Inflation falls below 4 percent, triggers rate cut hopes

New Delhi - India's annualized inflation rate fell to its lowest in more than 13 months, slipping below 4 percent-mark to 3.92 percent, triggering hopes that it would give the central bank sufficient headroom to cut benchmark interest rates and ease liquidity crunch.

According to government data released Thursday, the wholesale price index, India's most widely watched inflation measure, fell to 3.92 percent in the 12 months to February 7, lower than the previous week's figure of 4.39 percent, mainly on account of reduction in prices of manufactured items.

A year ago, the figure stood at 4.98 percent.

Inflation had raced into double digits in June last year after the government raised fuel prices, and peaked at 12.91 percent on August 2.

The index for the Primary Articles Group (which has a weight of 22.02 percent on the WPI or Wholesale Price Index) declined by 0.2 percent compared to the previous week on account of lower prices of food articles such as barley and tea (down 1 percent each) and non-food articles such as castor seed (down 28 percent), linseed (down 9 percent), rape & mustard seed (down 7 percent) and copra and raw cotton (down 1 percent each).

However, prices of pulses such as moong, masur, urad and arhar rose 2 percent each while those of gram and maize advanced 1 percent each.

Prices of sunflower and groundnut seed also climbed by 4 percent and 1 percent respectively.

The index for Fuel, Power, Light & Lubricants Group (which has a weight of 14.23 percent on the WPI) rose by 0.5 percent compared to previous week, driven by higher prices of naptha (up 10 percent) and furnace oil (up 5 percent).

However, the prices of aviation turbine fuel (also known as jet fuel) slipped by 5 percent while those of light diesel oil lowered by 1 percent.

The index for Manufactured Products Group (which has a weight of 63.75 percent on the WPI) eased by 0.4 percent compared to previous week due to lower prices of textiles products, leather products, metals and machinery.

In the 'Food Products' group, prices of salt, oil cakes and cotton seed oil declined 2 percent each while those of rape & mustard oil slipped 1 percent each.

However, prices of prices of khandsari surged 5 percent, sugar and imported edible oil rose 2 percent each and rice bran oil climbed 1 percent.

In the 'Textiles' group, the prices of cotton yarn-cones and cotton yarn-hanks moved down by 4 percent and 1 percent respectively. However, the prices of cotton knitted garments rose by 4 percent while those of texturised yarn and hessian cloth jumped by 2 percent each.

Among 'Leather & Leather Products,' the prices of footwear (western type) declined by 1 percent.

The prices of 'Chemicals & Chemical Products' such as thinners, purified terephthalic acid (pta), benzene, p.v.c. resins and calcium ammonium nitrate n-content rose 28 percent, 9 percent, 7 percent, 5 percent and 4 percent respectively. However, the prices of enamels moved down by 3 percent.

Among 'Non-Metallic Mineral Products,' the prices of cement rose by 1 percent.

Among 'Basic Metals Alloys & Metal Products,' the prices of skelps (down 10 percent), oromild steel & tensile plates (down 9 percent), copper coils (down 8 percent), copper sheets (down 7 percent), other iron steel (down 5 percent), wire (all kinds), steel sheets, plates & strips, basic pig iron and foundry pig iron (down 4 percent each), zinc (down 2 percent) and ms bars & rounds and bars & rods (down 1 percent each) slipped. However, the prices of brass sheets & strips and steel ingots (plain carbon) moved up 7 percent and 2 percent respectively.

Among 'Machinery & Machine Tools,' prices of other cables (down 26 percent), rubber insulated cables (down 24 percent), enameled copper wires (down 8 percent) and p.v.c. insulated cables (down 7 percent) fell.

According to a statement issued by the Finance Ministry, the current rate of inflation is the lowest since the 3.8 percent recorded in the week ended December 29, 2007.

The latest decline in inflation rate has encouraged market analysts to believe that the central bank would cut rates soon to support faltering growth. Industrial output growth in the country had shrunk 2 percent in December, the second contraction in three months, reflecting deceleration in economic activity.

"Weakening economic activity and lower than expected inflation data suggest that there is clearly more room for rate cuts," said Sonal Varma, economist at Nomura International in Mumbai.

"We expect the RBI to cut both the repo and reverse repo rates by 50 basis points (bps) before March and by another 100 bps each by June 2009," Varma said.

"We expect the headline inflation rate to ease to below 2 percent by March end as prices of manufactured products continue to soften," said Manoranjan Sharma, chief economist at Canara Bank.

"The rapid fall in inflation is providing the central bank with additional headroom for further monetary accommodation," said Siddhartha Sanyal, an economist with Edelweiss Capital.

Commenting on the inflation numbers, Mridul Sagar, chief economist at Kotak Mahindra Bank said there are reasonable chances for the inflation to fall to about 2 per cent by March-end and move in to a brief deflationary spell and in to a negative terrain between June and September.

"We expected around 50 bps cut post Budget and we are still expecting something like that might happen. I am sure the central bank would take into account analysis of this whole macro position," Sagar said.

Agrees ICICI Bank CEO K.V. Kamath. When inflation is going towards 2 percent, there is scope for interest rates to go down, Kamath said. "Clearly there is a downward pressure on interest rates. There is further scope for a rate cut," he said.

According to D.K. Joshi, principal economist at domestic ratings agency CRISIL, inflation is on a downward trend due to a strong base effect and low demand and it should prompt the central bank to cut interest rates.

Joshi warned that unless the central bank takes steps soon to revive economic growth and boost credit availability, with the second round effects of the fuel price cuts getting factored in, inflation will drop at a faster pace and India could witness a period of deflation.

The Reserve Bank of India (RBI) Governor D. Subbarao said on Wednesday there was room to cut interest rates.

However, the governor warned that one should not expect rate cuts every time inflation falls.

"It's not automatic that inflation is coming down and you cut rates," Subbarao said.

"There certainly is room for cutting rates. The question is whether we should cut rates, when we should cut rates and by how much we should cut rates," he added.

Earlier, Commerce and Industry Minister Kamal Nath said, "RBI is looking at monetary policy and will perhaps respond to it falling inflation."