Is Demonetisation Modi's Act of Creative Destruction? - The 5 Minute WrapUp by Equitymaster
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Is Demonetisation Modi's Act of Creative Destruction?

Nov 30, 2016

In this issue:
» The 500 rupee note remains elusive .
» Are we prepared to enter the digital age?
» ...and more!
Ankit Shah, Research analyst

I am writing today from a small village near Pondicherry. I arrived here a week before Modi's big-bang demonetisation announcement.

I'm far away from my usual nesting place, Mumbai.

I have no television set in my room. No newspapers.

In the absence of the noise and distractions of the mainstream media, I've had the opportunity to look closely at the ground-level realities post 8 November.

I've been touring around the villages on my rented scooter...offering rides to the locals...observing the daily lives of the people at work (and outside banks and ATMs)...talking with shop owners...and at times just contemplating life and money over cups of masala chai.

Let me make one thing clear.

I DON'T want to speculate on whether Modi's decision is a masterstroke or political suicide.

If you want that, you can stop reading this right away and switch on your television. You'll find endless reels of it.

But if you are a serious long-term investor and are willing to look beyond the near-term consequences, I am going to take you on an insightful journey.

Imagine it's the year 2030. Modi is no more the prime minister. And there are no more long queues outside ATMs. In fact, your visits to the ATM have reduced significantly. From this vantage point, let's look back at what happened in November 2016.

When I look at Modi's demonetisation drive from that perspective, I look at it from an evolutionary perspective.

It reminds me of 'creative destruction', a term coined by one of the most influential economists of the 20th century - Joseph Schumpeter.

What is creative destruction?

It's the process by which something new brings about the demise of whatever existed before it.

In Capitalism, Socialism, and Democracy, one of Schumpeter's most popular works, he makes a potent point...

  • Economic progress, in capitalist society, means turmoil.

How can progress mean turmoil? How can destruction be creative? Does that confuse you? Isn't that a paradox?

The truth is that, for something new to arise, something old must die. That's the very essence of change in life...and in economics.

What Modi has unleashed on the people of India appears to be an act of creative act of radical change.

Will the change be good? Or will it be bad?

This is what people are curious to know. But it's the wrong question. That's because demonetisation cannot be good for everyone or bad for everyone. Some will be adversely impacted...and some will be better off.

The right question to ask is:

Who will benefit from the change? And who will be destroyed?

Remember, from the evolutionary perspective, this is a game of survival.

  • It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change. - Charles Darwin

In the aftermath of Modi's demonetisation move, we've seen a flood of reports about how demonetisation will lower India's GDP for fiscal year 2016-17. Brokerages, ratings agencies, and so-called stock market 'gurus' have been coming up with different figures every day.

Now, there's no denying that demonetisation is going to have a big impact on economic activity in the medium term. That's for sure.

But we're not pulling out our hair over this issue. We'll let the brokerages and the so-called experts indulge in the GDP number game.

Besides, according to big-picture expert Vivek Kaul, the media is obsessing over the wrong number. Vivek's not at all worried about the GDP number.

He's worried about another number. A truly critical number. A number that concerns every Indian, including you and me. And he believes that Modi's demonetisation drive is going to make this number worse.

How we deal with this number will, in Vivek's view, define the future of our country.

Here's everything that you need to know about this number.

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03:45 Chart of the Day

The only thing on everyone's mind these days is demonetisation. The scarcity of notes has seen the common man queuing up outside banks and ATMs for endless hours to withdraw their own hard earned money.

The other day my colleague was at a public sector bank to withdraw money for her daily expense. She waited in the queue patiently for almost two hours. With the bank shutting for lunch after 15 minutes, she gasped a sigh of relief seeing only one gentleman ahead of her. But my colleague's hope was shattered in the next few minutes as the gentleman ahead of her laid down large bundles of notes from his suitcase on the cashier's table. Seeing the large amount of cash, the cashier asked her to come after lunch.

But my colleagues' ordeal did not here. When she returned after lunch, the cashier was still struggling to complete the process of counting and depositing the notes in the gentleman's account. Finally, after an impatient wait of another hour, the colleague finally succeeded in withdrawing her money. But to her disappointment she was handed only Rs 2000 notes making her wonder how she would be making small grocery purchases.

Most of you have must have had a similar experience. Most of the people I have met have proclaimed support for the demonetisation drive but are very unhappy about the patchy execution by banks.

And one of the biggest grouse has been the acute shortage of the Rs 500 note.

Was the government well prepared to execute the demonetisation?

If reports are to be believed then the government planned to bring the Rs 2000 notes first to expedite the replacement of the void 500 and 1,000 rupee notes. This is because four 500 rupee notes would have to be printed for every one 2000 note. Even the government resources for printing do not seem adequate. The two printing presses, The Security Printing and Minting Corp. of India Ltd (SPMCIL) and Bharatiya Reserve Bank Note Mudran Pvt. Ltd (BRBNMPL) have a combined capacity of 24 billion pieces a year or roughly 2 billion pieces a month. The SPMCIL has printed only 15 million pieces of the new Rs 500 note. And with 22 billion of Rs 1,000 notes and Rs 500 notes to be replaced, it will be a while before the money supply is restored.

