Schrödinger’s Central Bank: Ahead of SC's Demonetisation Judgment, the Key Issues

A version of this article first appeared on the author’s blog, Indian Constitutional Law and Philosophy, and has been published with permission.

Last week, it was announced that a Constitution Bench of the Supreme Court would be delivering judgment in the constitutional challenge to the Union government’s 2016 banknote demonetisation. The case itself had been heard through November 2022, and reserved for judgment on December 7.

Some constitutional issues are at the heart of the case.

Judicial evasion

Recall that the demonetisation of Rs 500 and 1000 banknotes was announced on November 8, 2016. The case was heard in November 2022, six years after the fact.

When arguments began, the bench asked counsel for the petitioners whether the issues in the case had now become ‘academic.’ In response, counsel laboured at some length – both in court, and in their written submissions – to establish that even if demonetisation itself had become fait accompli, its constitutionality was still a live issue, especially as it concerned crucial and unanswered questions about the relationship between the Reserve Bank of India and the central government.

Notably, in their written submissions, the government and the RBI urged the court not to get into the adjudication of purely academic issues.

For obvious reasons, petitioners before the court could not answer this question in the manner that it merited. Here, however, we have no such compunctions. The real answer is that the constitutionality of demonetisation is academic because the Supreme Court made it so. A perusal of the orders in Writ Petition No. 916/2016 (the matter eventually argued by P. Chidambaram) reveals that it first came up for hearing on November 11, 2016, three days after demonetisation was announced.

A further perusal of the orders in Writ Petition No. 906/2016 (designated as the lead matter) reveals that the demonetisation challenge came before the Supreme Court on the following dates: 15.11.2016, 25.11.2016, 2.12.2016, 5.12.2016, 9.12.2016, 15.12.2016, 16.12.2016, 27.1.2017, 7.3.2017, 21.4.2017, 31.7.2017, 15.9.2017, 19.3.2018, 28.3.2018, 10.7.2018, 24.8.2018, 10.12.2018, 25.2.2019, and 2.9.2019. That is a total of 19 hearings, before it was actually heard by the Constitution Bench in 2022.

Indeed, the hearing of December 16, 2016 is particularly important, because on that date, a two-judge bench of the Supreme Court referred the matter to a Constitution Bench as it raised questions of constitutional importance, and simultaneously interdicted all high courts from hearing any matter pertaining to demonetisation. Effectively, therefore, the Supreme Court took sole charge – and sole responsibility – for deciding this case.

Let us for a moment grant that regular housekeeping issues justified a one-month delay between the filing of a case and the referral to a Constitution Bench. Even after that, the Supreme Court had ample time to adjudicate the case while the issues were still live (as the right to privacy case showed, the court is entirely capable of hearing and deciding constitutional cases quickly when it so chooses).

But the court didn’t do that. It evaded. It dodged, ducked, and weaved. It stung like a butterfly and floated like a bee.

A large number of the orders after December 16, 2016, involve the court granting “one final opportunity” to the respondents to file counter-affidavits. Ultimately, what the record reveals is that the Supreme Court simply wasn’t interested in hearing the demonetisation case while its orders may still have had some bite.

This is why, despite the petitioners’ gallant attempts to demonstrate that the issue is not academic, one is left distinctly unconvinced. Because even if this bench were to buck the trend of judicial deference to the executive, find that demonetisation was unconstitutional, and lay down standards and principles ‘for the future’, this would be of no use if, when that hypothetical future arrived, a future court once again simply evaded deciding the case until it became a fait accompli.

As the long-pending challenges to the reading down of Article 370 and the constitutionality of electoral bonds show, judicial evasion remains very much a part of the court’s repertoire at the moment.

Also read: What Is Stopping Our Justice System From Tackling the Cases Pending Before Courts?

Substantive Issues: The Status of the RBI

As a perusal of the written submissions, and the coverage of the oral arguments reveals, many challenges have been raised to the constitutionality of demonetisation. At the heart of the case, however, lies the crucial question of the relationship between the Reserve Bank of India and the central government.

This is implicated by Section 26(2) of the RBI Act, which has been invoked as the legal authorisation for the 2016 demonetisation. Section 26(2) states, in relevant part:

On recommendation of the Central Board the [Central Government] may, by notification in the Gazette of India, declare that, with effect from such date as may be specified in the notification, any series of bank notes of any denomination shall cease to be legal tender…

The key legal issue turns upon the meaning of the phrase ‘on recommendation.’ Petitioners argue – in essence – that if central bank autonomy is to mean anything at all, then the recommendation has to come independently from the RBI, and anterior to the central government’s actions. The recommendation from the RBI cannot come at the instance of the central government.

