Consumers' choice to minimise discretionary purchases pulls down inflation

Consumers are choosing to minimise discretionary spends after PM Modi's demonetisation move and that is what brought down inflation rates in November.

The country’s estimated inflation rate was supposed to drop 10-15 bps to 3.90%; however, CPI fell lower than estimated as the demonetisation move was predicted to reduce the ‘demand-pull’ inflation. Image Source: Pixabay

India’s inflation rate eased 57 basis points in November after the government’s decision to withdraw Rs 500 and Rs 1000 notes.

Consumer Price Index (CPI) cooled to a two-year low of 3.63% in November from 4.20% in October.

Demand-pull inflation, simply put is inflation caused because of a disproportionate or lop-sided upsurge in consumer demand which was not able to be met by suppliers.

Consequently, price levels rise because of this imbalance, giving rise to inflation.

Aditi Nayar, analyst from ICRA told Zeebiz, “Given the deferral of demand for big ticket consumption items, demonetisation is likely to modestly reduce demand-pull inflation."

She further added, "Anecdotal evidence suggests that consumers are choosing to minimise discretionary purchases. Consumption-oriented sectors, particularly those which involved a sizeable magnitude of cash transactions, such as real estate, construction, jewellery, travel and tourism, retail and trade are likely to experience a lull in the immediate term.”

Instead of an uptick in demand that was anticipated, India faced quite the contrary.

“The boost to rural demand from the near-normal monsoon and the pickup in urban demand from the of the Seventh Central Pay Commission’s (SCPC’s) recommendations, were expected to drive a consumption-led uptick in growth in H2 FY2017. The likelihood of the same has faded significantly after the withdrawal of the legal tender status from November 9, 2016 for the existing currency notes in the denominations of Rs 500 and Rs 1,000,” Nayar said.

The inflation rate for vegetables for the month has been registered at (-) 10.29% as against (-) 5.74% in October.

A report by Care Ratings analysts, Madan Sabnavis and Manisha Sachdeva on December 13 said inflation rate will be moderated in December as horticulture will be impacted on falling price levels.

“However, the index will move towards the 5% mark subsequently as these trends get reversed and will be influenced by rabi outcomes,” the analysts added.

“Consumer spending makes up 55% of India`s economy and most people buy and get paid in cash. The virtual overnight removal of 86 % of the currency in circulation has left companies, farmers and households suffering,” a report by Reuters said.

Forcing a former cash-based economy to turn digital overnight and introduction of Rs 2000 notes to possibly increase consumer spending has probably backfired on the government.

Zeebiz spoke to Care Rating economist, Kavita Chacko, who said, “It was expected that an increase in consumer spending will reduce the excess capacity in manufacturing and this would gradually prompt fresh investments and capacity addition. The fall in demand will drag down the overall economic growth for the country.”

“With consumer demand likely to be pressured for the remainder of the fiscal, the GDP growth will moderate and investment revival will be delayed,” Chacko added.

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