Since the announcement of the demonetisation drive on November 8, the market has been starved of the official stance on the economy. The RBI’s fifth bi-monthly policy review manages to shed some light in this respect. And the verdict is: insignificant impact on year-end inflation while full year growth (as measured by GVA) is now expected to be 50 bps lower at 7.1%.

Prima facie, this sounds reassuring as it puts to rest extrapolation of extreme assumptions and views, which seems to have flanked the popular narrative ever since the announcement of demonetisation.

With the impact of demonetisation expected to be transitory and short lived by the central bank, the status quo on monetary policy was justified amidst some deterioration in external variables like US interest rates (accompanied by a stronger dollar) and international crude oil prices. As noted by the RBI, an increase in both these variables could potentially provide an upside risk to the inflation trajectory, resulting in the central bank overshooting its near term inflation target of 5% for March 2017.

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Having said so, it should be noted that the decision to maintain status quo was against the market expectation of a 25 basis point cut in the repo rate. If the assertion for staying pat was so unambiguous, why was the market expectation so tilted towards expecting incremental monetary easing?

The answer clearly lies in the assessment. The demonetisation exercise presents a labyrinth of economic possibilities laced with various underlying assumptions. There is no denying that the shortage of cash in circulation would impinge upon economic transactions with cash intensive and unorganized sectors expected to face the brunt of adjustment in the near term. As long as the multitude of restriction on withdrawals are in place (expected to be at least until December 30), the process of effective re-monetisation will continue to stay behind the process of demonetisation. While this artificial liquidity crunch may not impact the per capita income levels in the near term, it definitely lowers the per capita purchasing power. With the process of re-monetization expected to take another 2-3 months, chances of growth remaining subdued even in Q4 remain strong.

This temporary disruption on growth will soon be followed by significant structural changes ushered in by the GST regime from April 1, 2017, which could also keep growth momentum weak at least in the first few months as economic agents adjust to the new normal of indirect taxation in the country.

Hence the adverse impact on growth could be deeper or prolonged with net impact likely to be more than what the central bank is penciling in currently.

The picture on inflation is also likely to be sobering as:

* Favourable monsoon has ensured that seasonal food price disinflation plays out as per anticipation

* Demonetisation is expected to delay any recovery in industrial capacity utilization (which continues to remain at its lowest level since the Lehman crisis) and thereby dampen any pickup in domestic pricing power

* While there has been some weakness in rupee and increase in crude oil price, its impact is likely to be limited given the likely increase in negative output gap post demonetisation and small weight of trade-ables in the CPI basket

* Household inflation expectations have corrected sharply by 130 bps in Nov-16. Interestingly, the survey was conducted before the announcement of demonetisation. It is reasonable to assume further correction in inflation expectation post demonetisation.

In my opinion, the CPI inflation is poised for a significant undershooting, with the year end figure likely to be lower than the 5% target by as much as 50 bps. This should provide reason and space for the RBI to consider incremental monetary easing.

The upcoming quarter is likely to be as eventful as the current one, if not more. Clarity on demonetisation impact, announcement of FY18 Union Budget, Fed’s assessment of changes in fiscal policy, etc. would provide further cues for our own monetary policy setting. If all of them turn out to be favorable, then don’t be surprised if RBI takes a bold move!

The writer is group president and chief economist at YES Bank