In the present case, however, the chronology reveals that the process was initiated through a central government letter ‘advising’ demonetisation on November 7, 2016, followed by the RBI recommendation to that effect on November 8, 2016 (see Sections III and IV of the Petitioner’s written submissions). This reversal of the process is ultra vires Section 26(2), especially as the RBI Act, as a whole, is premised on the independence and autonomy of the central bank. On the other hand, it is the case of the government and of the RBI that it is open for the Central Bank to base its ‘recommendation’ on the advice and inputs of the central government, especially on issues within the executive’s domain (such as combating terror financing, eliminating fake currency, and eliminating black money).

The RBI can still make an independent decision based on those inputs. Indeed, the Attorney-General’s written submissions make no bones about this, arguing specifically that, in the context of Section 26(2), an “integrated role that will be played by RBI and the Central Government acting together in promotion of public interest” (para 2.1). According to the government, therefore, central bank autonomy does not mean an arms-length distance between the government and the bank, but rather, an ‘integrated role’ in which both organs ‘act together.’

The core issue, therefore, is how do we understand the place and scope of the central bank in our constitutional scheme, and what do we mean when we say that the central bank is meant to act ‘independently’ of the government. In this context, there are two points worth flagging.

First, in the context of the interaction between different institutions, the ability to initiate a process has a significant bearing upon questions of independence and autonomy. For example, recall the decision of the Supreme Court of Kenya in the BBI case: one of the questions before the Supreme Court was whether the President of Kenya could (directly or indirectly) initiate an amendment process that – according to the Constitution – was meant to be the reserve of the People (“the popular initiative”). Upholding the findings of both the Kenyan High Court and the Kenyan Court of Appeal, the Supreme Court found that the President could not.

Underlying this finding was the insight that the independence and autonomy of the People to initiate constitutional change would be largely illusory if a figure as powerful as the President could effectively make use of the same avenue: it would then become a top-down amendment process rather than a bottom-up one. While the context is different, of course, the considerations in the present case are largely similar: it is an open question to what extent two institutions can act in ‘together’ and in an ‘integrated’ manner, when one of the two institutions is the political executive.

Given that fourth branch institutional independence is already exceedingly weak (for example, the RBI Governor is appointed by the executive), if the central government was effectively allowed to play an initiating role under Section 26(2), it is an open question to what extent any subsequent ‘recommendation’ from the RBI would be at all ‘independent,’ in any meaningful way.*

Secondly, if we read the Attorney-General’s submissions closely, there emerges a rather surprising internal contradiction within the government’s own case on this point. One of the arguments made by the Petitioners is that, unless given a narrow construction, Section 26(2) suffers from the vice of excessive delegation: it does not lay down any guidelines or considerations on the basis of which the RBI is supposed to make a recommendation for demonetisation.

The Attorney-General’s response to this is interesting: he argues that the question of excessive delegation does not arise, because under the scheme of the RBI Act, in the domain of currency management and regulation, the Bank occupies a status even higher than Parliament. Consider:

RBI is not just like any other statutory body created by an Act of legislature. It is a creature, created with a mandate to get liberated even from its creator. (Paragraph 1.1.1).

And:

What is taking place, by virtue of Section 3 of the Act, read with the other provisions therein, is the transplanting of the primary responsibility of currency management in the country from the domain of the union executive to an expert body, the RBI (which acts through its Board), set up exclusively for this purpose. (Paragraph 1.1.2)

And:

The RBI is specifically empowered to do certain things to the exclusion of even the Central Government. Therefore, to place its decisions at a pedestal lower than that of even an executive decision, would do violence to the scheme of the Act. (Paragraph 1.2)

What we have, thus, is Shrödinger’s central bank: simultaneously higher than parliament, while working ‘together’ with the executive; higher than Parliament when it comes to justifying the scheme of the RBI Act, but on par with the executive when it comes to justifying demonetisation; in essence, the central government wants to eat its cake (by defending the RBI Act’s unconstrained delegation of functions to the RBI), but also have it (by retaining a broad role for itself in the performance of those functions).

This is nothing other than a plea for executive impunity.

Due Process: A Sealed Cover in All But the Name

Let us assume, however, that the central government’s interpretation of section 26(2) is correct.

At a minimum, however, for the recommendation to be a recommendation, it would still require the RBI to exercise independent judgment, and not act as a rubber stamp for the government. It would also require the recommendation to meet constitutional standards of rationality, at the very least. This, then, leads to the procedural part of the petitioners’ challenge, i.e., a challenge to the decision-making procedure that underlay the 2016 demonetisation.

