A couple of months back we had suggested that the Indian Meteorological Department was being overly cautious in projecting this year?s monsoon. Well, it has arrived and it looks okay. So do some other things. Inflation looks to be on the downswing. Wholesale price inflation was at only 5 per cent in early June. In fact, all indications are that the present cycle of inflation reached its peak in March-April and since then has been easing.

One good indicator is the difference between the provisional and revised numbers for inflation. When inflation is rising rapidly, this difference widens, that is provisional data underestimates the extent of price rise. When prices are falling, which is rare in India, the reverse tends to happen. The gap between provisional and revised figures started rising from the middle of December 2002 and hit a peak in the first two weeks of March 2003, when the revised rates of inflation were 60 to 80 basis points higher than the provisional figures.

The gap has eased down since, and for the week ended 12 April 2003, it was down to a ?normal? level of 12 basis points. Though manufactured goods still show inflation at 4.6 per cent, the other stuff ? cotton, oilseeds, edible oil and energy ? are all easing up. It is more likely than not that inflation by the end of September 2003 will be below 4 per cent, and by the end of the current fiscal year in the range of 3 per cent.

The US Federal Reserve (Fed) cut rates by 25 basis points last week, though a significant section of the market expected a cut of 50 basis points. The revised estimates for US GDP pulled down estimated growth in the first quarter of 2003 to 1.4 per cent (from 1.9 per cent). Combine the two and it is more than likely that the US Fed will cut rates at least once again in the months to come. The European Central Bank will have to cut rates again and perhaps again. All of this monetary easing leaves the Reserve Bank of India (RBI) in the awfully comfortable position of having as much as 300 basis points to chip away at the short end of the yield curve. Why persist with a repo rate of 5 per cent when the cost of international short-term money is 1 per cent, and likely to remain there for some time?

This anomalous condition only encourages a variety of unhealthy outcomes. Companies that can, raise low cost funds overseas, substituting domestic borrowing. Which leads to greater capital inflows and a further hardening of the rupee, besides chipping away at private domestic demand for credit. Economic agents bring in funds with an investment horizon of one to three months. They deploy it in treasury bills and other short-term liquid assets, standing to thereby earn arbitrage at the rate of the difference between short-term rates here (5 per cent or thereabouts) and that overseas (1 per cent or so). The up-tick in stock markets is both consequence and cause of such movements into the equity markets. Since the beginning of June 2003, the rupee has strengthened both against the US dollar and the euro. Significant inward capital movements alone can explain this.

Finally, as the GDP numbers, which are due to be released later today, will show, the Indian economy while doing reasonably well, could certainly do very much better. Lower than required levels of investment is certainly the principal constraining factor. Now, some people, including this columnist believe that inadequate investment is principally a consequence of structural rigidities in the system, including the constrained fiscal conditions of government. Some others have stressed upon the cost of capital as the principal limiting factor. One of the reasons for the RBI to work so forcefully towards lowering the interest rate regime under conditions of a 12 per cent consolidated government deficit was to provide that impetus to private investment. Without excessive success it would seem. But having come so far and given the favourable external conditions, why not go the full hog and lower short-term rates by a couple of hundred basis points?

The author is economic advisor to ICRA (Investment Information and Credit Rating Agency)