India's central bank faces a tricky balancing act in fighting inflation expected to surge in coming months and keeping the country's fragile economic recovery on track, economists say.
Central banks across the world are facing similar dilemmas after cutting interest rates aggressively in the face of the world financial crisis and now having to decide when to start tightening policy as recoveries take root.
Asia's third-largest economy reported a return to inflation last week as a result of soaring food costs fuelled by a bad monsoon and economists said they expected further sharp price rises in the months ahead.
Annual inflation, which had been in negative terrain for 14 weeks, rose 0.12 percent for the week to September 5, according to the latest Wholesale Price Index (WPI) figures, India's most watched cost-of-living benchmark.
"In the coming weeks, inflation is expected to rise on a sustained basis, up to seven percent by March 2010," said Siddhartha Sanyal, economist at Edelweiss Securities. Some analysts believe inflation could hit eight percent by March.
The resurfacing of inflation, along with a still nascent economic recovery, has confronted the central bank with a dilemma about when to take the first steps to tighten monetary policy to keep a lid on prices. Reserve Bank of India governor Duvvuri Subbarao struck a hawkish tone last week, saying "inflationary pressure (in India) is a more urgent concern" than elsewhere, raising the prospect he might move before other central bankers.
But at the same time, he said, "We will not exit from the accommodative monetary policy unless we are assured recovery is secure." Economists said Subbarao's words underscored the delicate nature of the bank's task.
The Reserve Bank has cut interest rates six times since October 2008 with the repo - the rate at which it lends to commercial banks - now at a record low of 4.75 percent. The reverse repo, the rate at which it borrows from banks, is at a record low of 3.25 percent.