Demonetisation to impact activities in cash-intensive sectors

Demonetisation could result in short-run disruptions in economic activity in cash-intensive sectors like retail trade, hotels, restaurants and transportation, and the unorganised sector, RBI said today.
The withdrawal of old Rs 500 and 1,000 notes "could result in a possible temporary reduction in inflation of the order of 10-15 basis points in Q3 (October-December period", the central bank said in the Fifth Bi-monthly Monetary Policy Statement Resolution of the Monetary Policy Committee (MPC).
RBI, however, kept retail inflation target of 5 per cent for the fourth quarter of the fiscal and the medium-term target of 4 per cent within a band of +/- 2 per cent while supporting growth.

MPC, RBI said, felt that the assessment is clouded by the still unfolding effects of the withdrawal of specified bank notes (SBNs).
"The outlook for GVA (gross value added) growth for 2016-17 has turned uncertain after the unexpected loss of momentum by 50 basis points in Q2 and the effects of the withdrawal of SBNs (Rs 500/1,000 notes) which are still playing out," the policy document said.
Downside risks in the near term could travel through two major channels.

One is "short-run disruptions in economic activity in cash-intensive sectors such as retail trade, hotels and restaurants and transportation, and in the unorganised sector".

The second channel is aggregate demand compression associated with adverse wealth effects.
On price situation, RBI said retail inflation measured by the headline Consumer Price Index (CPI) eased more than expected for the third consecutive month in October, driven down by a sharper than "anticipated deflation" in the prices of vegetables.
The liquidity conditions have undergone large shifts in third quarter so far, it said.
Surplus conditions in October and early November were overwhelmed by the impact of the withdrawal of old high denominations notes from November 9.
"Currency in circulation plunged by Rs 7.4 trillion up to December 2; consequently, net of replacements, deposits surged into the banking system, leading to a massive increase in its excess reserves," RBI said.

The six-member MPC took note of the upturn in the prices of several items that is masked by the easing of inflation on base effects during October in its policy decision.
"Despite some supply disruptions, the abrupt compression of demand in November due to the withdrawal of SBNs could push down the prices of perishables in the reading that becomes available in December," RBI said.
On the other hand, prices of wheat, gram and sugar have been firming up.
"While discretionary spending on goods and services in the CPI excluding food and fuel - constituting 16 per cent of the CPI basket - could have been affected by restricted access to cash, the prices of these items may weather these transitory effects as they are normally revised according to pre-set cycles," it added.

RBI said prices of housing, fuel and light, health, transport and communication, pan, tobacco and intoxicants, and education - together accounting for 38 per cent of the CPI basket - may remain largely unaffected.
"Going forward, base effects are expected to reverse and turn unfavourable in December and February. If the usual winter moderation in food prices does not materialise due to the disruptions, food inflation pressures could re-emerge," the RBI monetary policy review added.