Modi's War on Cash: The Seen and the Unseen - The 5 Minute WrapUp by Equitymaster
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Modi's War on Cash: The Seen and the Unseen

Nov 26, 2016

In this issue:
» Demonetisation and the Broken Window Fallacy
» Replacing the Old Rs 500 and Rs 1,000 Notes is a Challenge for the RBI
» ...and more!
Rahul Shah, Co-Head of Research

The demonetisation saga rolls on. It's safe to say that the move has had a polarising effect on people's opinions. The government has deservedly received both applause as well as criticism.

Many people have taken sides. Many want to but don't know which side is right. Many others have no idea how it will all play out and are just hoping for the best.

That many people are confused is completely understandable. However, what's less understood is the underlying reason behind the confusion.

It's easy to say 'we don't know what might happen'. That's fine. No one fully does. But let me try to explain with an example.

The kids in my housing society love to play cricket. However, they're aren't concerned about the consequences of hitting the ball too hard. One day a ball struck hard crashes into my window, breaking the glass.

I am furious.

Now what if someone says, 'forget it, at least the local glazier will get some business.'

Let's assume it costs Rs 1,000 to repair the glass. The glazier will be happy. The carelessness of the kids in my society has certainly helped his trade. But should I therefore conclude that it's good that kids break windows?

No, of course not.

So what is the logical fallacy here?

It is called 'the broken window fallacy'.

You spend Rs 1,000 to fix your window. This is what is seen. However, you could have spent the same Rs 1,000 on something else, say a nice pair of shoes. By not buying the shoes, you have deprived the local shoemaker of some business. This is what is unseen.

This explains much of confusion about the effects of Modi's war on cash. We have all been caught up in what is seen. There's not enough attention being paid on what is unseen.

Let's have a look at some of these issues.

Corporate profitability

Seen: Any move to reduce corruption is a long-term positive for honest businesses.

Unseen: Even honest businesses have suppliers and customers that use cash. An example is the auto industry. The industry is experiencing supply as well as demand hit that will take time to sort out. Cash dominated industries like retail, textiles, jewellery, handicrafts, jute, fisheries and many others have taken a huge blow. Another good example is the Rs 70 billion bicycle market in Punjab as reported today in The Financial Expres.

Real estate

Seen: Cash is a big component of real estate transactions. Demonetisation will reduce this cash component and thus bring down prices.

Unseen: Falling property prices will cause pain to existing home buyers. Almost everyone buys a home with the help of a home loan. Falling prices will reduce the value of their collateral. The problem of dual financing will also raise its ugly head.

As Richa wrote in The 5 Minute WrapUp yesterday,

  • 'It's a well-deserved blow to those who evaded tax and used unaccounted income to buy property. Yet, the common man who paid tax, employed his deposits and savings, and used 'white income' to buy a home will be hit worse: Not only did he pay tax, but now the value of his home is eroding because of those who didn't.'

    We already have 60% of the banks burdened with non-performing loans that are at historic highs. The banks and NBFCs may claim that their loan to value ratios are within limits. But most of them are over exposed to the realty sector thanks to the system of dual financing. With sector already reeling under the bad debt crisis, this could be the proverbial last straw to break the camel's back.

Interest rates

Seen: Banks are flooded with liquidity. Interest rates are bound to come down. Cheaper loans will give a boost to economic activity.

Unseen: Deposit rates will come down too. Banks are notorious for cutting deposit rates faster than lending rates. Savers will be thrown under the bus.

As Tanushree wrote in The 5 Minute WrapUp recently,

  • 'The government's concern so far has only been about lower interest cost for borrowers. The fact that at negative real interest rates, bank deposits will become unviable, has been of little concern. Reluctance to park money in low yielding bank deposits could have multiple adverse impact on the economy.

    First, the household savings appetite could truncate further.

    Secondly, investors looking for fixed returns may get lured by the steep yields offered by risky corporates on their bonds.

    Thirdly, households may choose to go back to investments in gold and real estate instead of growing their financial assets.'


Seen: The government will be richer after the dust settles. It will use its improved fiscal position to spend on infra projects. The economy will receive a boost due to this increased spending.

Unseen: Can government spending really compensate and pick up the slack? The short-term blow to employment may not reverse fully. Corporates are already downsizing.

As Tanushree wrote in The 5 Minute WrapUp recently,

  • L&T, which reportedly decided to lay off 11.2% of its total workforce, almost 14,000 employees, attributed it to business slowdown, digitisation and redundancies that led to downsizing. We are not surprised.

    In fact, we believe the situation could actually get worse.

    Consider this...

    First, Trump's win in the US. This has put India's IT sector in the spotlight. IT service companies, the last straw of hope in the critical job scenario, are themselves expected to lay off thousands in the years to come. And the situation could turn out to be even worse. We don't know as yet.

