The process of removing a currency unit’s legal tender status is known as demonetization. Every time the local currency changes, it happens. The present form of money is retired and removed from use, frequently to be replaced by fresh bills or coins. Occasionally, a nation will entirely switch over to a new currency.

Because it immediately impacts the medium of exchange utilised in all economic transactions, stripping a unit of currency of its legal tender status is a serious economic intervention. It can assist stabilise current issues or it can destabilise an economy, particularly if implemented abruptly or without notice. Having stated that, there are a variety of reasons why countries implement demonetization.

Demonetization has been used to reduce inflation or maintain a currency’s worth. Some nations have demonetized their currencies to promote commerce or create currency unions. Finally, demonetization has been explored as a technique to modernise a developing economy that is dependent on cash as well as to fight crime and corruption (counterfeiting, tax evasion).

Demonetization has been explored as a tactic to eliminate corruption and modernise a cash-dependent developing economy (counterfeiting, tax evasion). The 500 and 1000 rupee notes, the two largest denominations in the Indian currency system, which made up 86% of the country’s circulating cash, were demonetized in 2016.

On November 8, 2016, Prime Minister Narendra Modi of India abruptly informed the populace that the notes were useless as of that moment and that they had until the end of the year to deposit or exchange them for the recently issued 2000 and 500 rupee banknotes.

The government wanted to combat India’s thriving underground economy on a number of fronts, including eradicating fake money, combating tax evasion (only 1% of the population pays taxes), eradicating black money obtained from money laundering, eradicating terrorist financing, and promoting a cashless economy.

Advantages

Demonetization’s key advantage is that it will stop criminal activities because their source of funds is no longer recognised as legal cash. Counterfeiters are also impacted by this since they are unable to swap their “merchandise” for fear of being caught. It can stop tax evasion since people who were doing so must come forward and swap their current money, at which point the government may tax them in the past. Finally, by reducing the need of real cash, it can bring in the era of digital currency.

Disadvantages

The main drawback is the high expense of producing and minting the new money. Demonetization may also fail to have the desired impact of curbing criminal activities since these organisations may be resourceful enough to keep assets in forms other than actual money. Finally, if not executed with the highest expertise, this procedure is dangerous since it might send the country into complete disarray.

Impact on GDP

Demonetization often slows economic expansion and lowers GDP in the short run. Many industries and sectors can temporarily cease during the changeover process. The process of demonetization may prevent certain sectors from paying workers.

Once demonetization is complete, it frequently produces long-term economic advantages that eventually boost GDP. Demonetization aims to combat financial crime; by increasing transaction transparency or preventing the exchange of counterfeit currency, a government is often able to raise more tax income and make larger investments in their nation.

Demonetisation Verdict

Timeline
1) A plea was entered on November 9, 2016, challenging the Supreme Court’s decision to demonetize the high-value currency notes. The Reserve Bank of India (RBI) published a document in August 2017 claiming that 1.7 lakh crore in odd deposits had been made during the demonetization process. The RBI also calculated that the surplus deposits that the banking sector received as a result of the demonetization were nominally in the range of INR 2.8-4.3 lakh crore.

2) The Income Tax department reported in July 2017 that it had discovered around INR 71,941 crore in “undisclosed income” during the previous three years through searches, seizures, and surveys. The RBI released new banknotes with the INR 500 and INR 2000 denominations in August of that same year.

3) In September 2022, the Supreme Court established a Constitution Bench to examine the legality of the demonetization order. The court reserved judgement on the demonetization-related arguments in December 2022 and ordered the national government and the RBI to furnish pertinent data for review.

Verdict

The Supreme Court Constitutional Bench affirmed the Union Government’s decision to demonetize currency notes with values of Rs. 500 and Rs. 1000 by a vote of 4:1. According to the majority, the Centre’s notification from November 8, 2016 is legal and passes the propotionality test. Despite being well-considered, Justice BV Nagaratna disagreed, believing that it had to be unconstitutional due to legal issues.

Demonetization had a plausible connection to the goals (eliminating black marketing, terror funding, etc.), according to Justice BR Gavai, who read out the majority ruling. Whether or whether the goal was accomplished is irrelevant, he said. The majority believed that 52 days was a reasonable time given for exchange. The bench continued, noting that there are built-in protections, that Section 26(2), which empowers Centre to demonetize any series of bank notes of any denomination, cannot be declared unconstitutional due to excessive delegation along with the interpretation that the section can be used to demonetise a whole series of notes. 

In her dissenting opinion, Justice BV Nagarathna stated that the Centre could not just demonetize the whole series of Rs. 500 and Rs. 1000 currency notes since it was a serious concern. Despite the measure’s good intentions, she argued, it needs to be ruled illegal on legal grounds (and not on the basis of objects).