The demonetisation judgement: Questions on the decision making process and the autonomy of RBI?
– Aryan Soni and Tahir Syed
“Should there be a truly “independent” monetary authority? A fourth branch of the constitutional structure coordinate with the legislature, the executive, and the judiciary?”
— Milton Friedman
Introduction
The Reserve Bank of India Act of 1934 was enacted to shift currency management control from the Central Government to the newly founded Reserve Bank. The Reserve Bank of India (RBI) was established with the primary goals of solely regulating the issuance of bank notes, maintaining reserves to ensure monetary stability, and generally managing the country’s currency and credit system independently of the Government, according to the preamble and Section 3 of the Act mentioned above. The primary argument for this independence is the need to shield it from short-term political pressures that may promote re-election in the short term but create long-term economic damage.
Before establishing an independent authority, recessions and financial panics were widespread since investors and depositors lacked confidence in the banking system’s stability and solvency. As a result, as previously said, without some degree of autonomy, the Reserve Bank may be pushed by election-focused politicians to implement an unduly expansionary monetary policy to reduce unemployment in the short term. This might result in excessive inflation and a failure to manage unemployment in the long run.
Following a similar line of thinking, the Narasimham Committee, which was formed in 1991 to investigate the functions of banks, recommended the elimination of dual control in aspects of bank regulation. At the time, the banks were regulated by the RBI and the Banking Division of the Ministry of Finance. The committee recommended that this structure be abolished and that the banking industry is regulated solely by the RBI.
Demonitisation
Demonetisation is taking away a currency unit’s ability to be used as “legal tender,” which has been guaranteed under Section 26 of the Reserve Bank of India Act, 1934. India has seen demonetisation three times thus far, in 1946, 1978, and 2016. there are two ways to demonetise currency in India: first, by bringing a bill into the Parliament, where deliberation ensues, and then passing legislation. Secondly, by referring to the Reserve Bank of India Act, 1934, Section 26(2), which reads that “on the recommendation of the central board, the central government may by notification in the Gazette of India declare currency to be demonetised.”
On 8th November 2016, the Central Government issued a notification under Section 26(2), which notified that specific bank notes, i.e., the ₹500 and ₹1000, shall cease to be legal tender with effect from 9th November 2016.
Complete abuse of the decision making process
Demonetisation has tremendous consequences on the economy of the country. Such a policy initiative must only be recommended after considerable deliberation by economic experts and scholars of the field. It is pertinent that the decision-making process must be flawless and must not be influenced by any political agenda. However, in the present scenario, the demonetisation of 2016, the decision-making process is deeply flawed, and it is evident that it was hurried up and influenced to facilitate a pre-conceived . A plain reading of sub-section (2) of Section 26 of the RBI Act would reveal that the Central Government can exercise power only on the recommendation of the Central Board.
In the present case, it is evident that a reverse mechanism was adopted. The Central Government initiated the proposal for demonetisation and sought the opinion of the Central Board vide its communication dated 7th November 2016. The meeting of the Central Board was held immediately on the following day, i.e., 8th November 2016, at 5.00 pm. Within hours, a recommendation of the Central Board was sent to the Central Government on the same date itself, i.e., 8th November 2016. It can be seen from the Affidavit Served by the Union of India in 2018 in the case of Vivek Narayan Sharma v. Union of India (2023 SCC OnLine SC 1) that the recommendation to demonetise 17.97 lakh crore rupees emanated from the Government, and the whole process of deliberation with the central board and the passing on the information to the cabinet was completed within 2.5 hours on the 8th November 2016 (5:30 pm to 8 pm) This is an unfortunate Mockery of Rule of Law. Hon’ble Prime Minister went on National Television at 8.00 pm on 8th November 2016, in a slot that the Government had already booked since all channels telecasted the speech at 8.00 pm, and announced the decision on demonetisation. This indicates that the decision-making process was pre-meditated and rushed, which depicted a non-application of mind and was deeply and fatally flawed.
Furthermore, the deliberations and discussions between the bank and the Government cannot be reviewed as, according to the Affidavit Served by the Government in November 2022, essential components of the meeting, like the agenda and minutes, are not open to review under the reason of ‘secrecy.’
