Why in news? A majority of four judges on a Constitution Bench of the Supreme Court found no flaw in the Union government’s process to demonetise Rs500 and Rs1,000 banknotes through a Gazette notification issued on November 8, 2016.

Highlights

• The sole woman judge on the five-member Bench, Justice B.V. Nagarathna, disagreed with the majority, saying the government’s notification under Section 26(2) of RBI Act was unlawful.

What is the majority judges opinion ?

• They pronounced that statutory procedure under Section 26(2) was not violated merely because the Centre had taken the initiative to “advise” the Central Board to consider recommending demonetisation.

What was the sole judge opinion?

• Justice Nagarathna stated, that centre could have issued a notification under Section 26(2) of Reserve Bank of India Act allows central goverment to declare any series of bank notes of any denomination illegal tender after a recommendation from central board of RBI..
• In 2016, the government had initiated the demonetisation, not the Central Board.
• The opinion of the Board should be “independent and frank”.
• If the Board’s opinion was in the negative, the Centre could still go forward with the demonetisation exercise, but only by promulgating an ordinance or by enacting parliamentary legislation.

Why the demonetisation became matter of concern?

• Central Board had “hardly 24 hours to consider the proposal” of the Centre to demonetise the notes
• Official records show the Central Board acted merely on “assurances” given by the government that “embarking on the process of demonetisation result in reducing banknotes in the economy and a switch over to the digitalisation of the economy
• Decision-making process was “rushed” and “fatally flawed”.
• Demonetisation violated citizens’ right to property by taking away their money were “without substance”

What is Section 26(2) of the RBI Act 1934?

• Section 26(2) of the RBI Act reads thus: On recommendation of the Central Board, 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 save at such office or agency of the Bank and to such extent as may be specified in the notification.”

What is demonetisation?

• Demonetization is a process by which countries opt to reintroduce defunct currencies as legal money.
• It is the process of eliminating the lawful acceptance status of a monetary unit.
• The existing kind or types of currency are withdrawn through circulation and supplanted with new currency.

Reasons behind Demonetization:

• Problems like hyperinflation happen in any country, then the government considers demonetization as a solution to take back control and minimise the adverse situation.
• Negative situations or actions like counterfeit currency, black money, terror, drug trafficking and tax fraud can all be eliminated with demonetization.
• Demonetization is also used to introduce a new monetary system in some circumstances.

How Demonetization was a successful exercise ?

• Decreased tax evasion and increased tax revenue

Ex: The number of income tax returns filing increased from 43.3 million to 52.9 million between the financial year of 2016 and 2017

• It helps in higher long-term GDP due to higher tax revenue being reinvested in the nation

Ex: The Enforcement Directorate raided several forex establishments making backdated entries. Money laundering using backdated accounting was carried out by co-operative banks, jewellers, sellers of mobile phones, and several other businesses

• Fostered innovation by converting currency to digital currency and promoting digital transactions

Ex: The currency-to-GDP ratio was 12.1% in 2015–16. It declined to 8.8% in 2016–17

• Reduced overall crime by enhancing transparency and discouraging the circulation of black money.

Ex: Will help to reduce the activities and attacks by the Maoist Naxalite radical groups that attributed to lack of finance following demonetisation. The surrender rate had reached its highest.

Disadvantages

• Shortage of Cash

Ex: People faced difficulties in depositing or exchanging the demonetised banknotes due to long queues outside banks and ATMs across India.

• Futile exercise

Ex: Reports in the media noted that although the general public faced a severe cash shortage, some individuals were able to amass tens of millions of rupees in new banknotes; they thus described the demonetisation exercise as being futile

• Negative impact on share market crashing the prices of investment

Ex: Day after the demonetisation announcement, BSE SENSEX crashed nearly 1,689 points and NIFTY 50 plunged by over 541 points

• Reduction in industrial output as industries were hit by the cash shortage

Ex: growth in eight core sectors such as cement, steel and refinery products, which constitute 38% of the Index of industrial production (IIP), was only to 4.9 percent in November 2016, as compared with 6.6 percent a month prior.

• Adversely affected transactions in the agriculture sector, which are heavily dependent on cash.

Ex: Due to scarcity of the new banknotes, many farmers had insufficient cash to purchase seeds, fertilisers and pesticides needed for the plantation of rabi crops usually sown around mid-November

• Causes a loss of jobs and a decline in wages, particularly in the unorganised and informal sector and as well as in small enterprises.
• Incurs expensive administrative costs including printing, adjusting ATMs, and marketing the changes.
• Introduces new types of currency risk such as cybercrime

Demonetization’s effect in India?

• less liquidity and currency movement into the economy as a result of demonetization, inflation declines.
• The monetary supply will decline to some extent as black or illegal money flushed.

Real-World Examples

Eurozone (2002)

• Demonetization was the European transition to the euro in 2002.
• To facilitate the process, the European Central Bank needed to ensure that there was enough currency to be circulated and began printing banknotes and minting coins as early as 1998.
• When the euro was introduced, the central bank ensured that all citizens were able to access to the new currency and began providing banks with the new banknotes and coins several months in advance.