Deflation fears prompt analysts to urge for rate cuts

The sharp fall in inflation rate has triggered renewed fears of deflation, prompting market analysts to claim that the latest inflation data would open the way for the Reserve Bank of India (RBI) to cut interest rates further to lower the cost of credit for the corporate sector and push demand.

Since September, the RBI shifted its focus from arresting high inflation to boosting consumer demands and corporate investments and has aggressively slashed key short-term interest rates five times to ease liquidity crunch in the system and boost growth.

In the beginning of March, the central bank slashed its repo and reverse repo rates by 50 basis points (bps) each, effectively bringing down the key interest rates to 5 percent and 3.5 percent respectively. Earlier, the cash reserve requirement (cash reserve ratio or CRR or the proportion of deposits banks need to keep with the central bank) was also brought down by 50 bps to 5 percent. But with the consumer price index (CPI) or retail inflation still at an elevated level of over 9 percent in annual terms and dip in industrial production and contraction in exports as well as imports threatening to bring down India's economic growth rate to 7.1 percent or less in the current fiscal year, a sharp drop from 9 percent or more recorded in previous three years, analysts are hoping for one more round of rate cuts before the nation prepares for general elections in April-May.

Deflation is when the inflation rate falls below zero percent, resulting in an increase in the real value of money a negative inflation rate. Inflation reduces real value of money while deflation increases the real value of money.

According to the analysts, a decline of one percent in the index for primary articles contributed to the low inflation rate. However, the prices of many essential food items, including cereals, grains and pulses, remained high compared with the prices recorded in the corresponding period last year.

Analysts said a reduction in the prices of essential commodities might not happen, as a fall in the inflation rate only showed a fall in the rate of rise in the prices and it might not affect the actual prices.