Introduction

On November 8, 2016, the Prime Minister of India, Narendra Modi, announced the “notebandi”
initiative, declaring that the use of all Rupees (Rs.) 500 and Rs. 1,000 banknotes (equal to about
US$7.60 and US$15.30) of the Mahatma Gandhi Series would cease to be legal tender past
midnight that night. The public was given until December 31, 2016, to deposit their old currency
in exchange for newly designed Rs. 500 and Rs. 2,000 notes. Foreigners in India holding
demonetized currencies were given a deadline of January 31, 2017, and non-resident Indians had
until March 31, 2017. The government imposed a cap on over-the-counter cash withdrawals of
Rs. 24,000 (about US$355) a week for bank accounts and of Rs.4,500 (about US$66.50) a day
for ATMs. However, there were no restrictions on non-cash transactions such as checks,
credit/debit cards, etc

1. What was the purpose of the demonetization decision?

Newspaper reports indicate that the government’s intentions behind the 2016 demonetization
were two folded. First, it aimed to curb the circulation of “black money” and counterfeit notes,
thereby fulfilling the Prime Minister’s pre-election campaign promise to take on corruption and
black money in the economy. The Ministry of Finance indicated in its November 8, 2016
notification that fake currency notes of the specified bank notes (Rs. 500 and 1,000) have been
widely circulated and their use in financing subversive activities such as terrorism and drug
trafficking was causing an adverse effect on the economy.

According to a 2010 World Bank report, the size of India’s shadow economy averages 22.4%
and ranks as the fifteenth largest among the 88 developing countries studied. It has been
estimated by India Rating and Research (a credit rating agency and subsidiary of the FITCH
Group) that with the ban of notes (worth a total of Rs.4 lakh crore, or about US$4,000 billion) in
cash and fake currency, 12% of the black money will be terminated.

Second, the government aimed to promote a cashless, more digitized economy. However, some
reports state that a “cashless economy” is an afterthought policy of the government in response
to the reported negative effects of demonetization in India. The promotion of a cashless economy
through demonetization is an initiative under Prime Minister Narendra Modi’s Jan Dhan Yojana
– mission for financial inclusion.

2. Is India shifting to a more cashless economy?

Four weeks prior to the demonetization notification, the U.S. development agency, USAID,
partnered with the government of India to create a network of organizations under the banner
“Catalyst” to increase the usage of digital payment systems, particularly among low-income
groups. The purpose behind this partnership was to take a step towards financial inclusion – the
facilitation of financial access through numerous electronic platforms, thus limiting cash
transactions in the market. In 2016, USAID’s Beyond Cash report stated that 97% of retail
transactions in India are in cash, and only 29% of bank accounts have been used in the three
months prior to January 2016. In addition, only 6% of merchants accepted digital payments and
10% of consumers had used a debit card in the year 2015.

Since demonetization was implemented, there have been reports of a sharp rise in the usage of
payment networks such as e-wallets, Visa, Mastercard, Paytm, etc., thus indicating that the
policy may be simultaneously achieving financial inclusion. Certain opposition political leaders,
including former Finance Minister P. Chidambaram, expressed doubts about the possibility of a
“cashless society” in India, when transactions in other countries like the U.S. and Germany are
still significantly in cash. The question of whether demonetization in India actually addresses the
problem of circulation of black money in the economy has also been disputed.
3. How was demonetization brought into effect?

The 2016 demonetization policy was brought into effect through three legal instruments. The
first was the Gazette Notification issued by the Ministry of Finance stating that in the exercise of
its powers conferred under section 26(2) of the Reserve Bank of India Act (RBI Act), the central
government, on the recommendation of the Central Board of Directors of the Reserve Bank of
India, had declared that banknotes of the existing series with the denomination of Rs. 500 and
Rs. 1,000 shall cease to be legal tender from November 9, 2016. Second, the Ministry of Finance
issued a Gazette Notification specifying the new denomination of Rs. 2,000 notes. The third
Notification was issued by the Reserve Bank of India (RBI) to the banks specifying the actions to
be taken by the banks for people to exchange old denomination notes for the new series of bank
notes, called the Mahatma Gandhi (New) Series.

The 2016 notifications issued by the government prohibit the transfer or receipt of banknotes that
have ceased to be legal tender and restrict RBI’s obligation to exchange the old notes with new
notes after a certain deadline. This is despite the fact that, under section 39 of the RBI Act, the
RBI is under a continuous legal obligation to exchange old notes with new ones, thereby
prohibiting the imposition of a specific deadline. However, researchers at the National Institute
of Public Finance and Policy and the Indira Gandhi Institute of Development Research have
pointed out that the “ultimate purpose of demonetization” – to curb black money stored in the
form of cash – may not be achieved if there is no obligatory deadline for the exchange of notes.