The All Too Ubiquitous Rs 500 Note


The demonetisation drive has been hailed by the government as the big move towards a cashless economy that will usher in greater transparency and curb black money. But a million-dollar question remains - are banks and other financial institutions technologically competent to tackle the security issues associated with the shift towards a digital economy?

Can the common man fully trust that his hard earned money in the financial system will be safe from hackers and fraudsters?

And the answer does not seem be a comforting one!

Recently a taxi driver in Punjab became a crorepati overnight.

Here we are not talking of the moolah that he earned from winning a lottery. But rather the bounty of Rs 98 billion that was transferred to his Jan Dhan account. The glaring mistake was due to a wrong entry by the bank official who accidentally entered the Banking General Ledger account number in the amount column. The mistake was rectified the very next day. But not all such stories end on a happy note.

There have been several instances of debit and credit cards being hacked and large sums of money fraudulently withdrawn from the accounts of hapless account holders. And with a large population still not financial literate, they remain gullible to falling prey to such frauds easily.

Therefore, unless the whole financial system is made more secure and fool proof, the shift towards a cashless economy can prove to be a financial nightmare for the common man.


After opening the day flat, the Indian stock markets gained momentum in the post noon trading session amid expectations of positive gross domestic product (GDP) data to be released later in the day. At the time of writing the BSE-Sensex was trading higher by about 99 points (up 0.4%), while the NSE Nifty was trading lower by 35 points (up 0.4%). Sectoral indices are trading mixed with capital goods and banking stocks witnessing maximum buying interest.

04:55 Today's Investing Mantra

"Someone's sitting in the shade today because someone planted a tree a long time ago.". - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Ankit Shah (Research Analyst) and Madhu Gupta (Research Analyst).

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6 Responses to "Is Demonetisation Modi's Act of Creative Destruction?"


Dec 3, 2016

the write-up is good, I just wanted to hear from experts about the impacts of This so called masterstroke. But no one can predict the outcome. I think common people are not getting involved in the big governance issues of black money, Terror funding and all those bla bla. He is not responsible for parallel economy. Then who give us right to make him helpless, make him pay taxes for small mistakes(?) he have done. What is point to curb , crush this common man and unorganized industry sector for not their fault?. All financial issues and cash flow problems are policy makers mistakes. They should have solved them without touching common persons pocket. But creatively Modi sir have put his hand in the pocket and trying to extract as much possible from it. His heart touching speeches are holding people from reacting strongly , but how long they can be hold?
This is clearly a step to curb banks cash crunch situation, bad assets problem. Govt dont want to touch those who have not repaid the large loans from banks, instead it trying to get in cash from common people. But I fear about banks , what will happen if people dont ask them for new loans, will they be in a position to pay salaries?



Dec 1, 2016

Brilliant Writeup...

Kudos to you Ankit..

Keep it up...



Dec 1, 2016

Very strange conclusion on cashless economy basis crorepati taxi driver case. This is a problem of posting an entry, not that of cashless economy. Else One can counter saying that a lot of people get killed or robbed for cash, so cash should be banned, something that is quite illogical.


M V Nayak

Nov 30, 2016

Hi Ankit Shah
I have read your 5 minute wrap up on" Modi's creative Destruction'and felt very sad to hear such negative comments from highly educated and young person like you.

It is common sense that any big bang disruption to root out corruption and black money will entail some hardships to not only common man but also rich and neo-rich like you and political leaders. You have forgotten those days when you used to travel by train in crowded second class to go to your college or your office and eate vada-pav for lunch. Now I know you have cushy job and you are making this analysis sitting in an air conditioned office and quoting " Darwin." You have forgotten the struggles you yourself gone through those days.

You are also like any politician,arguing for the ordinary man but people are wise enough recognize hollowness of your arguments.

You and Mr Vivek Paul have the same mind set and do not provide any constructive suggestions to mitigate the hardships real or imagined.

Suggest you and other colleagues change your thinking objectively and come to the main stream help the nation to root out evils of black money economy.

Tanks & regards

You are also like any political leader, in the name of comon man


Jigish Mehta

Nov 30, 2016

Rahul it is always interesting to read your articles on 5 min premium wrap up as they normally cover current and interesting topics comprehensively also considering its impact on relevant shares or sector.
Hence, it is disappointing when you send IPO recommendations on it. We look forward to more meaningful and analytical articles.



Nov 30, 2016

If one has a tumour and a part of it is cut off, will it cure cancer? This is exactly what demonitazation is doing. Modi has done this purely for political benefits, not for country. By taking only the following steps, much better results could be achieved without such a large scale destruction.
1. He should clean up his own home first. If he can kill corruption of government employees and his fellow politicians, half of the problems will be solved.
2. Promote payment of taxes by giving incentives to tax payers. Less than 3% of Indian pay income tax, what can he achieve by squeezing out more and more from small number of people. And on the other hand there are some sections that do not have any income tax e.g. even high agriculture income is not taxable. Many times I ask myself that I pay so much of tax, but I am not able to get even basic facilities like good medical care from government, as my friends in other countries get.
3. Instead of taxing income so much, consumption should be taxed.
By taking small steps he could easily cure the problem, but it would not give him immediate political milage, so the result is that he drop a bomb on Indian citizens.

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