The “legality” of the demonetisation policy of November 8, 2016, has been set to rest with the majority decision of the Supreme Court (4-1), but not its economic “wisdom or soundness” (the evidence for the policy) and the “procedural” flaws (the decision-making process) which have been glossed over. These two latter aspects raise questions about accountability and transparency in governance, institutional integrity (also independence) and democratic checks and balances. The implication: It’s still hard to prevent such an event in the future.

Contrarian ‘wisdom’ of demonetisation

By now, there is no doubt that demonetisation caused a derailment of economy (India was the fastest growing major economy in 2015) by wiping out 86.9% of high-value currency notes (of ₹500 and ₹1,000) overnight from a cash-based economy. It caused massive and overnight loss of jobs and (small) businesses and none of its objectives were achieved.

The then Chief Economic Advisor Arvind Subramanian called it “a massive, draconian, monetary shock” which he said led to a fall of the GDP growth from 8% in the previous six quarters to 6.8% in subsequent seven quarters. The then IMF chief economist Gita Gopinath warned the world against attempting it. The Finance Ministry’s 2012 white paper on black money had specifically rejected the proposal to demonetise ₹500 and ₹1,000 currency notes to fight black money. The SIT on black money, set up in 2014, was silent on demonetisation and advocated reducing cash transaction limits.

Moreover, the RBI itself had rejected demonetisation on multiple occasions in 2016, before putting a stamp of approval “as desired by the government”, the dissenting judge Justice BV Nagarathna records.

In February 2016, the then RBI Governor Raghuram Rajan had argued against it “verbally”, which the RBI “note” later repeated, which Rajan’s 2017 book “I Do What I do” made public. In March 2016, the RBI had also rejected this suggestion from a Karnataka committee. The minutes of the RBI’s Board of Directors, which met hours (5.30 pm) before the demonetisation announcement (8 pm) of November 8, 2016, revealed that it had rejected the government’s arguments for it.

The minutes revealed, the Board of Directors had said (i) the spike in high-value currency notes was in “nominal” terms and “adjusted for inflation, this argument does not adequately support the recommendation” (ii) the presence of counterfeit notes of ₹400 crore was “not very significant” (0.26%) of ₹15.4 lakh crore of cash-in-circulation (CiC) and (iii) it was silent on the growth of “shadow economy” (suggesting it found no merit in it).

Why did it then approve demonetisation? The minutes revealed: “The Board was assured that the matter has been under discussion between the Central Government and RBI over the last six months during which most of these issues have been considered. Apart from the stated objectives, the proposed step also presents a big opportunity to take the process of financial inclusion and incentivising use of electronic modes of payment forward as people see the benefits of bank accounts and electronic means of payment over use of cash”.

But none of these facts were told to the apex court in the affidavits of the RBI and the Centre.

The RBI’s acquiescence (turning its own wisdom on its head) came after Rajan left and Urjit Patel took over as the RBI Governor in September 2016. The logic for the rejection of demonetisation by the RBI until then and that of the 2012 Finance Ministry’s white paper was same: Most black money is not held in cash but in gold and real estate and hence, demonetisation would be futile while imposing high cost on the economy; there are better methods to tackle black money.

‘Sealed cover’, policy-making and process

While the majority verdict upholds the “legality” of the policy (the dissenting one doesn’t), it steers clear of the economic “wisdom” or evidence for the policy decision (also by the dissenting one) and upholds the “procedural” aspect or the policy-making process.

For deciding both the “wisdom” and the “procedural” matters, the court relies on a set of documents which are critical but not in public domain or available to the petitioners. The court sought and received these documents after completing the hearing, turning these into “sealed cover” documents.

These documents are: (i) the Central Government’s letter of  November 7, 2016, which asked the RBI to approve demonetisation (ii) the “agenda note” of the RBI for its Board of Directors on November 8, 2016 (iii) the “recommendations” and the “minutes” of the RBI’s Board of Directors meeting on November 8, 2016 (iv) the “Cabinet Note” prepared on November 8, 2016 and (v) the “actual decision” and “minutes” of the Union Cabinet approving it on November 8, 2016.

