Indian economy may go into deflation by the second quarter of financial year 2009-10 as there are fears of inflation going below zero per cent in the face of unprecedented fall in crude and commodity prices.
"If the current pace in inflation-decline continues, the figure (in WPI-based inflation) may slide below two per cent by end-fiscal," HDFC Bank's Deputy Head of Treasury, Ashish Parthasarathy, said, adding "it may fall further to below zero per cent by Q2 FY10."
Inflation almost halved to a nine-month low of 6.61 per cent from this year's peak of 12.91 per cent, giving more space to the RBI to signal further cuts in interest rates.
Deflation occurs in an economy when the negative inflation prevails for a long period. In the event of deflation, the Reserve Bank will have to enhance money supply and lower rates further "to support inflation", IDBI Gilts' Economist, Amol Agarwal said.
Citibank India's Chief Financial Officer, Abhijit Sen, echoed this view saying that the rapid decline in the headline inflation is likely to continue in the coming months.
"In my view, deflation is a remote possibility in this economy. However, if the inflation continue to fall to much lower levels, this would have an impact on the profitability of banks, as it would affect the credit demand," Sen said.
The sharp decline in inflation has given a headroom for the Reserve Bank to slash its reverse repo rate by 0.5-1 per cent, he said.
"A lower inflation rate has offered the opportunity to the Reserve Bank to explore further monetary policy options including a cut in the short term reverse repo rate," Sen said.
Wholesale prices-based inflation declined by 0.23 percentage points for the seventh consecutive time during the week-ended December 13 as manufactured goods and food items became cheaper due to the cascading effect of fuel price cuts amongst other factors.
"(The) declining inflation rate provides more leeway to the RBI to further slash interest rates. I expect a 100 basis points cut in both the repo (short-term lending rate) and reverse repo (short-term borrowing) rates," said Crisil's Principal Economist DK Joshi.
India's Reserve Bank had hiked its key policy rates several times till October to hold-off skyrocketting inflation rate that rose to a multi-year high of around 13 per cent early this year.
However, with inflation now on the decline, the Central Bank has shifted its focus from fighting inflation to supporting economic growth with a series of rate cuts.
It cut the Cash Reserve Ratio (CRR), the percentage of cash banks are required to park with the apex bank to 5.5 per cent from nine per cent and the repo and reverse repo rates to 6.5 per cent and five per cent respectively.