for the temporary investment of terror funds. Unless transactions are made transparent and reflect real market value, black money and terror funds will continue to find their way into these businesses. • FICN can potentially be reintroduced into India after a break by Pakistan. In order to sustain action, the following are suggested: a. Enhance detection measures at public sector banks which have lagged behind some of the private banks over the years. b. Establish a forensic cell which monitors each case of counterfeit currency to better understand the technology being applied to counterfeit notes. This must contribute to future measures to enhance security against counterfeiting. c. The involvement of Pakistan established through a Special Court judgement in 2014 should be built upon to enhance international diplomatic pressure. Conclusion Demonetization provides an opportunity to encourage a shift to a digital economy. This is an essential requirement to not only reduce corruption but also create an electronic trail for transactions. This will help bring transparency into the financial transactions of individuals and organizations thereby constraining corruption, criminal proceeds, money laundering and the finance of terrorism, which are all linked given the common channels employed for transferring funds. While demonetization is likely to encourage it, incentives by the government for payment of bills can further encourage people to take up plastic and e-money options. This is also likely to be enhanced by the forces of market economy which are already offering money back options. Demonetisation is an important step in the fight against the finance of terrorism. However, it should neither be the first nor the last, if the interlinked threats of corruption, crime and the finance of terrorism have to be controlled. These must also not be addressed simply within departmental and ministerial silos. Instead, an all-of government approach is imperative if each of these challenges is to be met.

RATIONALE ANALYSIS OF DEMONETISATION

Economic growth slowed to 5.7 per cent in the first quarter of 2017-18 against 6.1 per cent in the preceding quarter. This was sharply below market expectations and came on the back of large-scale destocking undertaken by manufacturers ahead of the Goods and Services Tax rollout and the lingering impact of demonetization. What does the latest data by CSO reveals? The GDP recorded a growth of 7.9 per cent in April-June quarter last year. The April-June growth estimate, the lowest in at least five quarters, trended down on account of a sharp deceleration in manufacturing growth. Trade, hotel, transport, communication and services related to broadcasting” witnessed a pickup by growing 11.1 per cent in April-June from 8.9 per cent last year, while growth in “public administration, defence and other services” (in Gross Value Added terms) was clocked at 9.5 per cent in April-June as against 8.6 per cent last year. The Gross Value Added or GVA growth, which serves as a more closely watched estimate for quarterly growth, remained unchanged from the previous quarter at 5.6 per cent in April-June but fell sharply from the 7.6 per cent growth recorded in the April-June quarter last year. Only three of eight sectors showed a pickup in GVA growth in April-June. Construction and financial services sectors recorded a slowdown with the GVA for “financial, insurance, real estate and professional services” sector growing at 6.4 per cent, down from 9.4 per cent last year. GVA growth for the construction sector declined to 2.0 per cent in April-June from 3.1 per cent last year. GVA growth for “agricultural, forestry and fishing” declined marginally to 2.3 per cent from 2.5 per cent in the corresponding period last year, data showed. Government view on demonetization Finance Minister said that the demonetisation exercise had ended the “anonymity” around the money and identified it with its owner, enabling the government to bring it into the tax net. The RBI Annual Report reveals that almost all demonetised notes have been returned to the central bank. According to statement demonetisation has not completely eradicated black money but kept a check on a large part of it. The result of demonetisation has been that more and more people will now be compelled to come into the tax net, a fact evident from both direct and indirect tax numbers. What are some arguments which prove failure of demonitisation to remove Black Money? Demonetisation carried out on the incorrect premise that black money means cash. It was thought that if cash was squeezed out, the black economy would be eliminated. But cash is only one component of black wealth: about 1% of it. It has now been confirmed that 98.8% of demonetised currency has come back to the Reserve Bank of India. Further, of the Rs.16,000 crore that is still out, most of it is accounted for. In brief, not even 0.01% of black money has been extinguished. Black money is a result of black income generation. This is produced by various means which are not affected by the one-shot squeezing out of cash. Any black cash squeezed out by demonetisation would then quickly get regenerated. So, there is little impact of demonetisation on the black economy, on either wealth or incomes. The government now argues that it is good that black money has been deposited in the banks because those depositing it can now be caught. But the government had tried to prevent people from depositing demonetized currency by changing rules during the 50-day period. The government changed the goalpost earlier in November 2016 when it suggested that the real aim of demonetisation was a cashless society. Now it says that idle money has come into the system, the cash-to-GDP ratio will decline, the tax base will expand, and so on. But none of these required demonetisation and could and should have been implemented independently. Further, anticipating the failure of demonetisation in 2016 itself, the government started saying that demonetisation is only one of the many steps to tackle the black economy. The government’s argument that cash coming back to the banks will enable it to catch the generators of black income, and there will be formalisation of the economy, does not hold. Much of the cash in the system is held by the tens of millions of businesses as working capital and by the more than 25 crore households that need it for their day-to-day transactions. The big failure of demonetisation is that it was carried out without preparation and caused big losses to the unorganised sector. Why there was a need for a Cost Benefit Analysis Of Demonetisation? The RBI Annual Report reveals that almost all demonetised notes have been returned to the central bank. This number does not include the old notes with District Central Cooperative Banks for the short window when they were of demonetisationallowed to accept deposits. It also does not include the notes within Nepal. The shortfall of Rs 16,050 crore between the notes in circulation when the notes were demonetised and those that were returned, could therefore also be made up once these notes are returned to the RBI. There is no doubt that those with holdings of unaccounted cash lost some of their wealth in the process of laundering it. To some extent, taxes were paid on it in the process of legitimising it. But in addition to that, illicit wealth was redistributed from black money holders to money launderers. Whether the money launderer was a company owner, a bank employee or a Jan Dhan account holder, there was now a new breed of criminals with wealth obtained from illegal means. The total reduction in black money was therefore much smaller than what might have been envisaged. International evidence suggests that few countries address the problem of black money by demonetising their currencies. If the problem is large-scale crime, corruption, bribery, bureaucrat-politician nexus, rent seeking, tax evasion etc. the answer lies in reforming the criminal justice system, law and order, administrative reforms, bringing transparency in the functioning of the state and rationalisation and simplification of the tax system. In this context, the GST will be a far more effective mechanism to bring down tax evasion in indirect taxes considering the greater incentive for compliance that its design holds. • Demonetisation had provided an opportunity to encourage a shift to a digital economy. This will help bring transparency into the financial transactions of individuals and organisations thereby constraining corruption, criminal proceeds, money laundering and the finance of terrorism, which are all linked given the common channels employed for transferring funds. While demonetisation is likely to encourage it, incentives by the government for payment of bills can further encourage people to take up plastic and e-money options. This is also likely to be enhanced by the forces of market economy which are already offering money back options.

