UPDATE 2-India food inflation picks up; c.bank tightening seen

Thu Dec 17, 2009 4:20pm IST

* Food prices up 19.95 pct annually as at Dec 5

* Reinforces case for tightening

* Risk of inflation spilling over to broader economy

By Manoj Kumar

NEW DELHI, Dec 17 (Reuters) - Indian food prices surged an annual 20 percent in early December as supply shortages hit, heightening expectations the central bank is set to tighten policy to stop a breakout of inflation in the broader economy.

Food prices are jumping because of shortages after crops were hit by the weakest monsoon rains in 37 years and then flooding in parts of the country, but the price rises come as the economy is picking up strength after a dip in late 2008 and early 2009.

Food prices rose 19.95 percent in the year to Dec 5, picking up from an annual 19.05 percent rise a week earlier, weekly data showed on Thursday.

"Seasonality in food prices is not playing this year. Processed food prices are rising. Prices of non-food manufactured products such as textile, cement and autos are rising or going to rise," Nomura economist Sonal Varma said.

"We are now at the turning point where supply-side inflation could into demand-side inflation. So inflationary expectations have to be anchored."

For a graphic on food and wholesale price indexes and policy rates, see: r.reuters.com/pag47g

For a graphic on food prices and their impact on headline inflation, see: link.reuters.com/jah86g

The data reinforced market expectations that the central bank would tighten policy as early as January.

The benchmark 10-year bond IN069019G=CC was steady at 7.68 percent after rising 49 basis points since late November, when data showing the economy grew an annual 7.9 percent in the September quarter, its fastest in 18 months, boosted the market's view for a policy tightening.

The one-year swap rate INRAMONMI1Y= was at 5.06 percent, below a 12-month high of 5.15 percent hit on Wednesday but still 58 basis points above a 2-1/2-month low hit in late November.

The government, which has expressed increasing concern at the rapid rise of food prices, said it may import supplies.

"Food prices are going up, this is an area of concern. We have to take some appropriate measures... but best could be done by augmenting supply through imports," Finance Minister Pranab Mukherjee told reporters.

Food prices are politically sensitive in India and the government is under pressure from opposition parties and allies to contain inflation, especially food prices which are hurting poorer sections in the country.

SUPPLY PROBLEM

Monthly price data for November this week showed maufacturing prices rose an annual 4 percent, a sign the building economic recovery is allowing firms to pass on higher costs.

The annual wholesale price inflation, which stood at 1.34 percent in October, rose to 4.78 percent in November, and analysts said it could reach 8 percent by the end of the fiscal year in March, above the central bank's forecast of 6.5 percent.

The Reserve Bank of India cut its main lending rate by 425 basis points between October 2008 and April, slashed the cash reserve ratio and pumped cash in financial markets to shore markets and the economy up against the global financial crisis and slowdown.

Analysts expect the first step will be an increase in banks' cash reserve ratio (CRR) to drain funds from the market.

"By January, we are expecting 50 basis points increase in CRR. Policy interest rates may be raised in the January policy," said Nomura's Varma.

Reserve Bank of India Governor Duvvuri Subbarao has said that monetary policy was not the right tool to fix supply problems such as food shortages, but has also noted the risk the soaring food prices were factored into expectations for other prices, which would create inflationary pressures throughout the economy.

"I think the central bank has indicated that it is primarily a supply-side problem. I do not think monetary policy is an answer to this," said Abheek Barua, chief economist at India's No. 2 private sector lender, HDFC Bank.

"They will increase CRR only in January."

The central bank holds its next policy meeting in late January, but it can adjust monetary policy at any time.

It worked closely with the government last year to plan a joint response to reviving growth, and in recent months has signalled it was looking to exit is very accommodative policy.

"The RBI governor will do monetary tightening when he thinks it is needed. For that, I don't think he will be influenced by the finance ministry," said D.H. Pai Panandikar, president of independent think-tank RPG Foundation. (Editing by Alistair Scrutton, John Mair, Kazunori Takada)

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