As I sat chilling in a tea shop in India, a man ran from store to store yelling “he is here.” My friend, the shop owner, quickly gathered and dispatched his cash. The local early-warning-system for the tax collector had been activated. The tax auditor was making the rounds.

The first few businesses audited take a hit, but the neighbourhood watch made sure the majority evaded taxes. Conservative estimates suggest that for every rupee collected in taxes in India, at least two rupees remain outstanding. Compare this to $2 evaded for every $10 collected in the U.S.

So, on Nov. 8th, when Prime Minister Narendra Modi declared all 500 and 1,000 rupee notes non-legal tender in a bid to clamp down on corruption and “black” money, I rooted for him. People had until Dec. 31st to convert the notes to newly minted 2,000 rupee notes in regulated tranches. Large deposits were flagged and taxed.

The bombshell pronouncement without any public warning — intended to catch cash hoarders before they laundered their loot — effectively took out of circulation 86 per cent of the active currency notes. Dubbed by the government as a “surgical strike” against crooks, the Indian Supreme Court characterized it as a “carpet bombing” of the average Indian and ordered the government to alleviate the suffering. Ironically, Modi’s party had previously attacked the Congress government’s attempt to demonetize in 2014 as “strongly anti-poor.”

Demonetization is a much-lauded policy with long-term benefits for economies, especially if the inevitable short-term fallout is better managed and any inside information abuse is curbed.

For starters, it can result in more disclosed incomes and higher tax capture. Indeed, any number more than the current 1 per cent of Indians paying taxes will be a huge boon. With economists predicting as much as $45 billion (U.S.) in additional taxes, there would be plenty to cover the government deficit and increase spending on education, health, and housing.

The banks are also expected to benefit from the increased liquidity. In fact, in the first week alone, new deposits reached $44 billion (U.S.) and millions of people opened bank accounts.

Digital payment system registrations also increased, possibly contributing to better tracking. Moreover, economic activity should also increase (after the initial slowdown due to uncertainty, panic and poor execution) as people move cash into the formal economy.

Predictably, many including the European Union. welcomed the move in the name of improved transparency and economic growth.

Sadly though, it brought chaos to an economy where more than 85 per cent of wages and 90 per cent of transactions were cash-based. Though the long bank lineups have now diminished in urban areas, dozens of deaths, massive disruption, lost income, cash flow problems and lost jobs have put a damper on the initial enthusiasm on the Indian streets, but many of the hardest hit continue to stand by the prime minister as he connects with their deep frustrations over corruption.

Modi initially appealed for patience and 50 days. His New Year’s Eve message of short-term pain for long term gain, has resonance with a population that is used to, in Modi’s words, “sacrifice” to “cleanse” the system. Indeed, ritually offering oneself for a greater cause is a dominant virtuous theme in much of the East.

Unfortunately, the pain does not appear to be going away anytime soon. It may get worse before it gets better. The lower consumption is having a domino effect on sales, production and the overall economy. In fact, for the first time in 2016, Indian manufacturing as measured by the purchasing managers’ index (PMI) contracted in December.

In truth, corruption and tax evasion (arising from bribery, under-reporting, false invoicing etc.) is far from over. At best this policy may only capture a tiny fraction of the illegal funds. The rich, of course, have resources to absorb inconveniences. In fact, many hired the poor to convert their cash and one investigative news outlet pegs the profiteering from leaked inside information at $12 billion.

If Modi was serious, in the words of esteemed economist Jayati Ghosh, he could have taken “the most obvious steps — such as taking a strong line on the known illegal accounts held in Swiss banks and tax havens, or ending the ability to hold shares without revealing your identity, or making funding of political parties transparent.”

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The patriot or fraudster binary coupled with the underlying religious shame and pain theme favours Modi. Though the clear lesson is that simple populist policies sound good in theory, but their execution may not be as smooth and may even backfire on those who can least afford it.

Faisal Kutty is counsel to KSM Law, an associate professor at Valparaiso University Law School in Indiana and an adjunct professor at Osgoode Hall Law School. @faisalkutty.

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