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Is the Current Demonetisation Legal?

December 6, 2016


The Supreme Court is presently hearing several public interest petitions challenging the constitutional validity of Ministry of Finance notification number S.O. 3407(E).

Issued on November 8, 2016, the notification declared that 500 and 1000 rupees notes ceased to be legal tender as of midnight on that day. This “demonetisation” notification permitted unlimited deposit of the now illegal 500 and 1000 Rs. notes by people into their bank accounts, and over the counter exchange of the notes upto a limit of Rs. 4,000, subject to review after 15 days. The notification also imposed limits on both ATM and bank withdrawals of cash. Since then, the government has through executive order made many changes to the applicable limits. The Preamble to the notification stated that the objective of the notification was to eliminate fake currency used for financing terrorism and to address the problem of “unaccounted money” in the economy.

According to some estimates, 86% of Indian currency was in the now illegal Rs. 500 and 1000 notes. Since 68% of all transactions in India are cash transactions, drastically restricting the use of 86% of the currency has predictably thrown the country into a state of chaos. Notwithstanding the government’s efforts to ensure that banks can service the currency needs of the people, endless queues at banks, reports of slowdown of trade and business in the economy, and more than 50 reported deaths have led many to question the wisdom of this move and its efficacy in achieving its objectives vis-à-vis the costs to the people and abridgement of their rights. The Supreme Court likely will not entertain arguments regarding the efficacy of demonetisation since it has repeatedly expressed its deference to the government on policy matters. It must however decide the legality of this move. The demonetisation notification is illegal because it goes beyond the scope of what is permitted under the Reserve Bank of India Act, 1934, (“RBI Act”), the stated source of authority for the notification. There is also a prima facie case of direct and indirect abridgement of fundamental rights to movement (Article 19(1)(d)), trade or business (Article 19(1)(g), livelihood and in certain cases life (Article 21), the right to equality (Article 14), and the constitutional right to property (Article 300A).

It is clear that section 26(2) of the RBI Act empowers the government to demonetise, that is, to declare any series of notes as illegal tender. Therefore, that part of the notification which merely declares that “Rs. 500 and Rs. 1000” notes cease to be legal tender is permissible under section 26(2). In fact, the government twice before, in 1946 and 1978, carried out demonetisation lawfully, with the same goal of addressing unaccounted money. But neither the RBI Act, nor the Banking Regulation Act, 1949, empower the government to impose restrictions on cash withdrawals or deposits in the manner it has been done, and to discriminate between holders and non holders of bank accounts, as the present notification has done. Such actions require an authorising legislation, either an Act of Parliament or an Ordinance. Both in 1946, and in 1978, similar actions were authorised by an ordinance. The failure to issue an ordinance to provide the legal basis for the demonetisation notification this time renders the demonetisation exercise illegal. Even if the act of demonetisation is severed from the restrictions placed on people’s access to their cash and bank accounts, the latter stipulations are both illegal and unconstitutional on several counts.

First, Article 13 of the Constitution provides that the state shall not pass any law or issue any notification that violates the fundamental rights of the people. In Madan Mohan Pathak v. Union of India, the Supreme Court held that “public debts” are property and “the extinguishment of such a debt owing from the state amounts to compulsory acquisition of that debt”. Such compulsory acquisition must be for a public purpose and upon payment of compensation. In Jayantilal Ratanchand v. RBI, in the context of the 1978 demonetisation, the Supreme Court held that insofar as the demonetisation wiped out the RBI’s debt to the bearer of notes declared illegal, it constituted compulsory acquisition of property. Under Article 300A, the state may deprive an individual of property only pursuant to the authority of law, that is, by an Ordinance or an Act of Parliament. The Supreme Court has held that even a temporary deprivation of property can constitute deprivation within the meaning of this provision. The government’s failure to issue an Ordinance (since Parliament was not in session at the time of the demonetisation) to extinguish its debt to the people thereby depriving them of their property impermissibly violates Article 300A. Of course, even if the demonetisation had been sanctioned by an Ordinance, the Court would investigate if it met a public purpose and whether those who were deprived of their property were reasonably compensated. Here the Court would likely hold in light of Jayantilal that the Ordinance fulfilled a public purpose but there is a strong claim that the rationing of currency done by the government constitutes a form of creeping expropriation for which there has been no compensation, and that might nevertheless violate Article 300A.

Second, the extraordinary hardship caused by the demonetisation ordinance has impacted fundamental rights to trade, business and livelihoods of vast sections of the population and even the right to life of those who have died. While the government may “reasonably” restrict the rights to trade, business and livelihood of the people in the interests of the “general public”, the burden is on the government to show that such restrictions are reasonable. The test of reasonableness is whether the measure was necessary to achieve the government’s objectives, and whether less risky, less harmful alternatives were available. In Saghir Ahmad v. State of UP, the Supreme Court held that the reasonableness of a law must be assessed in terms of its “immediate effects” on the affected population. Unlike the 1978 demonetisation exercise that impacted only 1% of currency held, the 2016 demonetisation measure insofar as it impacts an estimated 86% of total currency has had severely punitive effects on many sections of the population, daily wage earners, those without bank accounts, those dependent on the informal cash economy for the major source of their trade and livelihood. The notification is unconstitutional for violating their fundamental rights under Articles 19 and 21.

The notification also discriminates between holders and non-holders of bank accounts. While the government may argue that such a classification is necessary to achieve their objectives of eliminating unaccounted money, insofar as the government failed to ensure that 100% of the population had bank accounts prior to the issuance of this surprise notification, the classification may be assailed as arbitrary and violative of the right to equality under Article 14.

We live in a country governed by the rule of law, and not by the rule of men. The objectives of the demonetisation notification may be laudable, whether the notification will achieve those objectives is debatable. But, as it exists, the demonetisation notification is illegal and unconstitutional.