A major worry for the poll-bound UPA government has certainly abated of late with inflation back in single digits. From peak levels of 12.8 per cent in August, the price rise is now 4 percentage points lower at 8.98 per cent. Policy wonks are already visualising a 5-6 per cent rate of inflation in March 2009. While that is certainly a welcome prospect, the big question is whether this lower rate is sustainable? Before one uncorks the bubbly, it is worth noting that this fall reflects a steep drop in the prices of petro products like naphtha, jet fuel and light diesel oil, thanks to cheaper global oil prices. Such a downtrend can well reverse itself if global oil prices start rising again. The
International Energy Agency has warned that the era of cheap oil is over and prices would soon rebound above $100 a barrel. Similarly, global commodity prices have declined. But they, too, can go up when China’s massive fiscal stimulus package kicks in.
That said, the return to single-digit inflation does provide room for the Reserve Bank of India (RBI) to lower interest rates to revive flagging industrial growth. High borrowing costs have hit India Inc’s bottom line. Corporates have postponed plans for capital expenditure. Projects worth $190 billion have faced delays due to slowing growth and a liquidity crunch. Clearly, this is the time for the RBI to make money cheaper. The central bank influences the lending rate of commercial banks through instruments like the reverse repo rate, the rate at which it absorbs liquidity out of system. Or the repo rate at which it injects liquidity into the system.
Expectations indeed are rife that it will cut both rates to create more liquidity to enable commercial banks to lend more to industry. Single-digit inflation, thus, enables the government to deal with the imperatives of a slowing economy. And some welcome respite ahead of crucial Assembly elections, and a national election in 2009.