India: Legality Of Demonetization Of Rs.500 And Rs.1000 Bank Notes

Last Updated: 17 January 2017
Article by Vijay Sirohiwal

Most Read Contributor in India, July 2017

The Government of India has taken a policy decision that the Bank notes in the denomination of Rs. 500 and Rs. 1000 shall cease to be a legal tender 8th November, 2016 onwards. Simultaneously, bank notes of Rs. 2000 were also introduced, possibly to carry a larger value of money with fewer notes.

The Reserve Bank of India Act, 1934 [hereinafter referred to as "RBI Act"] has been enacted inter-alia to regulate the issue of bank notes and keeping of reserves with a view to secure monetary stability in the country and generally to operate the currency and credit system of the country to its advantage.

The RBI is the sole note issuing authority and has the obligation to exchange those notes when demanded except when, and to the extent, it is relieved of the obligation by the Central Government.

Section 26(1) of the RBI Act provides that every bank note shall be a legal tender in payment or on account of the amount mentioned therein and shall be guaranteed by the Central Government. Section 26(2) of the RBI Act lays down that by notification in the Gazette of India, any series of bank notes of any denomination shall cease to be legal tender from a date and in a manner as specified in the said notification. Section 24 (1) of RBI Act provides that bank notes shall be of denomination values of different amount not exceeding Rs. 10000.

The Central Government had withdrawn the legal character of bank notes of certain denomination values at least on two earlier occasions. In the year 1978, the High Denomination of Bank Notes (Demonetization) Act, 1978 (hereinafter referred to as Demonetization Act) was enacted by the Parliament to avoid the menace of unaccounted money which had resulted not only in affecting the economy of the country but had also deprived the Public Exchequer of its revenue to a great extent.

The constitutional validity of the Demonetization Act was challenged before the Supreme Court of India. A Constitutional Bench comprising of 5 (five) Judges in Jayantilal Ratanchand Shah vs. Reserve Bank of India & Others 1 upheld the constitutional validity of the Demonetization Act.

The Preamble of the Demonetization Act makes it clear that where the availability of high denomination bank notes facilitate illicit transfer of money for financial transactions and which are harmful to the national economy or which serve illegal purposes, the Reserve Bank of India can demonetize high denomination bank notes in public interest. Thus, when the Constitutional Bench of the 5 Judges of the Supreme Court has upheld the constitutional validity of the Demonetization Act, this policy decision of the government can only be considered by another Constitutional Bench comprising of more than 5 Judges.

The present legal tender of Rs. 1000 and Rs. 500 was withdrawn on 8th November 2016 without bringing any specific legislation as was done earlier. This action of the government was challenged before the Supreme Court as well as various High Courts. The question that the legal tender character of bank notes can be withdrawn without bringing legislation is a debatable issue which can only be settled by judicial pronouncements.

The scope of testing the decision to demonetize the current legal tender of bank notes is very limited. The Supreme Court doesn't interfere in the policy making of the Government with respect to financial matters. Since it has come in public domain that the reasons for demonetization is to curb the illicit financial transactions which is affecting the economy including terrorist and naxal activities and to stop money laundering which is primarily done in high denomination notes. The growing menace of use of high denomination bank notes in betting, hawala transactions, corruption, black money, drug money will be significantly curtailed including circulation of fake currency notes.

The reasons given by the Government are certainly reasonable and cogent one. Section 26(2) of the RBI Act definitely gives such power. If the legal tender character of Rs. 500 and Rs. 1000 bank notes can be withdrawn without legislation, why did the government enact law on earlier occasion? The legality will certainly be examined by the Supreme Court/High Courts in the pending matters. Therefore, to avoid any legal lacuna, it would appropriate for the government to bring legislation and justify its actions.

The Government of India has been promoting electronic transactions which are cashless to achieve the goal of transparency in trade/dealing and include majority of the population within the tax net. Due to large scale prevalence of cash transactions, the revenue collection of the government is significantly reduced. The World Bank in July, 2010, estimated the size of the shadow economy to be about 23% of the GDP in the year 2007. The shadow economy deprives the government of its legitimate revenues which the government could have used for welfare and development activities. It is expected that the decision of withdrawing legal tender character of Rs. 500 and Rs. 1000 bank notes will bring a significant change in all aspects in the country.



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