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Falling inflation a cause of concern
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March 09, 2009 19:09 IST

After the initial euphoria, there is a growing concern as inflation goes down to less than a quarter from its 13-year high of 12.91 last August and seems headed towards zero and sub-zero levels beyond this month.

"Falling inflation denotes slackness in the economy. This is definitely something to be concerned about," Kotak Mahindra Bank's [Get Quote] chief economist Indranil Pan said. He sees inflation falling to zero and staying in the negative for some time.

". . . the sharp swing down is to an extent also due to the base effect. Last year, the domestic price of oil was high and now it is reduced. True, the commodity cycle has broken down and anyway inflation is likely to have been lower," he said.

Though some economists view the severe drop in inflation primarily due to the high base, Pan is not alone in not attributing the fall in inflation to the high base only.

Fitch Ratings analyst James McCormack says, "A period of mild deflation is possible, as there is little upward pressure on prices with declining demand and commodity prices."

He sees annual inflation to remain positive at 3.8 per cent in FY'10. While the inflation rate, based on wholesale price index, eased to 3.03 per cent in the week ending February 21, the consumer price index (CPI), which is still quite high, has kept the fear of a major crisis at bay.

"CPI tells a different story. The CPI-Agricultural Labour is still pretty strong, denoting that rural demand is doing pretty fine. Even the CPI-Industrial Workers is still at a much higher level than the WPI," Pan said.

"So, while a fall in inflation is worrying, there is no crisis scenario as with the US or the European economies.

India still has a baseline domestic consumption demand which should enable CPI to stay in positive," Pan added.

However, Asia-Pacific chief economist at Standard & Poor's Subir Gokarn says, "What we are seeing is a decline in inflation, which is year-on-year. Here, the base effect is dominating. It will be of concern when prices decline week-on-week or month-on-month."

While deflation-like crisis is not yet worrying the economists, they still want the government to be on the vigil. "Fitch believes RBI will continue to take action to counter the economic downturn, as it has been doing for some time. If it appears that prices may begin to fall on a broad basis, RBI is likely to take more aggressive policy actions," Fitch's McCormack said.

Kotak's Pan added, "The government has already taken lots of measures to boost consumption demand. The Reserve Bank of India [Get Quote] has also cut the policy rates and is trying to nudge the banking sector to cut rates. Shoring up the consumption demand in these ways is likely to help prevent a very rapid fall in the domestic inflation."

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