    Second, the demonetization-led economic slowdown which has brought corporate activity to almost a screeching halt. Even if it takes six months to adjust to this black money move, you can imagine the impact on job seekers and their families. Not to mention potentially huge job losses in the unorganized sectors.

Stock markets

Seen: This is a bad time for the markets. With profits sue to fall in the short-term, markets are falling.

Unseen: This is a great buying opportunity.

Here's Tanushree again,

  • As far as the long term outlook is concerned, there are two ways the stock markets can benefit. First, from the very improvement in fundamentals this would lead to and second, there's a strong possibility more money moves into stocks as black money investment channels dry up.

    But does this mean we should go out and buy every stocks we could lay our hands on? Absolutely not. The principles of stock selection still remain the same; buying fundamentally strong companies, run by a competent management team and available at reasonable valuations.

This is why it is important to ignore simplistic explanations. The current economic situation in India is unprecedented. The need of the hour is competent and honest and unbiased views on the government's war on cash aka demonetisation.

We believe, Vivek Kaul has done an excellent job in this regard.

You could do no better than read Vivek Kaul's insightful little report on this subject, Demonetisation: The Good, Bad and Ugly. It has some great information on how demonetisation could impact things like your investment and your property.

I strongly recommend you read the complete note here.

You can also read, Vivek's take on 'the broken window fallacy' here.

03:35 Chart of the Day

The data published by the Reserve Bank of India (RBI) on the number and amount of high denomination currency in circulation in India throws up a number of questions. Why did the central bank print so many of these currency notes in the first place? Now, India is primarily a cash based economy.

The numbers over the past few years show that the share of Rs 500 notes as a percent of total currency notes in circulation rose from 14.7% to 17.4% in past few years. While the share of Rs 1,000 notes remained constant.

Plugging the Currency Gap of High Value Notes

In terms of value terms too, the percent share of these high denomination notes rose from 84.1% to 86.4%. The reasons for printing these notes could be due to higher inflation thus a need for high value notes and also logistics and costs involved in printing of lower denomination notes.

The reasons may be varied. However, replacing these notes will be a huge task for the central bank and it would take months. Thus, this vacuum created by banning these notes which formed over four-fifths of currency in circulation needs to be plugged fast. The spill over effect of this is already visible in a drop in the consumption numbers for the country and this might just be the start of troubles.

Demonetisation: The Good, Bad and Ugly is a comprehensive report on the effects of this demonetisation. Reading this will equip you with the know-how of how to deal with the sudden impact of this historic move made by the government.


The global financial markets are witnessing volatility. The historic election of Donald Trump as the 45th president of USA has shaken global financial markets.

Most of the volatility was seen as speculation regarding an US interest rate hike by the Fed intensified. This came as data released during the week showed US home resales rose 2% in October to an annual rate of 5.6 million units. This was the highest level in more than 9 and a half years. The data pushed the dollar to its session highs and also sparked optimism regarding the US economy. The US markets were up 1.5% for the week gone by.

The hike, however small, will lead to a global change in the direction of interest rates. This could mean a pullback of cheap liquidity from emerging markets, including India.

In another news, the European Central Bank (ECB), in its Financial Stability Review warned for more volatility in the near future in global financial markets. As per the ECB, the risk of an abrupt global market correction has intensified on the back of widespread political uncertainty, posing a threat to banks, stability and economic growth. Stock markets in Germany and France were up by 0.5% and 1% for the week gone by.

Central banks across the world are trying to prod growth with the help of stimulus measures and near-zero or negative interest rates. This is seen because many nations today are struggling through a period of low to no growth. The reasons are many - ranging from central bank policy measures to deleveraging and demographics. The average consumer is saddled with large debts and is looking to pay them off. This means a lower outlook for growth. This low growth scenario is one of the reasons for all the scrutiny over interest rates.

Back home, the BSE-Sensex ended on a Flat note and was up 0.6%. The week started on a weak note, with FIIs outflows. The markets reacted to the possible slowdown in the economy amid the demonetisation. Further, the possible fed rate hike added to the woes. However, markets saw some recovery in the later part of the week. DIIs showed the buying interest. Demonetisation and the possible fed rate hike has created some fear in the market and this has led to volatility. We believe this would continue in short run.

Performance During the Week Ended 25th November, 2016

04:55 Weekend investment mantra

"Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Rahul Shah (Research Analyst).

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7 Responses to "Modi's War on Cash: The Seen and the Unseen"


Dec 1, 2016

I'm my view any announcement made by pm or f m has to be followed by notification or r b I instruction to bank.the amendment to law was place in parliament very recently , than how people believed them . politician are expert in changing their views on some pretext or another that has been done by govt.It is simply foolishness of people to believe on announcement or comments. we are democratic country uptil now but how long we will remain democratic I have my doubt the way in which we are being governed, excuse poor people, as it is their vote bank. this is first step towards dictatorship, if you open german history and read hitler you will observe very similarity, with passage of time refinement has come but aim is same.I was very optimistic when b j p came to power but all hopes are getting belied.



