Demonetization Is Legal, Says Supreme Court, But Was It Beneficial?


While upholding the demonetization decision as legal, the judges said they were only ruling on the legality and constitutionality of the decision-making process and not on the economic benefits of demonetization. But as much as the legality, economic impact or effectiveness of the policy also matters for the country and that is what this article seeks to measure, writes Latha Venkatesh.

While upholding the demonetization decision as legal, the judges said they were only ruling on the legality and constitutionality of the decision-making process and not on the economic benefits of demonetization. The dissenting judge, Justice Nagarathna also pointed out that “this court does not base its decision on the legality of any legislation as being effective in achieving the stated purposes”.

But as much as the legality, economic impact or effectiveness of the policy also matters to the country and that is what this coin seeks to measure. Has DeMo done anything for the economy? The Prime Minister has set three objectives, (i) “breaking the back” of corruption and black money, (ii) ending the circulation of counterfeit money and (iii) ending the financing of terrorism.

Let’s take these one by one. To break the back of corruption and black money. Related to this, DeMo supporters argued that there was too much cash in the system and that DeMo was intended to reduce cash in circulation and replace it with digital payments.

The government had expected that 25-35% of the big bills would not go to the banks because they would be irresponsible or black money. The Attorney General (AG) told the Supreme Court in late 2016, while the process was still ongoing. According to the AG standard, the goal of eradicating black money has clearly not been achieved. RBI’s 2017-2018 annual report pointed out that of the Rs 15.44 trillion of Rs 500 and Rs 1000 notes that were demonetized, Rs 15.310.7 billion or 99.2% were returned to RBI. .

The RBI board members were right. Minutes of RBI board meeting of November 7 (as disclosed by RBI to an RTI candidate – Venkatesh Nayak of Indian Express) indicate that a few board members had pointed out that the objective Eradication of black money could not be achieved through demonetization because such money is normally held in the form of land assets.

So what about the flow of money through the system. One rationale was that cash in circulation as a percentage of GDP had increased in the months leading up to the November 16 demo and that cash is a method of paying bribes. Here is the cash-to-GDP ratio before and since this year

Currency in circulation as % of GDP:

March 16 11.60%
March 17 8.21%
March 18 10.30%
March 19 10.84%
March 20 11.70%
March 21st 13.90%
March 22 12.82%
Sep 22 11.74%

#Source: RBI Annual Reports

The data proves that the cash-to-GDP ratio has not retreated despite DeMo. He resumed growing almost immediately.

The second objective was to put an end to counterfeit money. The data extracted from the RBI annual report since 2016 are as follows:

Number of counterfeit banknotes as % of all banknotes in circulation:

March 15 0.00071%
March 16 0.00071%
March 17 0.00075%
March 18 0.00051%
March 19 0.0003%
March 20 0.00025%
March 21st 0.000003%
March 22 0.00017%

The response to the Indian Express RTI revealed that board members noted that the number of counterfeit bills in the country is not at all significant. Also, the counterfeit reduction did not start after the demo in 2016, but in 2018-2019 due to the new series of banknotes with additional security features introduced by RBI in 2017.

The third and important objective was the reduction of the financing of terrorism. The media pointed out, even in the year after DeMo, that terrorists had been caught with the new 2,000 rupee notes. But more specifically, terrorism itself did not decrease immediately after November 2016. Here is some data collected by the South Asian Terrorism Portal; a portal launched by IPS KPS officer Gill

Year Number of terrorist events Number of civilians killed

Number of soldiers killed

2016 112 14 88
2017 163 54 83
2018 206 86 95
2019 135 42 78
2020 140 33 56
2021 153 36 45
2022 151 30 30

The data seems to suggest that terrorist activity did not diminish in the immediate aftermath of DeMo; but according to portal data, the number of casualties appears to have decreased after the abolition of Article 370 and the conversion of Kashmir into a union territory.

In short, DeMo’s stated goals have not been achieved. Or rather, if some of these goals are in sight – like a less monetary society – they are achieved by other mechanisms like the UPI.

DeMo may have pushed the economy towards more formalization and therefore better tax collection, but the formalization of the economy was achieved more peacefully and systematically through the GST. Against any minor benefits from formalization it might have gotten, deMo actually slowed the economy down for a few quarters. This is evidenced by the GDP growth trend after November 2016.

GDP growth (%)

Apr-June 2016 8.3%
July-September 2016 7.2%
Oct-Dec 2016 6.9%
January-March 2017 6.0%
Apr-June 2017 5.6%
July-September 2017 6.1%

The financial system was even more affected: the sudden and considerable increase in bank deposits led to a fall in borrowing rates which, in turn, led to a euphoria in lending to and by NBFCs; In 2018, the financial system began to face a series of defaults and the collapse of the NBFC. Of course, many were also guilty of fraud, but easy money in 2017 clearly exacerbated the problem.

The court may be correct that DeMo was not ultravires of the constitution or the RBI Act. Ironically, DeMo turned out to be a legally unleashed mistake on the economy.

(Edited by : Sangam Sing)

First post: January 5, 2023 11:05 a.m. STI


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