In the absence of access to the points of deliberation and looking at the hurried and hasteful process of decision-making, it is thus blatantly evident that the procedure adopted was in total violation of the procedure contemplated under sub-section (2) of Section 26 of the RBI Act.
Majority opinion
The hon’ble court in the case of Vivek Krishna v. Union of India had to decide whether the present case’s decision-making process was flawed and whether it followed the statutory process. The case comes under the purview of judicial review to examine the correctness of the decision-making process and not the decision itself. Unfortunately, the majority opinion fails to recognize the blatant and evident flaws in the decision-making process.
¶238: “The contention is that, since the Central Government is required to act on the recommendation of the Central Board, the proposal should emanate from the Central Board.”
The procedure established under sub-section (2) of Section 26 of the RBI Act requires the idea of demonetisation to emanate from the central board of the RBI and not from the Central Government. The primary contention, among others put forth before the hon’ble court, was that the idea emanated from the Central Government, not the RBI. Thus, the process was flawed regardless of the decision or the outcome.
While reviewing the decision-making process court held that;
¶239: “In a matter like the present one, it cannot be expected that the RBI and the Central Government will act in two isolated boxes. An element of interaction/consultation in such important matters pertaining to economic and monetary policies cannot be denied to the RBI and the Central Government.”
¶242: “the word “recommendation” would mean a consultative process between the Central Board and the Central Government.”…… …..“In our view, therefore, the enquiry would be limited as to whether there was an effective consultation between the Central Government and the Central Board before the decision was taken.”
¶245: “As already discussed herein above, the record itself reveals that the RBI and the Central Government were in consultation with each other for a period of six months before the impugned notification was issued. The record would also reveal that all the relevant information was shared by both the Central Board as well as the Central Government with each other. As such, it cannot be said that there was no conscious, effective, meaningful and purposeful consultation.”
Going by the excerpts above, the three main points that the court’s decision is based on i) is not treating the RBI and the central Government as isolated entities, ii) giving the term “recommendation” in sub-section (2) of Section 26 of the RBI Act a broader interpretation to include consultation and iii) the consultation between the RBI and Government for six months was sufficient enough to deliberate and conclude on such a revolutionary monetary policy.
These points formed the basis of the majority opinion that the decision-making process was correct and without flaws.
However, it is necessary to separate the RBI and central Government into two separate boxes, as their functions are intrinsically different by their formation. The function of the Reserve Bank has been elaborated by the apex court in Akshay N. Patel v. Reserve Bank of India (2022) 3 SCC 694;
¶192:”RBI is a special, expert regulatory body that is insulated from the political arena. Its decisions are reflective of its expertise in guiding the economic policy and financial stability of the nation.”
Therefore, it is evident that RBI is a body of economic and financial experts established to regulate the country’s monetary policy independent of political intervention. Whereas the central Government enjoys the people’s mandate but is also burdened with political agenda and sociological obligations. This distinct division in roles, functionalities, and formation is why they must be considered isolated entities. Thus, knowing how and where the proposal for a policy like demonetization emanated is vital.
Additionally, the use of the word “recommendation” in the statute is for a particular reason since RBI is a greater authority on the matters of economic and monetary policy, the humungous economic changes like demonetisation must come from their independence and honest suggestion, interpreting it to include consultation is giving the central Government a broader scope than what the statute initially intended to. Furthermore, even if we consider the talk between the Central bank and the Government for six months, without any details of this consultation being shared, it cannot be concluded that mere deliberation for six months would have resulted in a positive and definitive conclusion, the fact of deliberation for a particular period is not sufficient to assume that the “the recommendation by the Central Board was made after complete consideration of the matter based on all the relevant facts and material before it.”
Dissenting Opinion: the only voice of reason
Justice B. V. Nagarathna’s dissenting opinion is the voice of reason in the current judgment. She has pointed out the irregularity and the blatant flaws in the decision-making process. She has held that for the central Government to propose or initiate demonetisation, it should do so with its plenary powers under Entry 36 of List I of the Seventh Schedule of the Constitution of India by issuing an ordinance, ¶20(vi)“it has to be done only by an Ordinance being issued by the President of India followed by an Act of Parliament or by plenary legislation through the Parliament.” However, the central Government cannot propose or initiate demonetisation as it exercises power under subsection (2) of Section 26 of the Act.
