Inflation turns negative for first time in 30 years

19 Jun 2009

NEW DELHI: The rate of inflation, as measured by the wholesale price index, has turned negative for the first time in over three decades. The widely watched WPI fell 1.61% in the 12 months to June 6, sharply below the previous week's rise of 0.13%. This makes India possibly the only country with a negative inflation rate, though a number of European countries are nearing zero levels.

But unlike in Europe, where demand has been contracting, India isn't facing a deflation as industrial output remains positive and the inflation rate measured by the consumer price index (CPI) still stands at around 8% and shows no signs of a let-up.

Bankers are divided over whether a negative inflation rate will prompt the Reserve Bank of India (RBI) to cut its benchmark policy rates. With negative inflation, real interest rates (net of inflation) in the money market are high.

But some banks won't wait for a signal from RBI before they start cutting lending and deposit rates. And that's good news for home and consumer loan borrowers as well as for industry. UCO Bank chairman S K Goel said, "Interest rates should come down. We will take a look on Friday as to how much deposit and lending rates can be cut. My rough estimate is that we will be able to reduce by 100 basis points (equal to one percentage point) at least." A number of other top bankers such as Canara Bank chairman A C Mahajan also said they saw interest rates coming down.

For depositors, though, that isn't good news. HDFC Bank has decided to cut its deposit rates by up to 25 basis point from Friday. State Bank of Bikaner and Jaipur, the largest subsidiary of SBI, has also reduced deposit rates by up to one percentage point on various maturities effective today. The one-to-two year peak deposit rate has been reduced by 100 basis points to 7.25%.

The present low inflation is mainly on account of statistical reasons — primarily the high base in the same period of last year. Annual inflation is measured against prices a year ago. In June 2008, oil was at about $140 per barrel — almost double today's price of around $72. Similarly, commodity prices have fallen substantially since then. This has resulted in the average index of prices of all commodities falling vis-a-vis last year, despite the fact that prices of food articles have shot up during the period.

While describing negative inflation as unusual, finance secretary Ashok Chawla said it would not prompt the government to change its policies since it had been caused by the base effect and would get corrected in due course. Negative-to-low inflation should benefit manufacturers as input and raw material costs come down faster than prices of finished or value-added products, more so as domestic demand remains strong.

As the index of prices of all the commodities rose substantially in June-September 2008, the annual inflation rate is likely to remain in negative territory for the same period this year. Bankers feel that it will re-enter in positive territory in October 2009. Indeed, they worry that with commodity and oil prices bottoming out and demand picking up, inflation could bounce back in the third and fourth quarters of this year, especially if the monsoon turns out to be a poor one, as is being increasingly feared.