Falling IIP, CPI: Demonetisation shock is playing out, but wait for more cues

The decline in January consumer price inflation (CPI) that accompanied a drop in December factory output numbers, is a direct result of the demonetisation-induced cash crunch. The CPI fell to 3.17 percent in January, while the Index of Industrial Production (IIP) recorded in the month of December contracted by 0.4 percent as cash-crunch impacted overall demand. As cash situations turn normal, prices pressures will pick up yet again and the inflation numbers, thus, should start inching up from this point, rating agency Crisil expects, also citing the fact that so-called base effect will also wear out in the approaching months. Even then, most economists expect the consumer inflation to stay within the comfort zone of the central bank. [caption id=“attachment_2508150” align=“alignleft” width=“380”]  Reuters[/caption] If one looks at the CPI numbers closely, the major part of decline has come from decline in prices of vegetable and food items. Food inflation, in January, eased to 0.53 percent from 1.37 percent in the preceding month, while vegetable inflation showed a contraction of 15.62 percent. After several months of spike, pulse prices too have shown negative growth in the months of December and January, at negative 6.62 percent in January and 1.63 percent in December, which too helped to bring down the CPI print. As for the IIP is concerned, the major shock came from a large drop in the manufacturing sector growth, a contraction of 2 percent, and a bigger shock from a 3 percent contraction in the capital goods segments (which indicates trends in investment activity) as compared with 15 per cent growth in the preceding month. The contraction in economic activity was visible also in other key segments such as consumer goods and durables as well. It might take a few more months for the demand revival to happen leading to a growth pick up. Economists are still divided on the demonetisation impact on economy but none are upbeat on a sharp recovery in growth. “Capital goods have been declining throughout the year reflecting fall in capital formation. Low capacity utilization has already pushed down demand for fresh investment,” said Care ratings in a note. “Fall in consumer goods growth will further depress conditions. Based on this low performance we expect growth for the year to be marginally positive between 1-2 per cent compared with our earlier call of 3-4 per cent. We believe that it would take at least a quarter to move back to normal,” the rating agency said. In the last policy, the MPC (monetary policy committee )itself had acknowledged the uncertainty on growth on account of the demonetisation impact saying the MPC itself acknowledges this lack of certainty. A pick up in price pressures, coupled with a persisting trend of declining growth (unless economic activities pick up sharply) will throw fresh challenges to the Monetary Policy Committee (MPC) that held rates in last policy review, and surprised the markets with a major change in the policy stance. If demonetisation-resulted cash crunch doesn’t pass as expected and if the impact on economy stays longer, the MPC will find it hard to explain its hurried decision to move from an ‘accommodative’ stance to a ‘neutral’ stance early. For now, there are not many signs of growth recovery happening, but one needs to wait for more cues in the approaching months. (Data from Kishor Kadam)