Inflation dips to near-zero levels

20 Mar 2009, ET Bureau

NEW DELHI: India’s inflation rate skidded to a record low of 0.44% in the first week of March, well on course for a widely expected move into Financial crisis negative territory, triggering hopes authorities would be forced to intervene with steps to shore up demand in the economy.

The inflation rate as measured by the wholesale price index fell from 2.43% in the preceding week, led by plunging food prices and cheaper fuels. Very soon, buyers in wholesale markets may be paying less for most items, except food, than what they paid last March.

Economists say there is a good chance prices may continue falling longer than expected unless the government moves quickly to rev up demand. They expect Reserve Bank of India (RBI) to infuse more liquidity to counter this trend, besides cutting policy rates further.

“The higher base effect along with low demand in the economy is expected to keep inflation in negative territory for five to six months. Inflation will turn negative starting from April and will remain so until the end of 2009... We expect the Reserve Bank to ease liquidity to support growth,” said economist Tushar Poddar at Goldman Sachs.

Given the inflation outlook and macro environment, Goldman Sachs expects a 150 basis point cut by June in the cash reserve ratio, the funds banks have to keep with the RBI. Analysts say further infusion of funds through increased lending by banks may keep the system flush with liquidity.

“We expect continued policy action, including unconventional measures, to stem the deceleration in growth,” Citi analyst Rohini Malkani said in a research note. But the government maintained that though prices may drop to below 2008 levels, demand continues to remain strong. “I do not see any signs of deflation as demand for certain core sectors like steel, cement and automobiles is picking up, along with rural demand,” said cabinet secretary KM Chandrasekhar, who is the government’s seniormost bureaucrat. “Only those sectors that are heavily dependent on overseas demand will take time to pick up,” he added.

When prices decline, consumers typically postpone purchases in anticipation of catching the bottom. This causes further shrinkage of demand. Even so, companies manufacturing household electronic items say they are not worried.
“We are observing a slight easing of consumer spending and with the inflation coming down, we expect a positive impact on consumer spending,” said R Zutshi, deputy managing director of Samsung India.

One reason why companies remain optimistic is that prices in the retail market continued to rise faster than before in the week ended March 7. Retail inflation, measured by various consumer price indices (CPI), is still high. CPI for industrial workers has moved to 10.45% in January, the highest in over a decade.

But even retail inflation may eventually cool, if food, especially fruits and vegetables, become substantially cheaper in the coming months. They are already less expensive compared to January. Annual food inflation index has dropped to 7.24% from a 10-year high of 11.64% in January.

Prices of manufactured products, with a 64% weight in the WPI, did not change over the week. Inflation in this category could fall further if demand for manufactured goods does not pick up. While auto, cement, steel and retail sales in February beat market expectations, sectors such as real estate, freight and port traffic continue to be a cause of concern for policymakers.

The International Monetary Fund said this week that India should rely more on monetary policy to support the economy because it has already exhausted options such as additional spending and tax sops.