Modi's money medicine: Kill or cure?

India's Prime Minister Narendra Modi Image copyright Getty Images

This week will be decisive for Prime Minister Narendra Modi's audacious experiment in tackling tax evasion and corruption in India.

Two weeks ago he gave the world's seventh biggest economy four hours notice that he was going to cancel 86% of its cash - $220bn (£176bn) in total.

But on Friday the Supreme Court warned that unless something changes - and quickly - there could be riots on the streets.

So is India on verge of chaos?

I described the policy of scrapping India's two biggest notes - 1,000 rupees ($15, £12) and 500 rupees (£7.50, £6) - as economic shock and awe, and the effects have certainly been dramatic and for many Indians very disruptive.

But I am going to go out on a limb here. I think India is through the worst, and things are going to start to improve - probably quite rapidly.

Image caption Getting hold of a new 2000 rupee note is taking time

"Your hardship won't go to waste," the Indian prime minister reassured Indians at a massive rally of his Bharatiya Janata Party (BJP) on Sunday. "The country will emerge from this like gold."

It was an appeal for patience, but also a clear sign that Mr Modi recognises the execution of his economic shock therapy was not highly polished.

The so-called "demonetisation" is designed to target what in India is known as "black money" - stashes of corrupt cash on which no tax has been paid.

Indians have until 30 December to deposit their old notes in bank accounts or exchange them in small quantities over the counter for new currency.

Pay in more than 250,000 rupees and the tax authorities will want evidence that you have paid tax.

It is an effort to tackle the endemic corruption in the country, but opposition politicians have been united in their criticism.

They say the policy has been spectacularly ill-planned and has brought virtually the entire Indian economy to a juddering halt.

And there is truth in these claims.

The key was always going to be getting the new 2,000 and 500 rupee notes into circulation as quickly as possible.

That has not happened.

Image copyright NARINDER NANU/AFP/Getty Images
Image caption Long queues of people wanting to exchange the old notes formed across India

Ninety per cent of business in India is done in cash, and often it has seemed as if the entire population of almost 1.3 billion people has joined the same queue - the one you are standing at the wrong end of.

Quite rightly people want to know why more cash wasn't printed in advance; the new notes, obviously, but also the 100 rupee notes, which suddenly became the lifeblood of the economy.

They also want to know why the new notes are too small to fit in the ATM machines. That has been a huge problem because it means most of the new cash has had to be withdrawn from bank counters - a far slower process.

And they want to know why he chose a time when lots of Indians need extra cash.

It is planting season on the vast Gangetic plain - the breadbasket of the country - and farmers complain they do not have the cash to buy seeds and fertiliser.

It is also the start of the marriage season, and across India heart-broken brides and grooms have seen their elaborate wedding plans beached as the cash dried up.

And, as always, the poor are the worst affected. Day labourers, for example, suddenly found it impossible to find work and, as a result, many of them and their families have been going hungry.

Yet there are a number of reasons to believe the tide is beginning to turn, and the "temporary hardships" Mr Modi warned Indians to expect when he announced the policy, are at last beginning to ease.

First off, despite the privations many have suffered there has been no significant public disorder.

Image copyright PRAKASH SINGH/AFP/Getty Images
Image caption These notes are effectively valueless in India's cash economy

Yes, you meet lots of very frustrated people, but very few are actually angry.

Indeed, even after two weeks of queuing, it is rare to find anyone who doesn't support the intentions of the policy.

That might change if India has to endure many weeks more of this, as some economists suggest is possible.

There are elaborate calculations showing how long it will take to replace the almost 15 trillion rupees demonetisation has taken out of circulation.

But the government doesn't have to replace anywhere near that amount. Indeed, the logic of the policy implies the aim will be to significantly reduce the amount of cash in circulation to stop new stocks of black money building up.

And there is evidence that the cash crunch is already loosening up.

The queues outside banks are certainly getting shorter in Delhi, the Indian capital, and other large cities.

