India's central bank is expected this week to hike interest rates for the seventh time in less than 12 months to clamp down on soaring inflation as clouds gather over the country's booming economy.
Shares in India, one of 2010's hottest markets, have fallen to three-month lows due to expectations of interest rate rises, which will dampen economic growth currently running at 8.5-9.0 percent in Asia's third-biggest economy.
Annual inflation zoomed in December to 8.43 percent, up by nearly a percentage point from the previous month, led by a spike in the cost of food, petrol prices and commodities.
The Reserve Bank of India (RBI) has warned of "surging inflation." Further souring the mood, investment house Goldman Sachs issued an alert this month on India and China over inflation, telling clients to shift into Wall Street and other Old World share markets as a safer bet in coming months.
"We expect the Reserve Bank will raise rates by 25 basis points but the possibility of 50 basis points also has to be entertained," said HSBC chief economist Lief Lybecker Eskesen.
Rising prices have emerged as a major political and economic challenge in emerging markets across Asia, with China also expected to raise interest rates early next month to combat 5.0-percent inflation and a property bubble. In India, pressure has been steadily growing on the central bank and government to act to rein in inflation which threatens Prime Minister Manmohan Singh and his Congress party in the run-up to key state elections this year.
Rising food prices have added to public anger over a series of massive corruption scandals, creating a toxic mix for Singh's administration just 18 months into its second term. The price of onions, for example - a staple on family shopping lists and known as a politically potent issue - has tripled to 80 rupees ($1.75) a kilogram in a few months.
"A lot of countries are still flirting with deflation. On the other hand, we are having surging inflation," RBI governor Duvvuri Subbarao said last week. India's central bank has been one of the most aggressive in raising the cost of borrowing as the South Asian economy roared out of the global downturn.
It has raised rates six times since last March, pushing the repo - the rate on loans it makes to commercial banks - to 6.25 percent and the reverse repo - the rate it pays to banks for deposits - to 5.25 percent.
Economists are split on the efficacy of raising interest rates to tackle inflation driven by food prices, but all agree that sustained rising prices can lead to a destabilising wage-price spiral. This was one of the concerns raised by Goldman Sachs in its report on India, which also focused on a yawning record current account deficit of 4.1 percent of gross domestic product.
Investor enthusiasm for China is also cooling as it fights inflation and a property bubble amid expectations that the United States will experience a strong recovery.
"Asia is not in the sweet part of the cycle. The longer-term picture of Asia outperforming the US is taking a breather," said Tim Moe, Goldman's chief Asia-Pacific strategist, British media reported. But Goldman Sachs and other economic houses say they are still bullish on the longer-term outlook for India with its vast market of 1.2 billion people.
"There are near-term hiccups for sure," said Rohini Malkani, economist at Citi India. But the obstacles will "not be enough to derail the (India) story" with its vast consumer market, Malkani said.
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