That the Centre’s decision to withdraw high-denomination banknotes was going to impact economic activity in the short term was never in doubt. But the specific contours of the effects were probably a lot less understood at the time of that announcement. The deflationary shock has manifested itself in a deceleration in retail inflation, as demand for a range of goods and services has been damped. That the headline Consumer Price Index-based gauge hit a two-year low of 3.63 per cent for November is therefore no surprise, especially given the additional factor of a favourable base effect — the reading was 5.41 per cent in November 2015. The major contributor to the slowdown in price gains was the food and beverages group, where inflation eased to 2.56 per cent largely on the back of a slump in the prices of vegetables, a highly perishable commodity. But a closer look at the food group throws the spotlight on some trends that the Reserve Bank of India had flagged in its latest monetary policy review as areas of concern. Specifically, the prices of sugar and confectionery accelerated by 22.4 per cent while meat and fish and egg also reflected persistently elevated levels. The services sectors, including transport and communication and education, also manifested stickiness, underscoring the rationale for the RBI’s cautious approach in keeping benchmark interest rates unchanged.
Clearly, signals from the inflation data pose a conundrum before policymakers. With demand impulses taking a wide-ranging knock from the shortage of cash in the hands of consumers, proponents of policy accommodation would argue that the time is ripe for the RBI to cut borrowing costs to help impart some credit-fuelled economic momentum. But as the RBI’s Monetary Policy Committee itself articulated it on December 7, “while discretionary spending on goods and services in the CPI excluding food and fuel” could have been affected by restricted access to cash, the prices of those items may weather the transitory effects since they are normally revised according to preset cycles. More importantly, the MPC cautioned that food inflation pressures could re-emerge as a consequence of disruptions in agricultural activity as a result of the currency withdrawal. The spectre of upward price pressures from key components including food and fuel — OPEC’s output cuts are already pushing up crude oil — combined with the fading away of a favourable base effect could leave the RBI with little wiggle room to support growth. With the central bank’s March 2017 target for retail inflation of 5 per cent clearly in their sights, the monetary authorities may be persuaded to keep the powder dry.
