I have a very pessimistic hypothesis that this event will trigger a recession and that India has effectively committed economic suicide.

My reasoning behind this derives from the question, why doesn't this happen in developed economies? Or, in other words, why do people in developed economies / less corrupt countries prefer official institutions over cash transactions?

From a first principles perspective, I suspect that the answer is the services associated with these institutions and channels.

When I make a business transaction anywhere within the developed world, I am exchanging money for the promise of goods and services - creating a form of contract which binds me and the entity I am transacting with. This contract is enforceable (at varying cost) through the court system, which offers a form of insurance in case things go wrong i.e. one side or the other reneges upon their promise. It is therefore rational to participate within that system for that reason alone - it's very hard (or at least harder) for someone to disappear with your money without some consequences associated with it.

Participation within the system also grants access to additional services and benefits from civic services to relatively low transactions costs. Further, there is an active system which punishes deflection. Therefore all of these factors combined with social shibboleths serve to prevent deflection.

India has none of this. The court system isn't functional, civic services are non-existent, and there is no punishment for deflection. Therefore, there is no rational reason why an actor within this system would transact via the official channels - it increases costs and provides no additional benefits in return.

From this perspective, I believe that the "black" or parallel economy actually serves like a decentralized gross settlement system. People create contracts with the strength of their social ties in mind and they transact accordingly. When these people demonetized 80% of the tender in circulation, [1] they actually disrupted this settlement system and wiped out the central mechanism through which most business transactions are done. The reason why I think this is the case is because it is actually highly irrational to hoard cash - especially in an economy that suffers from a high amount of inflation. Surely anyone with even a tiny bit of prudence would invest / consume their ill gotten gains?

If my hypothesis is correct, then this war on cash will a) never achieve its goals, b) disrupt supply chains, c) suppress consumer activity, and d) create other unpredictable economic repercussions. This may be equal to institutional failure to perform settlements [2] within a developed economy - the velocity of money has sharply dropped leading to an economic crisis.

I don't know what comes next, but it's likely to go down in history as a Bad Idea in a year full of Bad Ideas.

[1] http://www.reuters.com/article/us-india-modi-corruption-idUS...

[2] Essentially the idea is that if one bank fails to settle payments within the system, then it could lead to a failure cascade due to how strongly all banks are tied together within a modern economy. http://www.econ.tcu.edu/quinn/crisis/Deleveraging/Bank%20Fai...