India:Inflation,activity and rates

Lower than expected prices, weaker activity and divergent rates, describe datasince demonetization. CPI inflation fell more than expected in November. Foodprices fell sharply and core inflation moderated sequentially, offsetting the rise infuel prices. High frequency data suggests that food prices have remained low overthe first ten days of December and it is getting increasingly likely that the RBI willget to its 5% by March CPI target comfortably. In other data, effective currency incirculation has fallen 60% since demonetization, implying a significant ongoingcash crunch; on the other hand 80% of outstanding cancelled notes have madetheir way back to banks already, suggesting that the negative wealth shock maynot be too high. Activity data has weakened, particularly for investment and ruraldemand. Credit growth has contracted sequentially. Foreign outflows have risen,especially in the debt market. Yet, RBI’s foreign exchange reserves remain atcomfortable levels. Alongside, domestic mutual fund inflows remain strong,mirroring consumer sentiments which have surprisingly risen back up. DespiteRBI’s pause last week, subdued prices and weak activity will likely culminate in a25bp repo rate cut in the February meeting.