Image copyright Getty Images
Image caption Most people were shocked to know that 500 and 1,000 rupee notes in their pockets had suddenly become illegal

As a result there is less urgency about getting cash and people are at last beginning to use it again.

This should quickly become a virtuous circle: the more we all spend, the more cash there is flowing through the economy, the less worried people will be about running out.

There is a big caveat here. More needs to be done to ensure cash gets out into the countryside where 70% of the population lives.

But India can take comfort from how calm the international markets have been.

Despite the scale and impact of the policy there has been no precipitous collapse in the rupee. That implies that investors aren't expecting major economic or social upheaval.

However, that doesn't mean the country is out of the woods yet.

The economy has suffered a major shock - the consensus among economists seems to be that demonetisation will clip at least !% off GDP growth this year.

Image copyright SAM PANTHAKY/AFP/Getty Images
Image caption There is no limit to the amount of old notes that people can deposit in bank accounts until the end of December

But many also believe that the policy will yield long-term benefits.

The huge cash injection the banks are receiving will lower interest rates and allow more lending - meanwhile traditional businesses will be under pressure to find alternatives to cash and thereby be drawn into the tax net.

Whether it will address the culture of corruption and tax evasion that drives the accumulation of black money is less clear.

It is estimated that this shadow economy makes up as much as a fifth of the entire Indian economy.

Demonetisation attacks current black money holdings - the "stock" of cash.

What needs to happen now is an effort to address the "flow".

The government says it has a whole raft of policies to try and do just that.

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Media captionOld 500 and 1,000 rupee notes are no longer in circulation

Earlier this year India began requiring retailers that received more than 200,000 rupees ($3,000, £2,400) in cash to report details of the sale, along with the buyer's taxpayer identification number.

Meanwhile there is a broader effort to draw Indians into the formal economy through the new national digital identification scheme, and the introduction of new financial services based on mobile phone technology.

At the same time the Indian prime minister says additional measures are on the way.

But tackling corruption is never easy, especially when it is as deeply entrenched as it is in India. Nevertheless there is agreement that Mr Modi has seized the political narrative in India.

Analysts say it has also given his BJP a huge advantage in the upcoming elections in Uttar Pradesh, India's most populous state, and crucial to Mr Modi's re-election prospects in 2019.

With no state election funding, India's parties depend on the illicit cash they collect from candidates and businessmen to fund their campaigns. Demonetisation will have emptied his rivals' campaign coffers at a stroke.

And it also offers the opportunity for another grand gesture.

I'm told by people close to the Indian leader that he is considering a huge cash giveaway in the New Year.

Once the 30 December deadline is over the government will be able to announce how much of the 15 trillion rupees it has taken out of circulation has been returned to banks.

The shortfall is expected to amount to many hundreds of millions of rupees.

The rumour is that he will return this to poorer Indians in the form of a one off payment of up to 10,000 rupees ($150, £120).

My sources say this will be presented by Mr Modi as a return of "black money" to those from whom it has been stolen, and also as compensation for the disruption people have suffered.

Image copyright AFP
Image caption India scrapped 500 and 1,000 rupee notes to crack down on corruption

There is likely to be one condition attached: that it be paid into a bank account, thereby adding momentum to the effort to draw Indians into the formal economy.

It is an intriguing suggestion, though many would regard any such a payment as an outrageous bribe to voters.

Even if this speculation proves unfounded, what is very clear is that demonetisation has reinforced the Indian leader's image as a strong decisive leader, willing to take bold decisions.

Mr Modi's enemies use a Hindi word to describe him. They say he is "chalu" - which means cunning and ruthless.

Chalu has very negative connotations, but even Mr Modi's most fervent supporters agree he is a very shrewd politician indeed.

This is my view, but I want to know what you think. If you disagree with my analysis don't hesitate to get in touch. I'm on Twitter @BBCJustinR.

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