Impact of Demonetization on India’s Informal Economy

Introduction

Demonetization is a significant economic policy where a government invalidates existing currency notes or coins as legal tender and introduces new currency in their place. India’s demonetization in November 2016 aimed to curb black money, corruption, and counterfeit currency, but its impact on the informal economy, which operates largely outside formal regulatory frameworks, was profound and multifaceted.

Characteristics of India's Informal Economy

India’s informal economy comprises unregistered businesses that predominantly operate on cash transactions, often lacking formal employment contracts and social security benefits. These businesses contribute significantly to the nation’s economic activity but are not fully integrated into formal banking systems.

Impact on the Informal Economy

Short-Term Effects (Negative):

1. Cash Flow Disruption: The sudden withdrawal of high-denomination currency severely disrupted cash-dependent businesses. Daily wage earners, street vendors, and small businesses faced challenges in conducting transactions, leading to income losses and reduced purchasing power.

2. Loss of Livelihoods: Many informal sector workers lost jobs temporarily or permanently as businesses struggled to adapt to the cash shortage. This increased poverty levels and economic hardship among vulnerable populations.

3. Supply Chain Disruptions: Informal supply chains, crucial for goods and services delivery, were severely impacted. The inability to transact in cash led to fluctuating prices, shortages of essential commodities, and disruptions in local economies.

4. Limited Access to Banking: A significant portion of the informal sector lacks access to formal banking services. This hindered their ability to exchange old currency for new, exacerbating the cash shortage and prolonging financial instability.

Long-Term Effects (Mixed):

1. Formalization Push: Post-demonetization, there was a push towards formalization as some informal businesses sought access to banking facilities and compliant business practices. This could potentially lead to greater tax compliance and transparency in economic activities.

2. Digitalization Adoption: The government’s emphasis on digital payments post-demonetization prompted some informal sector participants to adopt digital payment methods. However, challenges such as technological readiness and internet connectivity hindered widespread adoption.

3. Uneven Impact: The long-term effects varied across different segments of the informal economy. Larger informal businesses with some access to banking adjusted better than smaller, resource-constrained enterprises, which continued to face difficulties.

4. Black Money Impact: The effectiveness of demonetization in curbing black money in the informal economy remains uncertain. While it disrupted cash-intensive illicit activities temporarily, the long-term impact on reducing black money is debatable.

Case Name:
Vivek Narayan Sharma v. Union of India

Court:
Supreme Court of India

Date of Decision:
2nd January 2023

Bench:
Constitution Bench comprising:

• S. Abdul Nazeer, J.
• B.R. Gavai, J.
• A.S. Bopanna, J.
• V. Ramasubramanian, J.
• B.V. Nagarathna, J. (dissenter)

Issues Considered

The Supreme Court reframed the initial nine questions into six issues for consideration:

1. Interpretation of Section 26(2) of RBI Act: Whether the power to demonetize can extend to all series of banknotes.

2. Excessive Delegation: Whether the delegation of power under Section 26(2) of RBI Act is excessive.

3. Decision-making Process: Whether the decision-making process leading to the demonetization notification of 08-11-2016 was lawful.

4. Proportionality: Whether the demonetization notification was proportionate to its objectives.

5. Period for Exchange of Notes: Whether the period provided for exchanging demonetized notes was reasonable.

6. RBI’s Power: Whether RBI has independent power under Section 4(2) of Specified Bank Notes (Cessation of Liabilities) Act, 2017.

Majority Opinion

Issue 1: Interpretation of Section 26(2) of RBI Act

The majority held that the power under Section 26(2) of the RBI Act allows demonetization of any series of banknotes, including all denominations. The legislative intent is to manage and regulate currency effectively, and restricting the interpretation would lead to impractical outcomes.

Issue 2: Excessive Delegation

The Court found no excessive delegation as the RBI’s recommendation was crucial before the Central Government’s decision. The RBI Act provides sufficient guidance to ensure lawful exercise of power.

Issue 3: Decision-making Process

The majority concluded that the decision-making process leading to the demonetization notification of 08-11-2016 was lawful. Relevant factors were considered, and procedural requirements were met, including consultation with RBI and the Central Board.

Issue 4: Proportionality

Demonetization was deemed proportionate as it aimed to curb fake currency, black money, and terror financing. The Court applied the doctrine of proportionality, finding the measure suitable for achieving its objectives without unduly restricting rights.

Issue 5: Period for Exchange of Notes

The Court held that the 52-day period for exchanging demonetized notes was reasonable, considering previous norms and the practicalities involved in implementing such a massive exercise.

Issue 6: RBI’s Power

The Court clarified that RBI does not possess independent power under Section 4(2) of the 2017 Act without adhering to other provisions. The Act’s scheme aims to extinguish liabilities of demonetized notes and impose penalties for non-compliance.

Minority Opinion (Justice B.V. Nagarathna)

Justice Nagarathna dissented on the first three issues, arguing that demonetization required plenary legislation rather than a notification under Section 26(2) of the RBI Act. She criticized the lack of independent decision-making by RBI and Central Board, stating it was influenced by the Central Government.

Conclusion

The Supreme Court’s judgment affirms the legality of demonetization while acknowledging its contentious impacts. It underscores the importance of procedural fairness and proportionality in such significant policy measures affecting millions of citizens.

Implications

The judgment provides clarity on the constitutional validity of demonetization under Indian law, setting a precedent for future economic policy measures. It balances the state’s authority to tackle economic challenges with safeguarding individual rights and procedural fairness.

Conclusion

Demonetization in India had immediate and lasting impacts on the informal economy, exacerbating existing vulnerabilities while also catalyzing potential shifts towards formalization and digital adoption. To mitigate the adverse effects and harness potential benefits, sustained efforts are needed to enhance financial inclusion, improve digital literacy, and provide supportive infrastructure for small businesses. By addressing these challenges, India can leverage demonetization as a catalyst for long-term economic resilience and inclusivity, benefiting both formal and informal sectors alike.

In conclusion, while demonetization caused significant short-term disruptions to India's informal economy, its long-term implications underscore the need for targeted policy interventions aimed at fostering sustainable economic growth and integration.

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Article Compiled by:-

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(LegalMantra.net Team)

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