Low Demand Hammers Inflation To 3.75%

The fall in the inflation rate to an 11-year low of 3.75 per cent for the second time in six weeks for the week ended September 20 is being viewed by some economists as a cause for concern rather than celebration.

The latest data released by the government reveals that the wholesale price index (base: 1980-81=100) fell to a historical low of 3.6 per cent when computed on the basis of final indices for the week ended July 26 (latest available), compared with 4 per cent based on the provisional index. The provisional figures are revised as final after a lag of eight weeks.

Economists argue that the low rate of inflation, despite the recent hike in petroleum product prices, particularly diesel, is due to slack demand conditions. According to them, the RBI should use the busy season credit policy to signal a further cut in interest rates.

The economists said this has become imperative as real interest rates (nominal interest rates minus the inflation rate) have continued to climb to new highs as the rate of inflation has decelerated in the past few months. If the central bank signals a bank rate cut and the financial sector takes the cue and rolls back interest rates, then the present economic outlook can change, says Shashank Bhide, an economist with the NCAER.

Union finance minister P Chidambaram had indicated recently at the annual IMF-World Bank meetings in Hong Kong that real interest rates would narrow from the present levels. At the same venue, Reserve Bank of India governor C Rangarajan had told Business Standard that interest rates could fall further if inflation remained at low levels.

With the credit policy barely a fortnight away, some bankers and heads of financial institutions too endorsed the governors view and predicted that the bank rate would be cut by 25-50 basis points. This would trigger a cut in the deposit rates and thereby the lending rates, they added.

According to government officials, the main reasons for the current levels of low rate of inflation are the governments ability to rein in the fiscal deficit, tight monetary control and a freer import regime which has for all practical purposes placed a cap on domestic prices.

But economists argued that while these are contributing factors, the main reason was slack demand. The money supply is growing at a rate higher than targeted and imports are not growing at all. Still, consumer goods prices are languishing and producers are not able to raise prices. This reflects poor demand, says another economist working in the government.