Also read: Demonetisation Hearings: ‘Temporary Hardships Integral to Nation Building’: RBI Tells SC

This also leads us to perhaps the most egregious part of the present proceedings. It is obvious that a challenge to the decision-making procedure can hardly be made without access to the documents on the basis of which the said decision has been made. As the petitioners’ written submissions indicate, the following documents were sought for in this regard:

… (i) the contents of the Central Government’s letter dated 07.11.2016; (ii) the agenda note prepared by the RBI for the meeting of the Central Board on 08.11.2016; (iii) the Minutes of the said meeting dated 08.11.2016; (iv) the text of the recommendation made by the RBI on 08.11.2016; (v) the file containing the consideration by the Central Government on 08.11.2016; (vi) the Cabinet Note prepared on 08.11.2016; (vii) and the Minutes of the Cabinet dated 08.11.2016. (paragraph 7)

As the records of proceedings reveals, the government refused to provide these documents. Now, in the Supreme Court’s order of 7th December 2022, in which it reserved judgment, we come across the following line:

Learned counsel representing the Union of India and the Reserve Bank of India are directed to produce the relevant records.

This is mind-boggling.

In a constitutional challenge focused upon flaws in the decision-making procedure, the Supreme Court has asked the State to produce relevant evidence after the hearing is over. It has asked the State to reveal its decision-making process – which is under challenge – at a time in the hearing when the petitioners can no longer address arguments. And the Supreme Court is now going to hand down a judgment – ostensibly – based on materials that were the basis of the challenge before it, but which one side has not been given access to. This is, in essence, the sealed cover by another name: a decision based on secret material, which – let alone the public – even the contested party has not been able to see and address.

It is worthwhile, at this point, to quote the Stanford Encyclopaedia of Philosophy’s definition of the rule of law (in particular, the following element):

1. A hearing by an impartial and independent tribunal that is required to administer existing legal norms on the basis of the formal presentation of evidence and argument;
2. A right to representation by counsel at such a hearing
3. A right to be present, to confront and question witnesses, and to make legal argument about the bearing of the evidence and the various legal norms relevant to the case; and
4. A right to hear reasons from the tribunal when it reaches its decision, which are responsive to the evidence and arguments presented before it.

One would think that this is basic; yet, spot how many of these basic principles have been violated by this one single line in the Court’s order reserving judgment. And one needs to ask oneself what legal value is carried by a judgment which appears to fall short of complying with even the minimum threshold of what the rule of law demands.

It is important to note that this wasn’t the only avenue open to the Court. As I have argued before in the context of the Rafale case, the Court could have simply refused to look at the decision-making process. That would arguably have been judicial abdication, but it would also have been, in a way, intellectually honest. What we have now is a halfway-house to nowhere, where the Court wants to retain its power to scrutinise government action, while at the same time in a way that nobody can scrutinise it for how it goes about that task. Much like the executive, the Court wants to eat its cake and have it too.

Constitutional Standards

A quick, concluding point about the applicable legal standards in this case. The Petitioners have argued that the standard of proportionality should apply, as demonetisation impacted numerous fundamental rights. The Attorney-General and the RBI have resisted this. What standard they prefer is somewhat ambiguous: it has shifted between no judicial review at all, and light-touch rationality review. The core of their case is that when it comes to the economy and to banking, substantial play in the joints must be accorded to the government.

Two points arise in response to this. The first is that we have, once again, that internal tension in the State’s submissions. If the decision to demonetise came from an independent recommendation of the RBI – and if the RBI is itself an autonomous, independent body that is meant to take its decisions on non-political bases, then there is no reason why its decisions can’t be subjected to rigorous scrutiny, at the very least, on the defined parametres that it is supposed to apply.

More importantly, however, the proportionality standard does not commit the court to interventionist scrutiny. The four steps of the proportionality standard are flexible enough for the court to accord greater deference on economic issues: from the rationality prong to the necessity prong, at each step, the court can take into account that economic policy needs greater play in the joints, and thereby, lessen the burden of justification upon the state. The proportionality test, however, retains great value, because at all times it requires the State to justify its decision by giving due reasons. That is the minimum that should be expected of the State, within the context of the rule of law.

The history of the demonetisation case has already seen the unfortunate deployment of two recent judicial tools that inure to the benefit of the executive: judicial evasion and the sealed cover. As we await the final judgment of the court – especially on the substantive and procedural issues outlined above – it remains to be seen whether the trinity will now be completed with a judgment that is deferential to the executive on questions of fourth branch independence, due process, and standards of judicial scrutiny – or not.

It is important to clarify that this article is not making an independent case for central bank autonomy. This author does not agree with the argument that institutions like central banks ought to be encased from democratic control. It is important to be clear, therefore, that this article is not a first principles argument for the separation between the RBI and the central government, but rather, an argument within the existing statutory and constitutional context. In any event, RBI independence affects only the section 26(2) part of the argument, and not the others.