Legal tender

Topic: Money: From Barter to Digital Currency · NCERT: Class 10, Ch 3 "Money and Credit"; Class 12, Ch 3 "Money and Banking"

Meaning

Legal tender is money that the law says must be accepted when someone uses it to settle a debt or make a payment. No one can legally refuse it. In India, RBI banknotes and coins are legal tender, but cheques are not. This matters because legal-tender status is what makes a currency note final payment. When a note loses this status through demonetisation, it becomes just paper.

Explanation

How legal tender works

• Where the status comes from: a law gives it. The paper or metal itself is worth very little.
• What backs it: legal tender is backed by fiat money. Fiat money has value because the government orders it, not because of what it is made of.
• Why a note is trusted: every banknote is a liability of the RBI (something the RBI owes to the holder). That is why the note carries the words "I promise to pay the bearer…".
• Who makes what:
• The RBI issues banknotes.
• The Government of India makes coins under the Coinage Act, 2011. The RBI only puts the coins into circulation.

Two types: unlimited and limited legal tender

• Unlimited legal tender: RBI banknotes. They must be accepted for any amount.
• Limited legal tender: coins. They must be accepted only up to a fixed sum. The coin must be undamaged and must not have lost too much weight [6].

Coin	Must be accepted for sums up to
₹1 and above	₹1,000
50 paise (half-rupee)	₹10
Any smaller coin	₹1 [6]

• Coins now in circulation are 50 paise, ₹1, ₹2, ₹5, ₹10 and ₹20 [6][7].
• Worked example:
• A shopkeeper's bill is ₹1,500. You offer 150 coins of ₹10.
• The shopkeeper has to accept coins only up to ₹1,000. They can legally refuse the other ₹500.
• If you pay the same ₹1,500 in ₹500 notes, the shopkeeper cannot refuse, because notes are unlimited legal tender.

Money that is NOT legal tender

• Demand deposits are savings or current account balances you can withdraw at any time, for example by cheque.
• They count as money because people widely accept them. They are part of M1 (currency with the public + demand deposits + other deposits with the RBI).
• But a cheque can be refused. So demand deposits are money but not legal tender.
• UPI and card payments move demand deposits. So they are not legal tender either.
• A seller can refuse a UPI or card payment.
• The same seller cannot legally refuse RBI notes.

How legal-tender status is taken away

• Demonetisation means taking away legal-tender status from a series of notes.
• Legal route:
• The RBI's Central Board recommends it.
• The Government of India issues a Gazette notification under RBI Act, 1934, s.26(2).

• The notified series stops being legal tender.

• Coins can lose the status too. Coins of 25 paise and below stopped being legal tender from 30 June 2011 [7].

In India

• Institutions and laws:
• The RBI issues banknotes, which are unlimited legal tender.
• The Government of India makes coins, which are limited legal tender under the Coinage Act, 2011 [6].

• Legal-tender status is withdrawn under RBI Act, 1934, s.26(2).

• Past demonetisations:

Year	Notes	Legal route
January 1946	₹500, ₹1000, ₹10,000	Ordinance
January 1978	₹1000, ₹5000, ₹10,000	High Denomination Bank Notes (Demonetisation) Act, 1978
8 November 2016	Old ₹500 and ₹1000 ("Specified Bank Notes", SBNs)	Notification under RBI Act s.26(2)
30 June 2011 (coins)	25 paise and below	Ceased to be legal tender [7]

• 2016 in numbers:
• The SBNs were worth about ₹15.4 lakh crore. That was 86.9% of the value of all notes in circulation [2]. (NCERT says about 86%.)
• About ₹15.31 lakh crore of the ₹15.41 lakh crore came back to the RBI. That is about 99.3% (RBI Annual Report 2017-18) [2][3].

• Return ratio = (15.31 ÷ 15.41) × 100 ≈ 99.3%. Only about ₹10,000 crore (about 0.7%) did not come back.

• Ending the RBI's promise: SBN (Cessation of Liabilities) Act, 2017 [5][8]:

• From 31 December 2016, the old notes are no longer a liability of the RBI [5].
• A person may hold up to 10 old notes, or up to 25 for study, research or numismatics (collecting coins and notes) [5].

• The fine for holding more is ₹10,000 or five times the face value, whichever is higher. It is imposed by a Magistrate [5][8].

• Court check: in January 2023, the Supreme Court upheld the 2016 decision by 4:1 in Vivek Narayan Sharma v. Union of India.

• Latest case, the ₹2000 note:
• On 19 May 2023, the RBI announced that the note would be withdrawn from circulation. It continues to be legal tender [3][4].
• ₹3.56 lakh crore was in circulation on 19 May 2023. This fell to ₹5,743 crore by 29 November 2025, so 98.39% has returned [3].

Don't confuse with

• Money: all legal tender is money, but not all money is legal tender. Demand deposits, cheques and UPI balances are money (part of M1) but can be refused.
• Fiat money: fiat money explains why a note has value (the government orders it). Legal tender is the legal duty to accept that note in payment.
• Withdrawal from circulation: the RBI stops issuing a note and takes it back, but the note stays legal tender (₹2000, 2023). In demonetisation, the note loses legal-tender status (₹500/₹1000, 2016).
• Limited vs unlimited legal tender: coins must be accepted only up to a limit (₹1,000 for ₹1 and above) [6]. Banknotes must be accepted for any amount.

Prelims Hooks

• Legal tender cannot be refused in settling a payment. Cheques, demand deposits and UPI balances are money but NOT legal tender.
• RBI banknotes are unlimited legal tender. Coins are limited legal tender under the Coinage Act, 2011: ₹1 and above up to ₹1,000, and 50 paise up to ₹10 [6].
• Coins are made by the Government of India. Banknotes are issued by the RBI.
• Legal-tender status is withdrawn by a Government of India notification under RBI Act s.26(2), on the RBI Central Board's recommendation. The route was an Ordinance in 1946, an Act in 1978 and a notification in 2016.
• Trap: the ₹2000 note (May 2023) was withdrawn but is STILL legal tender, so it was not demonetised [3].
• Trap: coins of 25 paise and below stopped being legal tender on 30 June 2011 [7].

Mains Points

• Aims vs outcome of withdrawing legal tender:
• The 2016 aim was to destroy black money (income hidden from tax).
• But 99.3% of the SBNs came back [2].

• So most black money is not kept as cash. It is kept as gold, real estate or foreign assets. Acting against benami property and using tax data may work better than cancelling notes (GS-III).

• Institutional design (GS-II):

• s.26(2) gives the executive strong power to end legal-tender status. The only check is a recommendation from the RBI.

• Link this to RBI autonomy, judicial review (the 4:1 verdict, 2023) and the use of Ordinances vs Acts (1946, 1978, 2016-17).

• A gentler tool:

• The 2023 ₹2000 withdrawal kept the note's legal-tender status. Still, 98.39% of the notes returned without disruption [3].
• This shows that a clean-note policy (replacing old or unneeded notes with fresh ones) can manage currency without the cash crunch and informal-sector losses of sudden demonetisation.

Read more

• Legal tender and its withdrawal: demonetisation