Nov 28, 2016

Most of business people are saying that they have not seen this kind of slowdown in last 3-4 generations. The businesses that will survive this depression will easily survive for next 50-100 years.



Nov 27, 2016

Rahul Shah,
It is always good to play the devils advocate, however...
- Are you suggesting that the step SHOULD NOT HAVE BEEN taken because of the allegedly unseen effects...
Let me give you an analogy...
This is like giving ChemoTherapy to a cancer victim, there is BOUND to be some collateral damage, however that does not discredit that line of treatment...
Regret to say it is a shallow article... calculate the PROS and CONS, quantify by a number, extrapolate the effect after 2 years : It is indeed complex, as it is interlinked to other world events...
STILL : AS A PARENT TELL ME, are you leaving a better future for your CHILDREN...

Like (1)


Nov 26, 2016

Demonetisation has certainly hit the perpetrators of terrorism, the drug peddlers, the land mafias, havala traders, the gambling trade, the immoral traffickers who are a burden to the nation and drain on the economy. The people involved in these nefarious activities are the ones who will be unemployed.A large segment of the people waiting in the queues are the ones who do not contribute to the mainstream economy, but have been paid by the black money hoarders to exchange the banned currencies. It is fallacious to conclude that business has come to standstill due to people waiting in queues .

Like (1)

Jeevan Shetty

Nov 26, 2016

5 Minute Wrap Up writes on topical subjects. It is acceptable that they may not be subject matter experts in every field they write. Demonetization is one such area. This has come as a bolt from the blue. No body has done any research or study on this subject. Everybody is presenting their personal opinion. This is compounded by the political and business interests.

The broken window fallacy is over simplification of a complex situation and displays that the enormity of the challenge is not comprehended. The optimum solution can only be concluded on hindsight. It would be better appreciated if correct perspective is presented with no ready made solution being not available. It is like a surgical strike, although there is preparation, the exact outcome will be know only on hind sight.

It is common knowledge that bulk of the cash business uses both black and white money. Most people who complain camouflage their real problem of extinguishing of black money saying there is great inconvenience to business. They do not talk as how they are meeting the challenge of demonetization.

Like (1)


Nov 26, 2016

The article seems to demonise demonetisation and fails to acknowledge the terrorist funding, drug menace, high inflated real estate prices ,corruption, the prevalent inflation , inflated stock market .which would be impacted by the demonetisation .What is seemingly unseen by the authors and other writers is the harm done to the economy by the ill gotten wealth of the traders/businessmen/corrupt officials and politicians.Are the small traders/ businessmen ,the bullion traders, , real estate players and we all citizens not responsible for the mess. The small traders / medical practitioners/lawyers etc refuse to give receipts for transactions ,services rendered /give fake receipts and the buyers of the goods and services do not insist for receipts as the goods are priced lower.It is these large segment of non-tax payers/tax evaders who have been thriving on the ill gotten wealth (at the cost of tax payers ) who have been 'crying wolf' . The vast majority of the population who do not have any access to high priced fancy imported goods, diamond and gold jewellery, fancy cars, luxurious apartments and luxurious vacations are the ones who have shown immense maturity and willing to face temporary hardships for long term gain, which should be appreciated. Had the unaccounted money rolled back in the economy ,it would have a multiplier effect and led to higher demand for goods and services due to affordability which would have fuelled higher economic growth benefitting a higher segment of population. Demonetisation will certainly change the way of doing businesses and bring in more tax payers .The ball is now in Government's court to reduce taxes and enhance the goodwill of the masses who have hailed the Government decision.

Like (1)

sundaravaradan S.

Nov 26, 2016

Modi's war on Cash::::
What I see is imagined look of total NEGATIVISM by the Authors.(These Authors always show Negativism).

Corporate Profitability:
Comments;;; No cash will stop business...Ans: Why not Cheque, Card, UPI etc...??

Real estate:
Comments: White-Money Payers will also loose... Ans: (I am buying a Flat..), NO Reduction in Price, if paid in white...(ask Ashiana Homes).

Lower Interest Rates by Banks:
Comments: Bank FD Depositors will loose money...Ans..: LOL...Everyone knows the Flow to MF is enormous... Even EQM advises same! Let them allocate in lower Real-estate, Gold..What is the problem?

Comments: Lower employment.
Everybody is Short-Term blow... Govt. will revive Infra & other spending...leading to good employment.
So many Digital-Start-ups...!! Leading to employment.

Overall: More than 90+ % people, all over the world are praising Namo. So many Digital options like Paytm are used by veg-vendors. (Hope you saw the Whatsup, FB, News-Paper etc...) So many innovations implemented by Public...

Showing -ve side is Good....But, ONLY showing -Ve.... In all the articles by Authors....???
Please THINK...who is getting Brain-washed...?


Like (1)
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