Food inflation accelerates, RBI action imminent

Economists widely expect a 50-basis point rise in banks' cash reserve ratio (CRR) , the proportion of deposits lenders must keep with the central bank in cash.

"Even as food supply is expected to normalise in the coming months, higher energy costs and strong consumer demand will ensure (headline) inflation inches towards 9 per cent by March 2010, with risks clearly to the upside," said Rahul Bajoria, an economist with Barclays Capital in Singapore.

The food price index rose 17.40 per cent in the 12 months to Jan 16, higher than an annual rise of 16.81 per cent in the previous week, data released on Thursday showed. The index rose 0.4 per cent from a week earlier.

The fuel index rose to an annual 5.70 per cent, lower than an annual rise of 6.34 per cent in the previous week.

Higher food prices following a bad harvest of summer-sown crops are expected to keep headline inflation elevated, with some analysts forecasting the wholesale price index to touch double digits by March from 7.3 per cent in November.

Rate Worries

The debt markets have already priced in a 25-50 basis point increase in the CRR, with some dealers also hedging in anticipation of a 25-basis point rise in policy rates on Friday.

However, 24 out of the 25 economists polled by Reuters do not foresee any change in policy rates on Friday and expect a rise in key rates only in March.

"Current inflationary pressures are not driven by excessive aggregate demand," Rajiv Malik, an economist with Macquarie Securities, said in a note on Wednesday.

"So hiking of policy rates now will be relatively less helpful in checking food inflation, but could cause a negative impact on growth."

Dealers expect bond prices to rally and yields to touch 7.45 per cent if the RBI hikes only the CRR and keeps interest rates unchanged.

The country's economy is expected to expand at 7 per cent in the current fiscal year to end-March, faster than 6.7 per cent last year, helped by a recovering global economy and rapid expansion in domestic industrial output, a Reuters poll showed.

The economy grew 7.9 per cent in the quarter through September, its fastest in 18 months, while industrial production grew in November at its fastest pace in more than two years at 11.7 per cent.

That growth, however, has largely been fuelled by government stimulus spending and cheap credit following policy rate cuts totaling 425 basis points between October 2008 and April 2009.

Non-oil imports, which foretell production and capacity creation in the economy as the country primarily imports capital goods and basic raw materials, fell an annual 5.9 per cent in November.

The growth in bank loans, a barometer for private investment in the economy, continues to be sluggish. Bank loans grew an annual 13.7 per cent as of Jan 1 compared with the RBI's forecast of 18 percent for the current fiscal year ending March.