Surging food prices may prompt RBI to take action

Food price inflation picked up in mid-November, heightening concerns that it could raise broader inflationary expectations and adding to expectations monetary policy would be tightened in early 2010.                                           

The food articles index rose an annual 15.6% as at November 14, up from the previous week's 14.6% rise. The weakest monsoon since 1972 and then floods in parts of the country have hurt farm output and pushed up food prices.

"The Reserve Bank of India would be concerned about the spill over of food inflation in broader economy and building up of inflationary expectation," said Aditi Nayar, an analyst with rating agency ICRA.                                           

"Monetary tightening won't reduce the food prices, but it will at least try and stem building up of inflationary expectations." On Tuesday, C Rangarajan, chairman of  prime minister Manmohan Singh's Economic Advisory Council, told Reuters food price inflation was the biggest economic worry in the near term and a strong rise in food prices in November and December could prompt monetary action.                                            

At a quarterly policy review in October, the Reserve Bank of India (RBI) withdrew some emergency liquidity support measures but left key rates unchanged.

Analysts polled at the time expected the cash reserve ratio to rise by the end of January, with interest rates expected to have increased by the end of April. Food prices have tended to fall in November and December, but analysts are worried the seasonal dip may not be seen this year.                                            

In October, the annual wholesale price inflation rate was 1.34%. The RBI estimates it will be at 6.5% at the end of the fiscal year in March, and economists think it could be even higher.                                           

"We are likely to see more manufacturing inflation, given that manufacturing sector has been outperforming the other sectors," said Rahul Bajoria, an economist with Barclays Capital. India's industrial output grew 9.1% in September from a year earlier, helped by stimulus and festival demand.                                           

Government officials have said that stimulus measures will remain in place for the remainder of 200910 to ensure the recovery sustains, and analysts think the Reserve Bank is likely raise the cash reserve ratio (CRR), the proportion of deposits banks need to keep with it, before acting on interest rates.                                           

"There is a greater likelihood of a CRR hike than a repo rate hike. Simply because there is too much dollar liquidity," Bajoria said. Foreign funds have bought more than $15 billion of local equities in 2009, leading to an appreciation in currency and stock prices.

The RBI has said that there is a risk that if it raised interest rates ahead of other central banks, it could attract more inflows and complicate policymaking.