Inflation dips to 0.44%; paves way for rate cut

Written by Economy Bureau | New Delhi | Updated: Mar 20 2009, 07:06am hrs
Inflation tumbled to a record low of 0.44% in the week ended March 7, giving enough room for aggressive rate cuts by the Reserve Bank of India (RBI). Analysts said inflation would turn negative in the coming weeks, although the government vehemently ruled out the possibility of a demand contraction. Officials made a distinction between disinflation and deflation; the latter implies demand contraction. Inflation was at 2.43% a week ago.

The wholesale price index (WPI)-based inflation is at its lowest since the annual numbers in the current series began in April 1995. It is far below the previous record low of 1.13% on February 2, 2002. In the last 30 years, there is no record of inflation falling to this low since 1977-78, the finance ministry said on Thursday.

Much of the current fall in the inflation is due to a high base effect, since inflation was at a high of 7.78% in the corresponding week in 2008. Base effect refers to changes in the WPI number in comparison with the same period in the previous year, while the index effect is the change in the WPI against the period preceding the week in question.

Planning Commission deputy chairman Montek Singh Ahluwalia said the rapid fall in inflation gives the government leeway to take more steps to stimulate the slowing economy. It is a good development. It gives us reassurance that we can take measures to stimulate the economy, Ahluwalia said on Thursday. However, he said negative inflation would not be good from a growth point of view.

Stocks rose on Thursday, while the bond prices fell. The 30-share BSE Sensex ended up 0.28% at 9,001.75 points and the 50-share NSE Nifty ended up 0.45% at 2,807.15 points. The yield on 8.24% bonds maturing in 2018 ended at 6.82% on Thursday, above its previous close of 6.67%, on expectations of government debt supplies but a sharp spike was averted, as the results of the central banks buyback auction was in line with market expectations.

Policy makers tried to drive home the point that there are no signs of a fall in demand. There are no signs of deflation in the Indian economy, Cabinet secretary KM Chandrasekhar said on Thursday. It is more indicative of a base effect rather than any price effect, he said, adding that there was a revival in sectors such as automobiles, cement, steel and infrastructure and this would help an economic recovery. In sectors that cater to domestic demand, certainly the worst is over, he said.

Pronab Sen, chief statistician of India, said India will see disinflation by March end but no deflation. Disinflation is inflation being negative, whereas, deflation is negative inflation coupled with a contraction in demand.

Deflation working with recession is a much worse situation than a pure recession since it negates any effort to stimulate demand and delays the recovery, Sen said.

However, it was difficult to ascertain the demand level purely from the inflation numbers, Sen said, adding, For that one has to look at sales and output data.

Commerce secretary GK Pillai said interest rates should now start falling since the cost of funds has fallen. Deposits rates have fallen from 10-11% to 8-8.5% now. The cost of funds has also come down and I expect the interest rates to also slowly come down, he said.

However, there are still concerns of high lending rates. Indeed, public sector banks prime lending rates (PLR) are upwards of 11.5%, while private banks PLR is over 14%.

Pronab Sen said lending rates are high more from the increased risk perception of banks than from the high deposit rates. He also said that high government borrowings were negating the effects of decreasing policy rates. Rising government debt pushes up bond yields, which puts upward pressure on interest rates.

The Centre for Monitoring Indian Economy (CMIE) said in its monthly review on Thursday the countrys gross fiscal deficit is expected to remain high in fiscal 2010 for the second consecutive year. We do not expect any significant upward revisions in government revenues in the final budget for FY10, which will be presented in June 2009. Expenditure may be revised upward, albeit modestly, on account of an increase in the governments effort to negate any adverse impact of the global liquidity crisis on the domestic economy, CMIE said. In the interim Budget for 2010 fiscal, gross fiscal deficit is estimated at Rs 3,32,835 crore, which is 5.5% of GDP.

Inflation is down but real prices are not

Inflation as measured by wholesale price index fell to a record low of 0.44% for the week ending March 7. WPI-based inflation is expected to go to the negative territory soon. So, why does it seem prices paid for many daily items are not going down If inflation is so low, why are bank lending rates still on the higher side And should India worry about something called deflation

Some answers:

Why is WPI falling sharply

WPI is measures how the index for a particular week looks vis vis what it was exactly a year back for the same week. 0.44% inflation means prices for week ending March 7 rose by only that much vis vis the March 7 week of 2008. WPI was high last year this time, so the base effect (high denominator) explains one part of the sharp fall. But more important is that inflationary forces are subsiding rapidly. The best way to see this is to look at month to month changes in prices that are adjusted for seasonal effects. By month to month data analysis, WPI is already in negative territory.

So what about consumer prices

A: There seems to be a disjunction between inflation as measured by WPI and by consumer prices. The latest CPI (consumer price index) for industrial workers is around 9%. But CPI comes with a two month lag. So, we only have the January figure now. Also, the fall in fuel, transport costs, rents are probably working with a lag on final food and other consumer item prices. Also, sticky food prices may be a reflection of higher rural demand, influenced by public expenditure on employment creation and a few years of good harvest.

Is it deflation

Deflation happens when demand contracts (not just slows). We are at a point when inflation may turn negative in coming weeks. But, the economy as a whole continues to grow, even though at a slower pace. Therefore, it is disinflation negative inflation rate but over all demand not contracting and not deflation that India is looking at.

Will lending rates come down sharply now

Three factors are important: how sharply and how soon will the RBI cut policy rates, how and whether that will change banks perception of lending to business and how the RBI will manage the effect of high government borrowing, which puts upward pressure on interest rates.