In order to solve this problem, demonetization notifications in the past (in 1946 and 1978) have
been followed by ordinances and laws to “specifically override” the statutory obligation under
the RBI Act. In other words, to formalize the notifications and impose deadlines for exchanging
old notes with new ones it was necessary to pass or promulgate laws to that effect.

Laws in India are ordinarily passed by parliament through a legislative process. However, the
president does have special lawmaking powers, under article 123 of the Constitution of India, to
promulgate temporary ordinances if both houses are not in session and if it is necessary to take
immediate action. The underlying purpose is for the president to address any urgency that may
occur when parliament is not in session. An ordinance ceases to operate if it is not approved by
parliament within six weeks of reassembling (i.e. January 31, 2017). Under his lawmaking
powers, the President of India, Mr. Pranab Mukherjee, promulgated the Specified Bank Notes
(Cessation of Liabilities) Ordinance, 2016 on December 30, 2016, making it illegal to hold Rs.
500 and Rs. 1,000 notes after March 31, 2017. On February 27, 2017, legislation known as the
Specified Bank Notes (Cessation of Liabilities) Act, 2017 was passed by the Parliament of India
to continue to give legal effect to the demonetization.

4. Have there been attempts at demonetization in the past?

There have been two previous instances of demonetization in India. The first was in 1946 during
the British Colonial period, when the government demonetized high denomination notes (Rs. 500
and above) to curb black market money and tax evasion. On January 12, 1946, the Governor
General of India promulgated the High Denomination Bank Notes Ordinance, 1946, which
withdrew the legal tender status of 500, 1000 and 10,000 rupee notes. Notes were to be
exchanged for valid tender in accordance with a detailed procedure before January 22, 1946.
Chintaman Deshmukh, the then Governor of the RBI expressed his opinion that the 1946
demonetization was “not a revolutionary measure and even its purpose as a minatory and
punitive gesture towards black-marketing was not efficiently served.” By the end of 1947, notes
with a total value of Rs. 134.9 crores (about US$19,926,144) were exchanged out of a total issue
of 143.97 crores (about US$21,265,878.8). Therefore, only Rs. 9.07 crores (about
US$1,339,734.12) were “demonetized”.

The Ordinance was challenged by a person acting as an accountant for a temple trust before the
Allahabad High Court in B Ram Lal v. State (AIR 1954 All 758) on the grounds that the right to
acquire, hold and dispose of property under the Constitution of India was violated. Specifically,
the constitutional validity of sections 3 and 4 of the 1946 ordinance was challenged alleging that
these provisions were in violation of article 19(1) (f) of the Constitution. The court held that

[under the Constitution of India, what has been guaranteed is the right of every citizen to acquire,
hold and dispose of property undoubtedly places a restriction on the power of disposing of and
acquiring high denomination bank notes after a certain date, and high denomination bank notes
must be held to be property but Article 19 is subject to the restrictions mentioned in Clause (5) of
that Article. Under Clause (5), the State could make any law, imposing reasonable restrictions on
the exercise of the right of a citizen to acquire and dispose of or hold property in the interest of
the general public. The impugned Ordinance was passed because an emergency had arisen
because of great currency inflation and restrictions were placed because such restrictions were
necessary in the interest of the general public. (B Ram Lal v. State (AIR 1954 All 758), paras.
101, 102)]

The court upheld the constitutionality of the Ordinance by concluding that “once the high
denomination bank notes ceased to be legal tender, any restriction on their transfer to another
person cannot be said to be unreasonable.” Moreover, the Court held that since the Ordinance
provided for the exchange of high denomination notes for smaller denominations, it could be
considered a reasonable restriction. (Id. para. 104.)

India’s second experience with demonetization was in 1978, when the public was given three
days to exchange their 1,000, 5,000 and 10,000 rupee notes. According to the then Finance
Minister, Mrs. H. M. Patel, “the demonetization of high denomination bank notes was a step
primarily aimed at controlling illegal transactions. It is a part of a series of measures which
Government has taken and is determined to take against anti-social elements.” The concern that
drove the government to take this step was the behavior of agricultural prices, in particular rising
prices in spite of a bumper harvest and massive imports of edible oil failing to bring down prices
of mustard oil. A total of 73.1 crore (around US$1,139,451) was demonetized, 1,067 crores
(around US$166, 312, 116) and 650 crores of Rs. 100 notes and other denominations were added
into the economy. The process failed to destroy any money stock.
The demonetization in 1978 was introduced by an ordinance, which was then replaced by the
High Denomination Bank Notes (Demonetisation) Act, 1978. The Act was challenged before the
Supreme Court in Jayantilal Ratanchand Shah v. RBI (1997 AIR 370) on the grounds that it
violated the fundamental right to trade under article 19(1) (f) and 31 (now repealed) of the
Constitution of India. The five judge bench in this case held that the purpose of the Act was “to
prevent unaccounted money from being used for financing illegal activities and preventing the
state from realizing the revenues therefore demonetization served a public purpose and since the
Act provided a procedure for obtaining equal value of currency notes being exchanged hence
there was no compulsory acquisition.”

