Explainer: Why the Supreme Court upheld the legality of Modi government’s 2016 demonetisation move

A Constitution bench of the Supreme Court, in a four-one split verdict on Monday, upheld the legality of demonetisation of Rs 500 and Rs 1,000 notes brought by the Narendra Modi government in November 2016.

Hearing a clutch of 58 petitions, a bench led by Justice Abdul Nazeer held that the Centre had the power to issue an executive notification stopping the circulation of all notes of a particular denomination. However, one judge, Justice BV Nagarathna, said that the government could only do this by passing a law or bringing an ordinance and had limited powers of withdrawing notes through an executive notification.

Case in brief

The matter related to Prime Minister Narendra Modi’s announcement at 8 pm on November 8, 2016, that Rs 500 and Rs 1,000 notes – about 86% of the currency in circulation by value – would stop being legal tender from midnight. He said that this was done to curb black money, terror funding and money laundering.

This decision brought extreme hardship to the majority of India’s population, which is heavily cash-reliant, and even led to several deaths. Starting from a day after the announcement, petitions were filed challenging the legality of the move as well as the government’s arrangements to allow people to withdraw money from banks and exchange demonetised notes.

Arguments by both sides

The crux of the petitioners’ case was that under the Reserve Bank of India Act, 1934 – the law regulating legal tender – the Centre does not have the power to withdraw the complete circulation of notes of a particular denomination. It can only withdraw a series of notes, that too on the Reserve Bank’s independent recommendation.

However, this process was reversed in the present case, the petitioners argued. On November 7, a day before demonetisation, the Centre had sent a proposal for demonetisation to the Reserve Bank, which the central bank accepted in a “mechanical manner”, according to the petitioners. The entire process was conducted in haste, the petitioners argued, since it happened in just a day.

In addition, the petitioners argued that the action was disproportionate to the goals that the government sought to achieve and it affected the fundamental rights of citizens, such as right to equality (Article 14) and right to life and livelihood (Article 21).

However, both the Centre and the Reserve Bank argued that demonetisation was undertaken after obtaining all the approvals required by the law. They argued that just because the proposal came from the government, that did not make the move illegal since the final recommendation came from the Reserve Bank. They also argued that the court should not interfere in this matter since it was a policy decision.

Demonetisation is legal

At the outset, the bench observed that while it would not go into the efficacy of the decision, it could examine into whether the decision-making process was lawful.

The majority judgement, written by Justice BR Gavai, ruled in the government’s favour. It held that the government does have the power to demonetise all currency notes of a particular denomination through an executive order.

Section 26(2) of the Reserve Bank of India Act says that the Centre can demonetise “any series of bank notes” on the bank’s recommendation. The court said that this section cannot be interpreted to give the government “restricted power” to demonetise notes as it would lead to a situation where the authorities could demonetise some counterfeit notes of a specific denomination but not all notes. Such a scenario “will result in nothing else but absurdity”, the court said.

Further, the court said that there was an “inbuilt safeguard” that notes should only be demonetised on the Reserve Bank’s recommendation, ensuring that this power is not abused. It added said that the Centre was the country’s “highest executive body”, which is accountable to the legislature.

Taken after consideration

The court noted that the documents submitted by the Centre and the Reserve Bank in sealed cover showed that they had taken the relevant information into consideration while making this decision and the bank had even prepared a draft scheme to ensure that demonetisation could be implemented in a “non-disruptive manner’.

The documents showed that demonetisation had been “under active consideration for a period of six months” before it was implemented, the court said.

According to the majority judgement, “such measures undisputedly are required to be taken with utmost confidentiality and speed”, since the consequences could be disastrous if the news was leaked.

On the matter of the proposal originating from the Centre instead of the Reserve Bank, the court said that these two entities could act in isolation. Merely because the Centre first asked Reserve Bank to recommend demonetisation did not make the move illegal, it said, as long as there was “effective consultation” between the two.

The court also said that the move was not disproportionate, since it was undertaken for legitimate purposes, such as curbing black money. Further, there was also a “reasonable nexus” between demonetisation and its intended aim. Whether such a move was necessary or had less harmful alternatives, the court noted, was best left to experts, such as the Reserve Bank.

“The individual interests must yield to the larger public interest sought to be achieved by impugned notification,” the judges wrote. They said that demonetisation could not be “set aside on the ground that it caused hardship”.

Hasty decision

But Justice BV Nagarathna disagreed with the majority’s view. She said that the demonetisation notification and the subsequent legal amendments carried out by the Centre were unlawful.

“The objective of the Central Government may have been sound, just and proper, but the manner in which the said objectives were achieved and the procedure followed for the same, in my view was not in accordance with law,” she wrote.

She said that if an entire denomination of notes are to be demonetised, this could only be effected through a law made by Parliament or by an ordinance. Simply an executive order is not enough.

Further, if demonetisation is effected through executive order under the Reserve Bank of India Act, it could only be for a limited series of notes. Even in that situation, she said, an independent recommendation for demonetisation has to originate from the Reserve Bank.

However, in this case, the government first sent a proposal to the Reserve Bank, which recommended demonetisation “in a hurried manner”, she said.

Nagarathna wrote that the documents submitted by the Reserve Bank and the Centre showed that the bank was acting at the government’s behest. Since the entire exercise was “carried out in twenty-four hours”, she noted, the Reserve Bank did not have the time “to apply its mind to such an issue”.

“No adequate care and consideration were bestowed on such a crucial matter by the Central Board of the [Reserve] Bank having regard to the severe ramifications that the proposed demonetisation would have on almost every citizen of the country,” she wrote.

However, Nagarathna noted that since demonetisation has “been acted upon”, her judgement would only “apply prospectively” and not affect the actions undertaken so far.