Context

More than six years after the Centre’s decision to demonetise the Rs 1,000 and Rs 500 denomination notes in 2016, the Supreme Court in a 4:1 majority verdict, has upheld the move.

SC upholds Demonetization decision

Constitutionally valid: The Supreme Court ruled that the decision to scrap the high-value currency notes does not suffer from any legal or constitutional flaw.
Valid intention: The judgment said the decision-making process was not flawed merely because the procedure emanated from the government.
No overnight phenomena: The decision came up after six month consultation between the Reserve Bank of India and the Union government.
Executive decision: The top court also observed that the decision being the executive’s economic policy cannot be reversed.

What is Demonetization?

Demonetization is the process through which a nation’s economic unit of exchange loses its legally enforceable validity.
Currencies that are terminated are no more legally considered exchanges and have no financial value.
It is a process by which countries opt to reintroduce defunct currencies as legal money.

Demonetization in India

2016 is not the first instance of demonetization in India.

1946: The RBI demonetized Rs. 1,000 and Rs. 10,000 currency notes which were then under circulation.
1954: The Government introduced new currency notes of Rs. 1,000, Rs. 5,000, and Rs. 10,000.
1978: The Janata Party Government under Morarji Desai demonetized Rs. 1,000, Rs. 5,000, and Rs. 10,000 to curb illegal transactions and anti-social activities.

Reasons behind Demonetization

While demonetization is exceptional, governments around the globe have used it because of several reasons-

Formalization of Economy: Demonetization helps formalize India’s informal economy. It reduces the extent of cash transactions and help in the creation of a less-cash economy.
Inflation control: If problems like hyperinflation happen in any country, then the government considers demonetization as a solution to take back control and minimise the adverse situation.
Increased Saving: As a result of demonetization, people will tend to deposit their cash in the bank rather than at home. This will help them save more.
Eliminating counterfeit currency: Some negative situations or actions like counterfeit currency, terror, and tax fraud can all be eliminated with demonetization.
Introducing new system: Demonetization is also used to introduce a new monetary system in some circumstances.
Fight corruption: Demonetization is used to improve a cash-based emerging economy as well as fight corruption and criminality.

Pros and cons of Demonetization

[A] Pros

Governments can benefit from currency demonetization in several different ways, from preventing and reducing criminal activity to currency regulation. Below are the advantages of demonetization.

Increased money outflow
Increased revenue collection
Reduced conspicuous consumption
Curb over criminal activities and terror financing
Forbid tax avoidance and other financial crimes
Contributed to the dawn of paperless financial system and UPI
Ensured transparent funding of elections and election expenditures

[B] Cons

Some disadvantages of demonetization are stated below.

Furore and Panic among the general public ex. Long queues in Banks and ATMs
Disruption in economic activity and daily expenses
Supply-chain disruptions
Drop in rural demand
Black marketing of the new notes/ Old notes replacement mafias
Expenses issuing new currency and coinage minting can be high
Illegal activity will not be stopped entirely
May create disturbances among individuals

A critical evaluation

Black money is not just cash: The sudden demonetization was premised on the idea that “black means cash”. And, it is in high-denomination currency notes that black money would be held.
Benami transactions whitens black money: The truth is that illegal cash transaction, though black money, constitute a very small proportion of the black economy.
Much cash was accounted: Much of the prospected cash in circulation including a major chunk of ‘black money’ was collected back by the RBI.
Wealth is dispersed: The wealth is held in a variety of forms like, in undervalued inventory or balances held in tax havens abroad. A return is expected from this wealth. So, cash, on which there is no return, would be a tiny amount – 1% of the black wealth.
Schemes were exploited: Deposits in Jan Dhan accounts suddenly swelled as the poor were used as cash mules. Some bankers were caught helping their rich clients do this. There was a 30% charge for this. As a result, new black incomes got generated.
Suspicion over timings: Some suggested that demonetization was ordered for political reasons – that it was crucial to win the impending UP elections. It was thought that if the Opposition lost its black-money hoards, it would not be able to campaign effectively.
Bluff over objectives: Within days, the government changed the goalpost. It argued that the move would make the economy “cashless”. After few months, the goal became a “less cash economy”.
Fuss over fastest growth: Official data showed that the year of demonetization, 2016-’17, had the best growth rate for the decade. The reason is that unorganised sector data is not available so the GDP data uses the organised sector as a proxy to capture it.
Embraced as failure: Demonetisation is perceived as an ill-advised step that did not achieve any of its goals. The ruling party understood this and did not showcase it as an achievement in the subsequent elections.

How demonetization affected the poor?

Market vendors had to shut down their shops: Typically, market vendors farm on a daily basis and sell their production. The drop in customer traffic, however, forced the market vendors to shut down their shops.
Informal sector collapsed: Informal workers including domestic help, agricultural laborers, workers in factories, micro-business owners, daily-wage workers, etc. receiving their salary in cash were severely disadvantaged.
Household expenses distorted: Typically, working class people have basic jobs with fairly low wages. Due to the fact that there is a shortage of cash flow, many low-income workers experienced delayed salary payments.
Income loss to farmers: Disruptions, breaks in the supply chains feedback to farmers as sales fall, increased wastage of perishables, lower revenues etc.
Gendered impact: Demonetization amplified the inherent discrimination against women in Indian society who are financially excluded. Same was the case with sex workers and transgenders.

Conclusion

Demonetization brought about a policy-induced crisis for the country, adversely impacting the marginalized sections of society – women, farmers and workers – while doing little to curb the black economy.
However, it can be termed as a good intended policy with hasty execution.