It must be the funny political season, otherwise why else would otherwise sensible economists go bonkers in terms of explaining the recent sharp downturn in the inflation rate (latest rate – 1.6 percent). I can understand Congress economists going around the bend (though Jairam Ramesh has a guardedly sensible article in India Today), but economists not being able to understand that both the economic recovery, and the decline in inflation, is for real, is mystifying. Inflation is down in the entire world; China has witnessed negative inflation for the last two years; East Asia, in spite of large devaluations, is witnessing inflation less than 2 percent; even Indonesia should see inflation in single digits by the end of the year. But India, as always (but not for much longer), is sui generis; the top 5 explanations for “why inflation is not low” follow.

(5) The WPI is not the correct measure of inflation.

If the "correct" CPI measure isused, then inflation is still a high 5.7 percent, indeed, it is the highest in the world,excluding Indonesia. The unions, and the politicians, have joined forces over the yearsin refusing to modernize, and re-base the CPI series. It is still operating on a 1982base, with no plans for change. Why ? Because pension benefits, dearnessallowances, government and the large public sector wage increases are all tied toinflation as measured by the CPI ; hence, it literally pays (for some) to have an inflated,but politically correct, inflation rate. Indian technocrats (but not Indian economists?)have known about this political disease for some time now - hence, their preference forthe non-political wholesale price index (WPI).

(4) Inflation is low because of low food prices.

This may be a legitimate point. Mostpolicy makers look at core inflation i.e. inflation in non-food, non-fuel. Inflation inmanufacturing inflation (57 % of the WPI) has been less than 4 percent in each of thelast four years and is now averaging 2.2 percent.

(3) Money supply growth is still very high (>18 percent) so low inflation is anaberration.

This is the all too familiar monetarist refrain; these monetarists do notknow that India's money supply growth has been a constant for twenty years (since M3data are available) - it has ranged between 16.1 and 18.2 percent; and the volatility inIndia's money supply growth is the lowest in the world. (Even in strict monetaristGermany the volatility is 50 percent higher). Money Supply growth is the Hinduconstant. How a constant can explain a highly varying inflation rate (between 2.5 and12.9 percent, 1981 to 1999) only Indian monetarists can answer.

(2) Inflation is low now because of a high base last year.

It is the case that inflationin July for the last five years has recorded a 1 percent lower inflation than that whicheventually occurred for the entire fiscal year. If so, inflation for 1999 should be close to3 percent, which will still be the lowest average inflation in the last eighteen years (it was 2.5 percent in 1982). Inflation in primary articles from March-June was 9 percentcompared to the 4.6 percent recorded during Jan-March. So the present inflation isalready off a high base. Just wait for the next few months if the high base is really aconcern. Last year, inflation in primary (food) articles accelerated from 5.0 percent inJanuary 1998 to 11 percent in June, to 14.9 percent in the (state) election campaignmonth of October. If inflation is electorally important, then has the Congress won thebattle of three states but lost the war of the nation?

(1) Low inflation reflects low demand. This is the equivalent of catching the nose byswinging one's arm around the neck rather than the simple old-fashioned (butunsophisticated) method of directly catching one's nose. Why not just look at what hasbeen happening to inventories, and output, to find out about real demand? Industrialproduction index is up more than 7 percent from a trough of 0.1 percent in Oct. 1998,and 4.6 percent growth last July. Other growth indicators are also robust, with exportsregistering double-digit growth for the second month in a row.

All of this is terribly important for policy. In particular, the setting of interest rate policy.Unfortunately, macro policy cannot unfold with events because the President, and theElection Commission, are likely to view anything helping the economy as helping theBJP, and therefore a no-no. (It is a wonder that the Commission did not stop thegovernment from conducting national security operations in Kargil, so one has to begrateful for small favours). But what should interest policy be come October ?

The conclusion is straightforward. Unless interest rates are cut, and cut drastically, theeconomy will sputter again, as it has over the last eight years. No country has survivedsuch high real interest rates for very long, as prevailing in India today, and over the lastdecade. Real short-term interest rates in open non-crisis developing economies haveaveraged about 2 percent in the last decade and long-term rates about 5 percent. InIndia, with the WPI as the inflation measure, short-term real rates are 6 %, real depositrates are 9 % and real long-term rates for the best corporates are 11 percent. Thismindlessness has to be stopped. But what about the fiscal deficit, the lazy policy makermight say.

There is a reasonable argument that in India, high interest rates cause high fiscaldeficits. They do so primarily through the operation of the 12 percent Ponzi rule. Postaldeposits and government pension funds are all mandated to yield 12 percent! Thesesavings - which together account for over a third of the financial savings of households(more than Rs. 60,000 crore) - provide a floor for interest rates. Like the unwillingnessto update the CPI, the political economy of postal savings rates is that they provide thelifeline for states to finance their expenditures. If the States had to go to the market tofinance their unholy deficits, it is likely that they will have to pay considerably more thanthe close to zero percent financing at present (remember, the tax-payer pays for thedebt twice - first through higher real interest rates, and second through eventualfinance of the debt). So the next time your friendly politician or your lazy economistsays to cut the fiscal deficit, ask her to talk policy instead of motherhood; ask her to cutthe legs of the fiscal deficit, and the foundation of high real interest rates - the postalsavings deposit rate.

The author is Director, Oxus Fund Management, a New Delhi based emerging marketsadvisory and asset management firm.