Lower Inflation Puts A Strain On Bank Lending Rates

The twin factors of industrial slowdown and lower oil prices will pull down the rate of inflation rate further, said analysts. Inflation rate has hit the lowest-ever level in the last two years at 2.72 per cent for the week ended October 20 compared with 7.32 per cent in the last year.

Last time, when the inflation rate was lower than this level was on July 24, 1999, when it touched 1.91 per cent. Analysts expect it to go below the 2.50 per cent mark and even touch 2 per cent by the end of December.

The lower inflation rate will put pressure on banks to cut their lending rates as the real interest is going up. The inflation rate has been falling at a rate sharper than the nominal interest rates and this will put banks under pressure to cut the lending rates, said an analyst.

However, banks are not ready to cut rates at this moment as most of the them feel that despite a rate cut there may not be enough demand for credit. Analysts also pointed out that the low inflation rate for the week ended on October 20 was despite a sharp rise in the prices of vegetables. The rise in price of vegetables is, however, because of climatic factor and extra demand in the festive season. As this is slated to come down in the following weeks, inflation rate should come down further, analysts feel.

Said Sanjeet Singh, fixed income analyst, ICICI Securities and Finance: "The reason for a higher inflation in the last fiscal was a higher oil prices. Moreover, there is excess capacity in the economy and unemployment rate has also been increasing over the last couple of years. All these factors will push the inflation rate down further."

The high inflation rate last year -- and hence higher base -- had helped the interest rates to remain low and this will be the case during the next couple of months.

Indranil Pan, associate vice-president, Kotak Mahindra Capital Company, said: "The inflation rate will fall till December because of the higher base as the inflation was quite high during that time last year. Moreover, as there is no external and internal demand, and little possibility of oil prices to go up drastically, it should remain soft at least till mid-February."

Mohan Nagarajan, chief economist, Credit Analysis and Research Ltd, however, feels that the inflation rate should remain around the same level despite the low external and internal demand.

He said, "There is not much scope for further fall in the inflation rate as the margin in most of the businesses are already very low. However, the year-on-year inflation should remain soft around the 3 per cent level till the end of this fiscal."