NEW DELHI, DECEMBER 21 (REUTERS): A leading political ally of Narendra Modi has abruptly distanced himself from the Indian prime minister's move to scrap high-value banknotes, as broad initial support for the radical monetary reform showed signs of crumbling. The shift by N. Chandrababu Naidu, chief minister of Andhra Pradesh, came six weeks after Modi announced to a stunned nation that he would scrap 86 percent of the cash in circulation. While Modi remains by far India's most popular politician, any crack in his authority could have negative implications in state elections next year that will set the tone for his expected bid for a second term in 2019. Naidu's regional party is allied to Modi's nationalists and he heads a central committee set up to find ways to soften the impact on ordinary people of the crackdown against tax evaders, racketeers and bribe takers who rely on so-called "black cash". "I am breaking my head daily but we are unable to find a solution to this problem," Naidu told party workers on Tuesday in the city of Vijayawada. Modi, announcing the reform on November 8, cautioned that people would face temporary hardship. He promised to restore normalcy by the end of the year, when a deadline to deposit old 500 and 1,000 rupee banknotes expires. His announcement enjoyed popular support at first, with many people prepared to endure hardship as long as others are forced to give up their ill-gotten wealth or pay tax. But continuing shortages of new 500 and 2,000 rupee notes have caused tempers to rise as millions queue at banks and ATMs to draw money. With new 500 rupee notes, worth $7.50, in very short supply it is hard for people to buy necessities because of a shortage of change. "Modi is now a one-man army, every political ally will blame him if the cash crisis does not come to an end in the next 10 days," said P. Raja Rao, a political science professor in Hyderabad. Furious over the lack of cash, mobs attacked six bank branches in Uttar Pradesh on Tuesday, forcing police to rescue bank staff. The northern state, home to one in six Indians, is due to hold an election in early 2017 that is increasingly being viewed as a referendum on Modi's demonetisation drive. In the last 20 days, Modi's Bharatiya Janata Party (BJP) has won several local elections in western and northern states. Party officials said the wins were a clear endorsement of the new cash policy. "Each and every Indian understands the genuine intention behind the bold move. They trust the prime minister and we hope our political allies put an end to their doubts," said BJP spokesman Siddharth Nath Singh. ‘ECONOMIC SHOCK TO LAST TILL MARCH’ The negative shock from India's ban on high-value banknotes will last until the end of March but improved growth next year should fully compensate for the loss, a top economic adviser to Prime Minister Narendra Modi told Reuters. Bibek Debroy, a member of the government's main policy think tank, said on Wednesday the "demonetisation" drive would improve the fiscal position and urged the government to spend any extra revenue on public investment. By outlawing all 500 and 1,000 rupee notes in the surprise Nov. 8 announcement, the government hoped people would deposit illicit or untaxed income into banks, boosting tax collection and incentivising the millions operating in the "shadow" economy to enter the formal economy. The decision sucked 86 percent of cash out of circulation, forcing millions of people to cut outlays and clog banks in search of money, and leaving businesses struggling to pay wages. "There is certainly going to be a negative shock in Q3 and Q4 of 16/17, which should be compensated by a positive impact in 17/18," Debroy said in an interview, referring to the Indian fiscal year that runs until March. "A whole lot that was informal will become formal and a bit more organised," he added. "That is a positive externality in the slightly longer term." PAIN, THEN GAIN Most economists predict a short-term hit to economic growth from demonetisation, while the Reserve Bank of India has trimmed its growth forecast for the current fiscal year by half a percentage point to 7.1 percent. Debroy, however, said it was impossible to quantify the impact, because the government does not yet know how much cash will come back into the system and what it would do with any extra tax revenue. Some economists have called for emergency fiscal stimulus to stave off a sharp slowdown, but Debroy said the government should instead focus on public investment. "I don't like the word fiscal stimulus – even before Nov. 8 there was an issue about increasing investments, both private and public," he said. "What we are talking about is greater public investments in the form of creating assets. That requirement existed before Nov. 8." Debroy said the political fallout from demonetisation meant the government was now unlikely to meet an April 1 deadline to finalise its crucial nationwide Goods and Services Tax - the largest taxation overhaul in independent India. He said Sept. 1 was a more reasonable target. Modi needs to clinch a deal with India's 29 states on the tax, but the last parliamentary session was a washout as the opposition and government squabbled over the impact of his cash crackdown. Debroy expects the next session, set to begin before the government presents its federal budget in early February, to be more productive, narrowing the risk that GST is further delayed. "We are all suffering from a bit of myopia because the last parliamentary session was a bit of a mess. It might well be that the budget session would be a bit more productive," he said.