The Supreme Court emphasized that the time limit imposed for exchange of the high
denomination notes was necessary in order to cease their circulation as early as possible. The
Court held that “if the time for such exchange was not limited the high denomination bank notes
could be circulated and transferred without the knowledge of the authorities concerned from one
person to another and any such transferee could walk into the Bank on any day thereafter and
demand exchange of his notes. In that case it would have been well high impossible for the Bank
to prove that such a person was not the owner or holder of the notes on January 16, 1978.” The
Court therefore upheld the constitutionality of the Act.

5. What legal challenges does the 2016 demonetization face?

Writ petitions have been filed by advocates on behalf of individuals/organizations in the High
Courts of Kerala, Bombay, Delhi, Hyderabad, Gujarat, Karnataka, Calcutta and Allahabad
questioning the constitutionality of the notifications. In addition, a petition before the Supreme
Court of India filed against the Ministry of Finance and the Reserve Bank of India claims that
“fixing the date from which demonetization would come into force is the substratum of power
under section 26(2) [of the RBI Act] and constitutes an “essential law making function” which
cannot be delegated to be fixed by the central government on its own determination.” The issue
arises in the interpretation of the word “series” in this provision, i.e., whether the government
can withdraw legal tender of “all” bank notes of one or more denominations. According to
Prabhash Ranjan, an assistant professor of law at South Asian University, “[s]ince the RBI Act
does not define the word ‘series’, it is unclear whether ‘series’ in Section 26(2) refers to the
broader category of the ‘Mahatma Gandhi series’ of banknotes that the RBI launched in 1996 –
and has since been replaced by the Mahatma Gandhi (new) series from November 9 – or whether
‘series’ refers to the narrower category of different serial numbers with different inset letters
printed on the banknotes.”

It has been argued by Indira Jaising, a senior advocate of the Supreme Court of India, that if the
intention of the legislature was to vest the government with the power to withdraw the legal
tender of “all” bank notes of a particular denomination, then the use of the word “series” under
section 26(2) of the Act would be entirely redundant. The demonetization of the banks notes
would be consistent with section 26(2) if the government is able to prove to the courts that the
decision was made based on the recommendation of the RBI’s Central Board of Directors, since
RBI has sole authority to operate the currency and credit system and to decide their legal tender
status, whether it should include “all” or “few” series of bank notes.

The Madras High Court (in M Seeni Ahamed v. Union of India) dismissed the public interest
litigation filed by M Seeni Ahamed, State General Secretary of the Indian National League, who
sought an order that the central government reverse the decision to demonetize 500 and 1,000
rupee notes and to make them legal tender again. The court referred to the Supreme Court
decision in S.R. Bommai v Union of India (AIR 1994 SC 1918) which concluded that “where the
decision is one which does not alter rights or obligations enforceable in private law, but only
deprives a person of legitimate expectations, procedural impropriety will normally provide the
only ground on which the decision is open to judicial review.”

On December 16, 2016, the Supreme Court bench hearing petitions asking for the notification to
be quashed stayed all the matters pending before the High Courts and refused to interfere with
the implementation of the policy and also declined to extend the deadline for accepting old notes
outside the RBI. The Supreme Court established a five-judge bench to examine the constitutional
validity of the government’s decision to take Rs. 500 and 1,000 notes out of circulation. The
Chief Justice’s bench has framed nine questions for the Constitution bench, including whether
the decision was in violation of the RBI Act and other constitutional provisions, whether the
implementation suffers from procedural unreasonableness, and whether the curbs on the
withdrawal of cash from bank accounts has any legal foundation. The case has not yet been
scheduled for hearing before the Constitution bench.

At present, the fundamental question before the Supreme Court is whether the Court should
intervene in matters that come under policy decisions of the government. It has been held by the
Supreme Court in the past that it is not mandated to interfere in the policy decisions of the
government, except where such policy decision is afflicted with some “fundamental infirmity”
such as being unconstitutional. The Supreme Court in DDA v. Joint action Committee, Allottee
of SFS Flats (AIR 2008 SC 1343) held that a policy decision of the government is subject to
judicial review when the policy decision is unconstitutional, if it is de`hors´ [outside the scope
of] the provisions of the Act and the regulations; if the delegate has acted beyond its power of
delegation; or if the executive policy is contrary to the statutory or a larger policy.