NEW DELHI—Early last month, Prime Minister Narendra Modisummoned his cabinet to a room in India’s capital, told them to leave their cellphones outside and delivered a shocker: He was about to go on national television to declare that almost 90% of the country’s paper money would no longer be legal tender.
The move, prepared in secret by Mr. Modi and his advisers, kicked offa radical experiment in government control and instantly put India at the forefront of a nascent global campaign against cash. The European Central Bank has said it would stop printing the €500 note in 2018. Canada and Singapore have phased out their large-denomination bills. The Philippines, Denmark and others are tweaking regulations to nudge citizens to switch to electronic payments.
But no one has gone as far as Mr. Modi. Aiming to cut back tax dodging, terrorism and government corruption, he made India’s largest bank note and one of its most commonly used ones—the functional equivalents of America’s $100 and $20 bills—unusable overnight. Indians can deposit the discontinued bills in a bank before the end of the year to preserve their value. New bills are being rolled out, but so far they amount to only about a quarter of the $230 billion in cash that was voided.
India is hardly alone in seeking to drive underground money into the banking system. But the scale, pace and finality of Mr. Modi’s action make it a stunning and painful test of what had to this point been a largely theoretical debate.
“The great task that the country wants to accomplish today is the realization of our dream of a cashless society,” the prime minister said in a recent radio address.
For a country where few families pay any income tax and even large transactions are often completed in cash, the disruption has been significant—posing new risks for the world’s fastest-growing big economy and Mr. Modi’s popularity.
Home sales have flatlinedin the month since the Nov. 8 announcement. Daily uproar by opposition parties has brought Parliament to a standstill. Tourists have been stuck mid-voyage, unable to tip or buy souvenirs. And there have been long, sometimes tense lines at banks and ATMs.
The lives of the poor, in particular—many of whom depend on irregular, off-the-books employment paid in cash—have been upended.
Recently, after weeks of fruitless job-hunting near his Delhi slum, onetime factory worker Vijay Bhardwaj was contemplating riding out the crunch in his native farming village. Not that there is much money to be made there, either. “If there was work in the village, then I wouldn’t have come here,” he said.
In the gritty western city of Morbi, a major hub for makers of kitchen and bathroom tiles, production is down 30%, said Nilesh Jetpariya, president of the local ceramic-industry association. Short on cash to pay laborers and truckers, around a third of the city’s 650 tile factories are shut.
K.G. Kundariya has started paying employees at his three tile factories partly in groceries—rice, wheat, cooking oil—so they don’t go hungry. Local grocery stores don’t have enough cash to pay wholesalers, so ceramic companies have had to step in and offer guarantees just so supplies of staples like sugar and grain keep flowing.
Rohit Talwar, whose company in the northern city of Moradabad makes candle accessories and other handicrafts for U.S. brands likePier 1 Imports Inc., welcomed Mr. Modi’s move at first. But he has had trouble paying his workers and suppliers, who need cash to make critical purchases.
“In India, unfortunately, everything has cash involved at some point,” Mr. Talwar said. “You may want the entire country to go cashless, but you can’t make that happen overnight.”
Mr. Modi’s plan for the announcement was carefully coordinated. His ministers, once assembled, weren’t allowed to leave until their boss’s address to the public was complete, according to people familiar with the meeting. The government then ordered all banks closed for a day to prepare for an onslaught of customers.
But the almost unfathomable logistics of the effort have forced authorities to adjust course on the fly.
At first, people were allowed to exchange the discontinued bank notes for a redesigned 500-rupee note and a new 2,000-rupee note. That proved so unwieldy the government ordered banks to stop. Crowds at many branches grew so large that battalions of security guards were needed to keep order.
Now, Indians who have bank accounts—many don’t—can withdraw up to 24,000 rupees a week, about $350.
Even with those limits, the banking system is straining to keep up.
Navroze Dastur, managing director for India and South Asia at NCRCorp., an ATM maker based in Duluth, Ga., got the news of the cash cancellation on TV, just like everyone else.
Half of India’s roughly 200,000 ATMs are NCR’s. But Mr. Dastur didn’t get a sample of the new cash those machines would be dispensing until three days after Mr. Modi’s announcement, when a bank employee brought a few hundred fresh notes in a suitcase to the company’s office in Mumbai.
That was when Mr. Dastur noticed a problem: The new bills were slightly smaller than the old ones.
Huddling that afternoon with fellow ATM makers and regulators at the Reserve Bank of India, Mr. Dastur explained that engineers would have to open up each of the nation’s ATMs and manually reconfigure the cash drawers before they could dispense the new notes—a process that NCR estimated could take two months.
“I don’t think they realized the magnitude of the work involved,” Mr. Dastur said.
The RBI didn’t respond to requests for comment. Finance MinisterArun Jaitley said at a press conference in November that the machines couldn’t have been adjusted in advance lest word of the plan leak out.
The economy has already taken a knock, the central bank warned recently. Some businessmen worry that recovery could take a year or longer.
The Modi administration insists there will eventually be big benefits, including better tax collection, improved surveillance of crime networks, and more accurate monitoring of commercial activity itself.
Defenders of cash see risks in those same capabilities—including a loss of privacy and a vast expansion of government power.
Paper money, however, is starting to look vulnerable. China and Sweden are studying issuing their own digital currencies. The ECB has targeted €500 notes that had earned the nickname “Bin Ladens” for their popularity among criminals and terrorists.
Former U.S. Treasury Secretary Lawrence Summers, writing in The Washington Post, argued, “It’s time to kill the $100 bill.”
Technology has made it easier to press the case against cash. Credit and debit cards couldn’t penetrate the far reaches of the global economy. But phone payments are making tiny cashless transactions accessible.
Fewer than a third of Indians have a smartphone, according to research firm IDC, and patchy connectivity can make digital transactions cumbersome.
Still, millions of Indians have signed up for mobile wallets. Mom-and-pop shops, tea stalls and rickshaw drivers who had never even used a credit card have learned how to accept payments through their inexpensive smartphones.
“This is mostly happening because of developing technology,” said Harvard economist Kenneth Rogoff, author of “The Curse of Cash.” “That’s a big ally of governments.”