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Questions on demonetisation 2016.

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Demonetisation 2016 is the hottest topic in this academic year after Brexit. It is something that each commerce student must be aware of. No surprise if CBSE asks a question in upcoming board exams on demonetization and its consequences. Here is a brief introduction about the whole demonetization drive.

What is demonetisation of currency?

In simple words, means that Reserve Bank of India has withdrawn the old Rs 500 and Rs 1000 notes as an official mode of payment. Demonetization 2016 is the act of Banning /taking back of a currency unit of its status as legal tender. Demonetization is necessary whenever there is a change of national currency. The old unit of currency must be retired and replaced with a new currency unit.

What has the government done?

Prime Minster Narendra Modi’s decision to scrap high value notes of Rs 500 and Rs 1,000 has created a shortage of cash in the system, leading to a lot of discomfort for the general public and businesses. Also, since there is a shortage of newly printed Rs 500 and Rs 2,000 notes, the situation has worsened. The move has also led to a shortage of lower denomination notes such as Rs 100 and Rs 50 that are still legal tender, as people have taken to conserving whatever cash they have in hand.

  Reason for Demonetisation 2016

• To tackle black money in the economy.
• To lower the cash circulation in the country which “is directly related to corruption in our country,” according to PM Modi.
• To eliminate fake currency and dodgy funds which have been used by terror groups to fund terrorism in India.
• The move is estimated to scoop out more than more than Rs 5 lakh crore black money from the economy, according to Baba Ramdev, a staunch Modi supporter.

Who needs to worry?

Not the honest taxpayers. Even if you have Rs 10 lakhs as cash with you and you can prove its legitimacy, you don’t need to worry.

The surprise move by government is a disaster for people who have accumulated lakhs and crores of unaccounted cash under their pillows and mattresses. The winter is coming and these worthless pieces of paper can provide the corrupt some ephemeral warmth.

What experts think?

Almost all the stalwarts of the banking sector including Deepak Parekh, Chanda Kocchar think that the move will help curb black money in the economy.

According to MD & CEO, ICICI Bank BSE 2.35 % Chanda Kochhar who told ET Now, “this move will definitely bring about a whole amount of transition to no cash or low cash kind of transactions,”.

“A parallel black economy will collpase,” one of the leading lawyers in taxation laws, Harish Salve told ET Now.

Narayana Murthy, founder of the Infosys BSE 0.26 %, welcomed the government’s move in its fight against corruption. Murthy also added that “the dishonest will have to suffer, absolutely that is the right thing.”

HDFC Chairman Deepak Parekh anticipated that the Land will become cheaper and “one expects that real estate price will come down in medium term.”

But  with all the positives, government has not been able to explain anything for the people who don’t have a bank account.

Impact on Economy

Since our economy is heavily dependent on cash, as only less than half the population uses banking system for monetary transactions, demonetisation 2016 has hit trade and consumption hard. With people scrambling for cash to pay for goods and services, the move is likely to take a big toll on the country’s growth and output during the current fiscal. Consumption makes up for around 56% of India’s GDP , hence, a drop in spending will pull down growth. The current step could also lead to behavioural changes in households’ savings and their consumption pattern, say economists. Source: Quora ,  ET , ET

Article submitted by Dr. Vinod Kumar author of Ultimate Book of Accountancy.

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7 thoughts on “Questions on Demonetisation 2016”

it is very helpfull information. i apperciate if u will provide some more thann..

It is helpful

Appreciate the efforts put in to present ‘to the point’ information on the topic. It was very much helpful for my eco practical on demonetisation the next day!

Wonderful explanation

Nice explanation very much help ful to me in Viva practical on demonetisation.

Thanks . Mere ko bhut jyada help mila .kal ke liye kal eco practical hai

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