Scope for RBI to cut interest rates further, say economists.

Economists raised the possibility of deflation in the first half of the financial year starting April, after headline inflation rose at its slowest pace in 14 years since the new inflation series was introduced in 1995.

Experts cite record low inflation as evidence of weakening economic demand because of the global financial crisis and see scope for India’s central bank to cut key interest rates further to boost economic activity.

The low inflation rate, however, has not translated into low prices for items consumed by the common man. For example, sugar price inflation is 22 per cent on an annual basis. Similarly, prices of pulses and cereals — which constitute the basic consumption basket for most Indians — have not come down.

“The fall in the inflation rate does not carry comfort for the common man,” said D K Joshi, economist with ratings and advisory firm Crisil Ltd. He pointed out that the latest consumer price index (CPI) numbers for various categories are in double digits or near 10 per cent.
 

The overall food inflation rate has dropped 0.94 percentage points to 7.35 per cent in the reported week because of a fall in prices of tea, fruit and vegetables, gram, jowar and masur.

Economists now expect a short deflation in the first half of next fiscal because of the base effect. In FY09, prices of commodities and crude oil spiked sharply between April and August.

This means that even if prices stay at current levels, the inflation rate would fall drastically, since the index number for the corresponding period last year would be high.

An example is inflation for manufactured products. This category, which has a 64 per cent weight in the index, has stayed at the same level of the previous week. But its inflation rate has swung from positive to negative 0.75 because of the base effect.

Low inflation is, however, unlikely to affect the yield or return on government securities, since the amount of borrowing affects the return more than inflation or key interest rates set by the Reserve Bank of India (RBI), experts said.

“The yield is unlikely to come down because there is a supply-side pressure in the market,” said Indranil Pan, economist with Kotak Bank, referring to the fact that the government will borrow more to finance its widening fiscal deficit.

He said the market is not expecting any rate cut by RBI in the remaining days of the current fiscal.

With inflation falling, however, the real interest rate — the difference between the actual interest rate and inflation rate — has widened and some experts cite this as a reason for a further cut in interest rates.

But Joshi said if the CPI is considered, the real interest rate has not increased that much. “The expected inflation rate is important for calculating the real interest rate. I see inflation at 4 to 5 per cent in one year and beyond,” he said. Pan, too, said CPI inflation is unlikely to fall below 5 to 5.5 per cent in the next four months.

Meanwhile, the final estimate for inflation for the week ended January 10 this year was revised downwards to 5.46 per cent, against 5.6 per cent in the preliminary estimate made two months earlier.

Room for stimulus: Montek

India’s low inflation rate will enable policy makers to take more steps to stimulate a slowing economy, Planning Commission Deputy Chairman Montek Singh Ahluwalia said on Thursday. He also said there would not be sustained deflation in India.

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