Food inflation puts squeeze on RBI

While the immediate causes are different -- not enough rain in 2009, too much in 2010 -- food inflation puts the Reserve Bank of India (RBI) in a tight spot. It can do nothing to ease supply shortfalls but must battle the knock-on effects, at the risk of an aggressive rate response that slams the brakes on India’s heady growth.

The RBI, which is expected to raise interest rates next week for the seventh time in a year after headline inflation accelerated to 8.4% in December, is getting little help from a government that has taken only stopgap measures to address food prices.

Record global food prices add to India’s woes, which result from rising incomes but little investment over more than two decades in a farm economy beset by low crop yields, a lengthy chain of middlemen, and poor transport that means up to 30% of produce spoils before it reaches consumers.

When India’s overall inflation was stuck in double digits last summer it was a purely domestic phenomenon. Now, global food prices are at all-time highs and crude oil is near $100 a barrel, which limits India’s options and means any government measures to ease price pressures will worsen its fiscal position.

Petrol prices are up 22% since New Delhi deregulated them in June, but diesel and cooking fuels remain state controlled. The government, under siege from the Opposition over high prices and the handling of a series of corruption scandals, has put off a decision on whether to raise them.

“There’s a lot of repressed inflation," said Abheek Barua, chief economist at HDFC Bank, who said India’s usual strategy of importing its way out of temporary food squeezes will not work amid tight global supplies.

“Unless we have a huge productivity boost coming in some of these very critical sectors like non-foodgrain agriculture, I think we won’t be able to climb out of this mess for quite a while now," he said.

Beyond Food

Food isn’t the only source of inflation in India.

Rising overall demand in an economy growing at nearly 9% is running up against stretched capacity for everything from cement and steel to cars and skilled labour.

Credit growth, meanwhile, has picked up sharply since November, with real corporate lending rates turning positive only in recent weeks despite nearly a year of policy rate increases, adding to demand side pressures. The RBI’s policy lending rate of 6.25% is still well below inflation.

Surging rural incomes, resulting from government programmes that have increased spending power in recent years as well as the benefits to farmers and others of higher crop prices have driven up demand and prices for foods like meat, fish, eggs and milk.

Under its National Rural Employment Guarantee Scheme, the government on 1 January lifted minimum rural wages by 17 to 30%, which will drive consumption but add to inflationary pressures as well as the government’s fiscal cost, Nomura noted.

There has been plenty of talk in recent years about revamping a farm economy that is based on small holdings, remains heavily dependent on monsoon rains and lacks adequate cold storage. Opposition from politicians courting rural voters has meant reforms have been uneven and slow.

“There are no quick fixes on food inflation," said Samiran Chakraborty, regional head of research at Standard Chartered.

Missed Target

Few in India expect inflation to decline to the central bank’s 5.5% target by the end of the fiscal year in March. Citigroup, for one, expects inflation of 6.5 to 7% in the year starting in April, with an upward bias.

Most economists expect at least 75 basis points of rate rises this year, and the recent pick-up in inflation has helped push stocks down more than 6% in 2011 and steepened the long end of the yield curve.

Still, not every part of Asia’s third-largest economy is seeing breakneck growth. Industrial output in November rose by just 2.7%, an 18-month low that was well below forecasts.

This week, commerce minister Anand Sharma sent a letter to the finance minister that was released to the media, arguing that monetary policy may not be the right tool for dealing with high food inflation. That underscored the tension between the RBI’s inflation-fighting mandate and the government’s growth obsession.

Austerity is unlikely to come from New Delhi, which is not in the habit of trimming spending on social programmes, especially with major state elections looming this year.

While asset sales and a bumper 3G airwaves auction will help the government meet its fiscal deficit target of 5.5% of GDP in the year that ends in March, subsidy burdens for food, fertilizer and fuel are all risks to its 4.8% target budgeted for the next fiscal year.

“You have loose monetary, loose fiscal policy, no excess capacity, and this combination usually ends up in tears," said Jahangir Aziz, chief India economist at JPMorgan.

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