Inflation fell sharply by 116 basis points to nine-month-low of 6.84%, for the week ended December 6, below the Reserve Bank of India's comfort level of 7% for this fiscal, raising expectations of deeper cuts in interest rates while government readies a second round of fiscal stimulus. The Centre on Thursday sought Parliament's approval for additional spending to the tune of Rs 55,604.83 crore, which entails a cash outgo of Rs 42,480.10 crore.

Falling inflation prepares the ground for relaxation in the monetary policy, which not only lowers markets rates but also reduces the cost of the government borrowings that would be required to meet additional expenditure. Inflation tumbled as the cut in petrol and diesel prices by Rs 5 and Rs 2 effective December 6 reflected into the data.

Fuel index fell by 3.7%, while primary articles and manufactured goods' pace of price rise dipped by a meager 0.4% and 0.3% respectively. Analysts expect inflation to reach close to 2% by March-end 2009 as commodity prices fall globally and demand looses steam in a slowing economy. Inflation dropped for the sixth consecutive week to a nine-month low, setting the stage for reduction in the interest rates.

"The trend is clear for falling inflation and this will translate into lower interest rates," said Ashok Chawla, secretary, department of economic affairs, ministry of finance. He said RBI is keeping a watch on inflation and 'may take steps if necessary'. Arvind Virmani, chief economic advisor to the finance ministry, on Wednesday argued for a more aggressive monetary policy for mitigating financial effects of the global crisis. Suresh Tendulkar, chairman of the prime minister's economic advisory council had suggested the RBI should pare reverse repo rate —the rate at which banks deposit funds with the RBI—to improve lending in the economy. Bank credit fell by 35% in November over October, while banks' investment in G-sec rose by 400% in the same period.

Markets reacted positively to lower inflation numbers. The 30-share BSE Sensex closed up 3.72% at 10,076.43 points and the 50-share NSE Nifty ended up 3.60% at 3,060.75 points. The yield on the 10-year government bond paper closed lower at 5.48% on Thursday, down from of 5.80% on Wednesday, in anticipation of rate cuts. Rates in the call money markets were steady at 6.40/6.50%. Globally, central bankers are lowering rates to beat the ongoing recession and slowdown.

"Inflation would reach close to 2.25-2.40% by end-March," Yes Bank chief economist Shubhada Rao said. The RBI may cut repo and reverse repo rates at the monetary policy review meeting in January, although a reduction in cash reserve ratio looks unlikely, Rao said. RBI governor D Subbarao said last week the economic outlook is uncertain and central bank would take swift action as and when required to protect growth.

The industrial output growth fell by 0.4% in October, and the outlook remains bleak as indicated by a 15% fall in excise duty collections in November. On Tuesday, former finance minister P Chidambaram said in the Parliament the government could consider a further cut in domestic fuel prices if global crude prices continue to slide.

The wholesale price index based inflation for was revised up to 11.30% the week ended October 11 from 11.07%. Annual inflation was 3.84% during the corresponding week of the previous year. The inflation data of the week does not capture the impact of 4% excise cut across the board announced last week on December 7 as a part of the stimulus package to revive the slowing Indian economy.