All you wanted to know about legal tender

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The demonitsation drive has had all of us running hither and thither to replace our useless currency notes with new notes that are ‘official’ legal tender. Hopefully, hoarders of suitcase-fuls of black money are left scratching their heads on what to do with their high denomination notes, which are illegal.

What is it?

But what is legal tender and why is it so all-powerful? A country or its citizens may use many modes of exchange in their daily lives. History tells us that ancient humans used salt and spices as currency. But ‘Legal tender’ is the money that is recognised by the law of the land, as valid for payment of debt. It must be accepted for discharge of debt. The RBI Act of 1934, which gives the central bank the sole right to issue bank notes, states that “Every bank note shall be legal tender at any place in India in payment for the amount expressed therein”.

Legal tender can be limited or unlimited in character. In India, coins function as limited legal tender. Therefore, 50 paise coins can be offered as legal tender for dues up to ₹10 and smaller coins for dues up to ₹1. Currency notes are unlimited legal tender and can be offered as payment for dues of any size. So does this mean an autowallah is obliged to accept your new ₹2,000 note for a short hop? Not necessarily! If you are yet to get into the auto, the autowallah can turn you down despite it being legal tender. But once you make the trip, and you have incurred a debt, he cannot refuse to take your ₹2,000 note. And he certainly cannot sue you to recover that debt.

Why is it important?

The cancellation of the legal tender status is important because paper money derives all its value from the Government’s recognition of it. Tomorrow, if the Government declares gold to be completely worthless, will it put us Indian citizens into such a tizzy? You can guess that it probably will not! Citizens will probably ignore the government and continue to hoard gold. This is because our tendency to view gold as something of great value does not come from any government diktat; it comes from tradition.

But for a piece of paper to function as a medium or exchange and store of value, it needs to enjoy unquestioning acceptance from the public. This can only be ensured by declaring such paper currency notes as ‘legal tender’ through a fiat, with the RBI or the Centre promising to ‘pay the bearer’ an equivalent sum if the currency note is presented to them.

Why should I care?

The withdrawal of currency’s legal tender character can lead to sudden jolts to your personal finances, as has happened now. And demonetisation moves are not as rare as you think. The largest demonetisation move in world history unfolded when the European Union was born in 1999 and its member countries demonetised their national currencies to adopt the Euro from 2002. In the 1990s, Australia withdrew its paper currency notes and replaced them with polymer notes. India has demonetised ₹10,000 notes on two occasions, in 1946 and 1978.

With many large economies now bracing for a full-scale war against tax evasion, many nations are mulling the idea of withdrawing legal tender status for their high-value notes. All this makes an even stronger case for you to go cashless and shift to plastic/electronic banking.

The bottomline

All our wealth, the scriptures tell us, are pure maya. Well, paper currency is maya too. Without a government fiat to make it legal tender, it’s is just a piece of paper.

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Published on November 14, 2016
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