India: Food price spiral may force govt to hike interest rates

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Rajeev Deshpande, TNN, 16 January 2010, 04:21am

NEW DELHI: With inflation for December 2009 touching 7.3% and fears that it will rise further over the next couple of months, driven in good measures by a steep increase in food prices, government is bracing for the inevitability of a rate increase and a graded exit from the fiscal stimulus.

A hike in interest rates, apart from an increase in reserve ratio, is now on the cards despite the government's keeness to nurture growth in the wake of last year's slowdown. Reserve Bank of India moving to tighten money supply by revising policy rates is seen as a "sooner than later" option.

The relentless rise in food inflation is sharply eroding government's comfort zone over positive indicators like a healthy rise in the index of industrial production which registered an 11.7% growth for November 2009 on a year-on-year basis. "No government would be happy with food inflation nearing 20%," said official sources pointing to the priority the issue was commanding.

There is a strong view that sectoral measures like banning food exports, reducing import duties, releasing excess foodgrain and cracking down on hoarding will not help beyond a point. Even if inflation was food-driven, it still needed a monetary response and this school of thought seems to have dominated the thinking in the central bank.

While the government seems reluctantly reconciled to a rate hike, it is looking more carefully at its options with regard to withdrawing the stimulus it had rolled out in tranches since late 2008. Keen to preserve the recovery that has seen 7.9% growth in the July-September quarter, the government may move slowly on rolling back the sops, possibly providing a hint in this direction in the 2010-11 Budget on February 26.

With the Budget being both a political and economic document, the government does not want to upset industry too much.