Indian food prices moderated slightly but still rose nearly 19 percent annually in mid-December, and a central bank deputy said food inflation could drive headline inflation as growth picks up and capacity constraints emerge.
Indian 10-year bond yields, which this week rose to their highest in 13 months in anticipation of monetary tightening, eased on Thursday as the slight dip in food prices reinforced a view the central bank would wait until January to gauge inflationary pressures before deciding on any rise in interest rates.
Economists said the central bank could first raise the cash reserve ratio (CRR) for banks by 50 basis points next month to drain excess cash from the financial markets, and then go on to raise policy rates, possibly from April onwards.
"As growth picks up, the risk of food inflation spilling over and posing wider pressure rises," Reserve Bank of India Deputy Governor Subir Gokarn said, adding that its January policy review would focus both on growth and inflation, instead of the previous policy focus on growth.
India's economy grew a surprisingly strong 7.9 percent in the September quarter, but Gokarn noted that the performance of the economy was uneven and driven in part by stimulus spending. "The 7.9 percent is a nice aggregate number, but it consists of some sectors doing well and some not. And again in that 7.9 percent a major part is government spending. This poses a dilemma about timing and managing exit strategy," he said.
Government data showed on Thursday food prices rose an annual 18.65 percent in mid December after the driest spell in nearly four decades and floods in some parts of the country hurt crops. although it was below the previous week's 19.95 percent rise. "A hike in cash reserve ratio will make sense. We expect it to be raised by 50 basis points by January policy," said N.R. Bhanumurthy, an economist with the National Institute of Public Finance and Policy.
India and South Korea are expected to be among the first Group of 20 economies after Australia to begin raising interest rates. India's benchmark 10-year bond yield ended at 7.68 percent, lower than Wednesday's close of 7.71 percent. The fuel index rose an annual 3.95 percent in the 12 months to December 12, as the statistical aberrations caused due to price spikes of 2008 faded out, while manufacturing prices rose an annual 4 percent in November.
Annual wholesale price inflation, which stood at 1.34 percent in October, rose to 4.78 percent in November, and analysts have 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. Separately, Finance Minister Pranab Mukherjee said the government was not yet thinking of unwinding fiscal stimulus until economic recovery was full and durable.
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