The issue was related to having log in /etc directory. By default Splunk assumes files in /etc directory are configuration file and Splunk has a stanza by default that will index the whole file in $SPLUNK_HOME/etc/system/default/props.conf:
[source::(.../etc/...|....(config|conf|cfg|inii|cfg|emacs|ini|license|lng|plist|presets|properties|props|vim|wsdl))]
sourcetype=config_file
CHECK_METHOD = modtime
The workaround is to set priority higher than the default stanza using source stanza in props.conf (If you use host or sourcetype in the props.conf will not work), specify CHECK_METHOD so it will not use modtime.
For example:
[source::/etc/log/*]
sourcetype=log_in_etc
CHECK_METHOD = endpoint_md5
priority = 10
Type of message to look for in splunkd.log is:
02-09-2011 21:15:17.993 INFO WatchedFile - Will use tracking rule=modtime for file='/etc/log/test.log'.
02-09-2011 21:15:17.994 INFO WatchedFile - Modtime is newer than stored, will reread file='/etc/log/test.log'.