When income is stagnant, a logical outcome could be curtailing expenditure. But rural India seems to be fine with paying higher prices for services that range from education to matinee shows.

The chart above shows inflation for services and a few discretionary items has been higher in rural areas compared to urban centres. It is also clear that farm income has stagnated and farmers now face a potential fall in their income—a trend which is visible in the sharp disinflation in food prices in recent months. The developments have brought forth the worrying possibility of increasing distress in rural India. Media reports on farmers destroying their own crops because of low prices, and recent farmer protest marches by the farm community are ample evidence of the distress.

But then, why are rural citizens willing to match their urban counterparts in spending for discretionary items to an extent where service providers can increase prices?

Shubhada Rao, chief economist at Yes Bank, says that perhaps the share of disposable income of rural families for spending on these items has remained intact, or may have even increased. Of course, this would apply only to households where disposable income is at relatively high levels, and certainly not farmers facing distress.

“Food disinflation is leading to lower incomes, but it is also leading to lower food bills for the household. Hence, the share of expenditure on other items can remain intact despite a fall in income," said Rao.

That said, some services, such as education and medical, are not discretionary in nature.

Also, imbalance between demand and supply in services also manifests into higher inflation. Increase in schools, hospitals and even cinema halls in rural areas takes time and the dividends of infrastructure are not short-term.

In contrast, the demand for such services has been growing sharply in India on the back of growing disposable income.

However, we cannot ignore the implications of high services inflation, coupled with food disinflation, on policymaking. This is a puzzle that the Reserve Bank of India (RBI) faces while formulating its policies because steady services inflation lends support to core inflation. Monetary policy is most effective in denting core inflation, but the RBI’s mandate is to keep headline CPI inflation within the 2-6% band. Headline inflation has averaged 3.9% ever since this mandate was given to the RBI in June 2016, but core inflation hasn’t behaved as well.