No matter what index is used, the Indian economy is showing zero inflation. The annualized seasonally adjusted (SA) figures for three measures of inflation for the latest quarter are as follows, (unadjusted figures in brackets): WPI, 1.1 and (2.6); WPI, manufacturing, -1.0 and (-0.1); CPI, 1.6 and (5.6). Non-farm bank credit has also slowed to a crawl, and at 7 % (unadjusted is at 1.1 %) it is at one of the lowest levels in the last decade; and industrial production is more likely at zero growth rather than the year on year figure of 2.5 percent, or the latest quarterly (not seasonally adjusted) figure of –6.4 percent.

The raw inflation figures show that inflation is at a historic low; the seasonally adjusted figures suggest that it is even lower, and without planning!, we have reached the much desired figure of zero inflation. Ordinarily this would be a cause of celebration. But these are not ordinary times, and the figures are suggestive of something terribly wrong with the conduct of macro, and interest rate policy, in India.

What else does zero inflation reveal? Simply, that the economy is weak, very weak. And what are the reasons? Globalization. The world economy is going through its worst collective downturn for only the second time in the last fifty-five years; the last such slowdown occurred in 1973-74 when the oil price was quadrupled by OPEC. Some commentators have argued that since exports are only a small part of our GDP, approximately 10 percent, that India is not that vulnerable to global downturns. This is false on at least two counts. First, what matters is not the size of traded goods, but the size of what can be traded; and with the decline in tariff and non-tariff barriers, the share of tradeables is now very large. Second, if exports are growing at 20 percent (like last year), then as a very rough approximation they were adding at least 1 percentage point to GDP growth. Exports are presently (latest quarter) declining at approximately a 15 to 20 percent annual rate (the raw data shows an absolute decline of 17.5 percent in just the second quarter). In other words, more than a 1 percent decline in aggregate GDP growth is due to the global slowdown.

Are there any domestic responses to a global slowdown? If it is a market economy i.e. one with few controls and/or distortions, then there is precious little that individual governments can do. But if an economy has been "blessed" with past mistakes, then the mere removal of these distortions can be a strong source of growth. This is the happy predicament in which Indian policymakers find themselves today.

The distortions are several, and legion. In India there is now a virtual industry of pronouncements to help the economy - the need of the hour, second-generation reforms, etc. Typical is the recent pronouncement by the dean of industry lobbyists, CII's Tarun Das (Economic Times, 21 Aug): the government needs to concentrate on three areas - public infrastructure, disinvestments and exports. No mention is found in most experts dossier of the biggest distortion, and therefore the biggest source of future and "free" growth: the role of managed, and exorbitantly high, real interest rates in the economy.

It is important to investigate as to why Indian industrialists have not been demanding the removal of mis-managed interest rates. A real borrowing rate of close to 10 percent, let alone the 15 + level for most firms, would kill any entrepreneur. Yet I have noted in several forums over the last five years that industrialists are mostly amused by my tirades against managed interest rates. Why should they not be championing the cause of competitive interest rates? For the simple reason that the major industrialists in India have never suffered the yoke of extortionary real rates; being card carrying members of the BLIP (bureaucrats, left-intellectuals, major industrialists and politicians) brigade, they are masters of the system. They do not suffer from high rates; relations with politicians, NPAs of banks, and lack of good bankruptcy laws allows them to borrow, and never repay. One area I am in agreement with Marx.

So the next time you get worked up about the high cost of borrowing in India (done in the name of the poor, or in the name of government pensioners who deserve an annual 12 percent real return, or other such perfidious nonsense peddled by our politicians and old-fashioned economists) and get worked up about government bailouts of banks, and mutual funds, and non-performing assets, and wonder why nobody is bothered - at that time also get worked up about the lack of a market economy in India, about the lack of economic freedom, and about the monopoly presence of state capitalism.

Zero inflation points to both the cause and the remedy for most of the economy ills. The governor of the Reserve bank of India, Dr. Bimal Jalan, had correctly noted almost three years ago that what ailed the Indian economy was the "structure of interest rates". This was Bimalspeak for the fact that interest rates were sticky, and that there was a scam in the setting of interest rates. The scam was in the form of the government setting up high rates for so-called "small and old savers" (a story bought by most politicians and several present and past policy makers) who "contribute" to these postal deposit schemes. The scam was in the "use" of these savings - all towards highly unproductive, and corrupt, state expenditures.

Full credit to the Finance Minister, Mr. Sinha, for realizing this scam and in not being taken in by the fashionable speak of some old fashioned economists who attributed high real interest rates to - high fiscal deficits. As noted in last weeks article (Capital Markets - RBI holds all the cards), India has had high fiscal deficits, in the range of 8 to 10 percent, for the last twenty years - during this time, real interest rates have ranged from 0.5 to 15 percent i.e. high, and constant, fiscal deficits prevailed with real interest rates of 1 percent, 2 percent…., and now close to 12 percent. Indeed, such high administered rates fuel higher deficits - interest payments as a fraction of the deficits were only 25 percent at the time of the financial crisis in 1990-91; today they account for almost the entire consolidated fiscal deficit of the Indian economy - yes, close to 10 percent of GDP.

As an end to the scam, and a prelude to market determination of interest rates, a government committee was constituted to provide a roadmap of reforms. If the Business Standard is to be believed (Stemming the drain, 14 Aug, 2001), this committee has recommended that the savings deposit rate be tied to the bank rate! Clearly, the control freaks are not only not relinquishing control, they are expanding their 50 year long freakish empire. It is hoped that this RBI housed committee will negate this recommendation and others like it e.g. tying the savings deposit rate to the government securities rate. Deposit rates should be set by the needs of the savers and investors; if it has to be administered, best to set it at a discount to the prevailing inflation rate.

There is only one answer to problems of Indian industry, competition with China, and India having a decent chance of finding its due place among nations (and making my forecast that this is India's decade come true): competitive cost of capital. Let the games then begin.