A five-member Constitution bench of the Supreme Court on January 2 upheld, by a four to one majority, the Indian government’s decision in November 2016 to demonetise old currency notes of Rs 1,000 and Rs 500. The legality of the policy was the subject of judicial review – not its wisdom or soundness.

Demonetisation was held to be a valid exercise of power by the Central government under Section 26(2) of the Reserve Bank of India Act, following the proper procedure of consultation with the bank.

The judgement, coming six years after demonetisation, was largely an academic exercise as there could be no redressal of any injury to the public caused by the measure. However, it was a missed opportunity to discuss the trust and public confidence in the currency of the nation. This question is likely to become more critical as the government proceeds to introduce digital currency, a fundamental transformation of the nature of money as we know it.

It could have provided an occasion to discuss if the government may unilaterally cease to guarantee the value of the currency, by a notification or by an act of Parliament. By the same logic, could a government also modify or limit the character of the currency as legal tender, at will or in the name of public welfare, by limiting its exchange or the duration of circulation?

These are not hypothetical questions, but matters of deep public concern in view of the unprecedented scale of demonetisation in India, where 86% of the value of currency in circulation ceased to be legal tender overnight. Millions faced severe hardships in exchanging or depositing the demonetised notes. The unconditional promise embodied on the currency note became an act of grace and favour to be conferred under arbitrarily imposed conditions for different groups of people.

Demonetised Rs 500 currency notes. Credit: Scroll Staff.

Section 26 of the Reserve Bank of India Act deals with currency notes as legal tender. Sub-section 26(1) declares that every bank note issued by the Reserve Bank of India will be a legal tender at any place in India, and will be guaranteed by the Central government. Sub-section 26(2), confers power on the Central government, in consultation with the Reserve Bank of India, to withdraw the legal tender character of any of the series of banknotes issued.

Once withdrawn, the banknotes cannot be legally used as a medium of exchange or to settle financial obligations. A currency note is also a promissory note, a store of value guaranteed by the Central government. The guarantee under Section 26 of the Reserve Bank of India Act is unconditional and not limited by time.

The government issued several notifications directing the manner in which the demonetised notes could be exchanged or deposited in bank accounts. An ordinance issued on December 30, 2016, later ratified by an Act of Parliament, Specified Bank Notes (Cessation of Liabilities) Act, 2017, declared that the specified bank notes which had ceased to be legal tender will also cease to be liabilities of the Central bank under Section 34 of the Reserve Bank of India Act and will cease to have the guarantee of the Central government under sub-section (1) of Section 26 of the Reserve Bank of India Act.

The act effectively extinguished the guarantee and the right of the holder to redeem the value of the cancelled notes. The act provided for discretionary and conditional exchange for certain classes of people.

A fiat currency – currency that is not backed by a commodity – has no intrinsic value. It is grounded entirely on trust that the sovereign nation through the government or a lawfully designated agency will guarantee the value of the currency note. The public has the confidence that they can reclaim its full value without undue burden or loss.

Demonetisation is a legitimate public policy tool used by countries around the world. But it should be used in a way that the trust in the currency is not eroded. The public should be facilitated rather than constrained in exchanging the demonetised notes. Other considerations, such as tax evasion or money laundering, could easily be checked or tracked without infringing the rights of the people.

For context, with the introduction of the Euro in 2002, 11 member states of the Eurozone (currently 20 countries) demonetised their national currencies. Even after 20 years, the Deutsch mark or Belgian franc or Spanish peseta can be exchanged at their fixed value in the offices of the respective national central banks.

The Supreme Court discussed at length the meaning of the word “any” to construe whether it refers to “any” or “all” series of bank notes. This is in reference to sub-section 26(2) of the Reserve Bank of India Act on the central government’s powers to withdraw the legal tender character of “any” of the series of banknotes issued.

Credit: Aakash Dhage via Pixabay.

The Supreme Court also held that the measure satisfied the test of proportionality, and that there was a reasonable nexus between the measure and the objectives it sought to achieve.

However, the question of guarantee was not discussed but only mentioned in reference to the 2017 Act. Justice BV Nagarathna, in her dissent, held that the guarantee would remain as long as the notes remained in circulation even after the legal tender character of the bank note was withdrawn. However, it was not clarified when the guarantee would cease.

The question of guarantee is an important one especially in the context of central bank digital currency, which is being introduced on a pilot basis in India. Among its many attributes, the most powerful aspect of a digital currency is its programmable feature.

A digital currency is not a digital substitute for paper currency – it can be modified, withdrawn, restricted or limited in its usage. Limits can be imposed on how much of and for what purpose and for how long the currency can be used. Although this was not within the scope of the judicial review, the court may have perhaps missed an opportunity to clarify the true extent or limits to the guarantee of the currency by the state.

Kaushik Jayaram is a former central banker who worked for many years in an international financial organisation.

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