Since the petitioners had no access to these key documents, it amounts to denial of natural justice. The court’s role, as also that of the Centre and RBI, is not only questionable for not giving access to the petitioners, but also for turning demonetisation an “academic exercise” and a “fait accompli” for delaying the verdict on 58 writs for six years.

Policy and policy-making as ‘fait accompli’

Even while turning it into academic and fait accompli, the court verdict could have addressed important governance issues (short for rash policy making and undermining democratic checks and balances) to prevent recurrence: by fixing the Centre’s accountability and transparency and the RBI’s institutional integrity. As for the Parliament’s absence in such a key policy decision, the court found nothing amiss even while finding that the Specified Bank Notes (Cessation of Liabilities) Act of 2017 was a post facto development.

The verdict didn’t examine the “wisdom” by stating that it is “best left to the wisdom of the experts”; even the dissenting one says the policy was in “the best intentions” and for a “noble objects for the betterment of the Nation”.

These observations ignore that this “wisdom” was contrary to what domain “experts” had said over a long period of time – (a) the 2012 Finance Ministry’s white paper (b) the 2014 SIT (c) Rajan’s “verbal” presentation, RBI’s subsequent “note” and reply to the Karnataka committee in February-March 2016 and (d) the “minutes” of the RBI’s Board of Directors rejecting the Centre’s key arguments.

The court also ignored post facto evidence that demonetisation hurt the people and the economy. Cash was rationed for months and more than 100 died in the queues (apart from massive and overnight loss of jobs and businesses). The GDP growth fell from 8.3% in FY17 (the demonetisation fiscal) to 3.7% in the pre-pandemic FY20.

Demonetisation failed to achieve any of its stated, and later added, goals.

  1. Cash-in-circulation (CiC) has risen sharply from 10.7% of the GDP at the time of demonetisation (FY17) to 14.4% in FY21 and 13.7% in FY22 – thus, outstripping gains from digitisation of transactions and claims of bringing transparency in financial dealings.  

  2. Tax efficiency has fallen from 11.2% of the GDP in FY17 and FY18 to 9.9% in the pre-pandemic FY20. In FY22, it was 10.8% and in FY23 it is expected to fall to 10.7% – still below the FY17/18 level.

  3. Black money didn’t extinguish as 99.3% cash came back to the RBI and the rest 0.7% was locked in (a) currencies “confiscated or seized by enforcement agencies or produced before a court on or before December 30, 2016” (b) “exchange” of currencies held by District Central Cooperative Banks (DCCBs) “pending before the Hon’ble Court” and (c) currencies with Nepali “citizens/financial institutions”. The final tally was never disclosed. The “windfall gains” never materialised, despite a witch-hunt by the IT department.

  4. Since ₹2,000 currency notes (not available until then) were issued immediately in 2016, the scope for storing black money in high-currency notes became far easier, not tougher.

  5. No claim has been made or evidence provided by the Centre and RBI in their affidavits or argued by their lawyers that terror funding and incidents have stopped.

  6. The only evidence of a positive gain the RBI gives in its affidavit is that counterfeit notes have reduced – but the RBI’s minutes had said in November 2016 that this was too small and insignificant to begin with (0.26%).

The sum and substance of the demonetisation saga then is, had the Centre acted wisely, taking into consideration the experts’ views, that of the RBI’s or its own committees (white paper and SIT) or opted for course correction when it became evident that demonetisation was not working, much of the pain to the people and the economy could have been averted. The court, on its part, could have intervened timely, and not waited for six years, it would have helped the people and the economy too. Even now, six years later, it could have fixed accountability, paved a more rational policy making and procedures to prevent recurrence. Worse, the risk of another preventable economic misadventure remains.

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