Inflation data for November read together with the PMI suggests that demonetisation started to bite immediately. The Wholesale Price Index (WPI) eased down to 3.15 per cent year-on-year for November, lower than the 3.4 per cent recorded in October. The Consumer Price Index (CPI) for November was 3.64 per cent year-on-year, the lowest rate in two years.
Both indices are rather urban oriented and the rural economy has been hit harder because it is less banked and cashless systems don’t exist. The WPI measures factory gate and wholesale prices. Many B2B segments are wholly banked and would not have been directly affected by dearth of notes.
Nonetheless, areas such as food prices, where dealings are often in cash, have seen a dramatic drop in inflation rates. Food inflation (CPI), which contributes almost 50 per cent of CPI weight, dropped to 2.1 per cent in November, down from 3.3 per cent in October. The Reserve Bank of India's ideal target for the CPI is 4 per cent, with an upper tolerance level of 6 per cent and lower limit of 2 per cent. If the trend persists, CPI could drop below the lower limit.
But, a sudden spike in inflation might also occur due to the effect of demonetisation on agriculture. There isn’t much prior history of demonetisation. But, during the Soviet Union's demonetisation drive in January 1991, food prices dropped in the short run and then sky-rocketed up, with some items rising 700 per cent. Farmers were desperate to get rid of perishables during the cash-shortage period. But farmers also lacked financial resources to plant new crops, leading to scarcity and much higher prices some months down the line.
The Purchasing Managers Indices (PMIs) indicate expansion / contraction with the 50 mark as “zero”. The Services PMI for November dropped to 46.7, which was a sharp contraction. It was the first contraction since mid-2015 and a steep decline from the 54.5 registered in October 2016. It was the biggest fall since November 2008 when the subprime crisis triggered a crash. The manufacturing PMI dropped to 52.3, which indicates some expansion was happening. But, it was down from 54.4 in October.
Low inflation, services contraction and manufacturing slowdown all point in the same direction. There is lack of demand translating into less activity. Anecdotally, December did not seem to get much better. So, we could expect similar trends and perhaps, manufacturing contraction.
Under the circumstances, every consumer-facing sector is likely to take a hit in Q3. This “should” be discounted since it has been predictable since day 1. But has it been? The Nifty was at 8,550 on November 8 and it is now down by about 5 per cent. This is not much of a reaction.
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Stock market prices reflects consensus estimates. The problem is that nobody has a good template to estimate future trends. There are multiple questions without concrete answers. How much currency does the government intend to put back in circulation? How long will it take to print and distribute that currency? How even will that distribution be? How long will the government maintain currency controls? How soon can mobile networks (to enable cashless transactions) be rolled out in underbanked rural areas with poor connectivity? Will consumers turn cautious about spending for the long term, given the privations in this period? We have no answers.
The Q3 earnings will come through in January and so will the Index of Industrial Production for November. Those data will be useful. But the situation is not amenable to linear estimates. The stock of currency is constantly changing and so is sentiment. The next few months will be a roller coaster.
The author is a technical and equity analyst