Spectre of food prices haunts govt's reform agenda

A labourer pulls a plastic sheet to cover sacks of paddy from rain at a grain market in Chandigarh January 13, 2010. The return of inflation to the headlines comes at the wrong time for the ruling Congress party as it mulls reforms which could entail painful adjustments to freer markets by millions of Indians.

NEW DELHI (Reuters) - For a barometer of India's appetite for economic reform, look no further than the lowly lentil, the mainstay of the Indian diet which has jumped in price by 42 percent in the last year.

Food inflation has hit an 11-year high, giving government populists worried about consumer anger more sway over reformists to hijack investors' wish-list of reforms.

The return of inflation to the headlines comes at the wrong time for the ruling Congress party as it mulls reforms like the liberalisation of the agricultural sector, which could entail painful adjustments to freer markets by millions of Indians.

These reforms also include drives to make the power sector, retail and labour more responsive to market forces by cutting state-run subsidies that may help widen the 2009/10 fiscal deficit to a 16-year high of 6.8 percent of GDP.

"Inflation is a distraction that reinforces the government's lack of appetite for reform and gives it a convenient excuse for not doing anything," said V. Ravichandar, managing director of Feedback consulting in Bangalore, which advises multinationals on doing business in India.

Ahead of a Jan. 29 policy review, authorities seem more focused on whether to tighten monetary policy to rein in inflation at the risk of hurting an incipient recovery.

NO GREAT EXPECTATIONS

Few expected speedy reform in Prime Minister Manmohan Singh's second term. But there were hopes he would push policies to liberalise the state and boost both foreign and domestic investments to achieve growth rates similar to China's.

Singh has a freer hand, no longer relying on the communist parties that propped up his first term government.

Many investors wanted cuts in subsidies for fuel, fertiliser and food. India's growth story has been dogged by persistent high inflation, often because of supply bottlenecks blamed on state-controlled prices as well as poor roads and rail.

Reformers have been trying since 1991 to roll back a heavily socialist state that since Independence in 1947 has nationalist sectors from banks to mines, and subsidies on food staples like wheat.

But with 42 percent of Indians living on less than the poverty line of $1.25 a day, reform has always been a political hot potato. Many farmers who receive subsidies for basics such as rice helped Congress win last year's election.

It can still take 11 days to transport new cars from Chennai factories to salesrooms in northern India, while it is only a two-hour journey by plane. The world's biggest rail network has just 20 refrigerated wagons, and many fresh vegetables rot in transit.

"Inflation makes dealing with irrational subsidies much more difficult," said Pratap Bhanu Mehta, head of the New Delhi-based Centre for Policy Research. "It's a vicious circle, unless you deal with power and agricultural subsidies you are not going to fix long-term supply problems.

Mehta pointed to the government giving cash compensation of $2.6 billion to state oil firms this month to cover losses on sales of fuel at below market rates to consumers. It is money better spent on infrastructure, he said.

But at a time when Indians are squeezed by high prices, cutting subsidies only becomes harder. A late monsoon and drought has forced the government to focus on getting economic growth back on track.

"The government has been preoccupied in getting the macro economy right, and they may have succeeded", said Amit Mitra, Secretary General of the Federation of Indian Chambers of Commerce & Industry.

Officials say food inflation is temporary, and they expect reforms in the next session of parliament due in mid-February.

"In the beginning of March we should see a sharper than usual seasonal decline in food prices," said Abhijit Sen, a member of Planning Commission.

Still, other Asian countries like China face rising inflation as economies recover, but India may be in the trickiest position.

Paul Schulte, a strategist at Nomura, told the Economic Times this week that India was "the number one inflation problem" country in the region in 2010.

While there have been little street protests, the opposition such as the communists in West Bengal and the Dalit leader Mayawati in Uttar Pradesh are attacking Congress over prices.

Food prices have been key to political survival in the past. Onion prices helped push out a state government in 1980.

"Unrest is always one step away in India. It can suddenly flare up," said political analyst Mahesh Rangarajan.

"Inflation has helped put further reforms on hold. You can't do privatisation, you can't reform fuel prices, fertiliser prices, when most of your voters' home budgets are already hit."

(Editing by Paul de Bendern and Sanjeev Miglani)