It is pertinent not to include consultation under the interpretation of the word “recommended” in the RBI Act of 1934 because there is an entirely different process to be followed after consultation of the idea between the central bank and the Government, that is, the issuance of an ordinance by the President followed by an act of the Parliament, the ordinance route even gives the central Government the power to reject the RBI’s opinion if such process is followed. This process is evidence enough to indicate if the proposal emanating from the central Government should be initiated after this process and by not simply issuing a gazette notification under subsection (2) of Section 26 of the Act. “Recommendation” to issue a gazette notification should exclusively emanate from the body of experts of the central bank.
Nagrathan J. went on to hold the notification dated 8th November 2016 issued under subsection (2) of Section 26 of the Act as unlawful. However, since the notification dated 8th November 2016 and the Act has been acted upon, the bank notes of ₹500 and ₹1000 have been wholly demonetised. She prospectively overruled the decision to ensure complete justice by virtue of article 142 of the Constitution.
Question on RBI’s autonomy
The Reserve Bank of India is the chief regulatory and subject-matter authority on currency management. The Central Bank’s structure is shown in Articles 20 to 26 of the RBI act. Theoretically, it is a separate organization that operates independently of the Central Government. It is a unique, expert regulatory body shielded from political intrusion, and its choices accurately reflect its knowledge of maintaining the country’s economic and financial stability. Technically, Section 30 of the Act allows the Government to supersede the central bank if it determines that the RBI has failed its obligations. The use of section 30 to supersede the authority of the central bank can only be initiated after providing the Parliament with a report on the events explaining the failure of the RBI to fulfil its legal requirement.
However, due to globalisation and liberalisation, extensive communication exists between the bank and the finance ministry, and the Government, at times, has been known to enforce its will, often against the views of the RBI governor. In India, “consultations,” which are sometimes used as a kind way to describe unilateral “government orders,” are typical between the central bank and the finance ministry.
In 2017-2018, two governors, Urjit Patel and Viral Acharya were compelled to resign before the end of their tenure because officials did not concur with the views of the Finance Ministry. Hence, they were displeased with the Government’s alleged interference in critical RBI decisions.
The principle of RBI’s autonomy should be expanded beyond the scheme of the Act. The Reserve Bank has become more of a quasi-governmental agency than an independent one due to the continuous government intervention and, most notably, as a majority of the significant authorities are appointed by the Central Government; for example, according to Section 8 of the RBI Act, the Central Board of RBI is appointed by the Government, similarly, according to Section 45ZA and 45ZB, the Government also enjoys significant power in the Monetary Policy Committee. Furthermore, there has been constant degradation of the central bank’s statutory power through minor legislative amendments that directly or indirectly diminish the central bank’s independence from the Government.
On the global front, a review of the system in existence in the United States, United Kingdom, Europe, Japan, and Canada reveal that these countries’ central banks have been set up in a way that allows them to act more autonomously compared to India, but accompanying protections may differ. The Federal Reserve Bank of the United States is autonomous in that monetary policy, and related decisions are made independently and are not subject to federal government approval. Similarly, an international treaty guarantees the European Central Bank’s (ECB) independence. The treaty not only forbids the ECB from soliciting or accepting instructions from any institution, Government, or other entity, but it also forbids governments and other institutions from influencing the ECB’s decision-making bodies. Furthermore, the UK and Canadian central banks can only be overturned in exceptional circumstances. Lastly, data indicates that more autonomous central banks, such as those in Germany, Austria, and Switzerland, achieved lower inflation than those with tighter links to their governments, such as those in Norway, New Zealand, and Spain. The International Monetary Fund (IMF) stated in April 2015 at a conference titled “Rethinking Macro Policy.”
In conclusion, while the Reserve Bank of India is theoretically an independent body, its autonomy has been repeatedly challenged by the Government’s interference in its decision-making processes. This trend towards greater government control over the central bank is concerning as it could undermine the RBI’s ability to maintain economic and financial stability in the country. To ensure that the central bank can act autonomously, the RBI must be shielded from political intrusion, and its decisions reflect its expertise and knowledge of currency management. By protecting the RBI’s independence, India can effectively pursue economic objectives and achieve long-term economic prosperity.
Aryan Soni and Tahir Syed are students at Gujarat National Law University, Gandhinagar