A summer drought has already taken a bite out of farm incomes and regional economies in India. It could have one sting left: undermining the power of the country’s central bank.

A wholesale index of food prices in India jumped more than 19% in December. Sugar and some beans and lentils are now at all-time high prices.
The price gains have raised alarms at the central bank. The Reserve Bank of India’s problem, though, is that its key inflation-fighting tool -- interest rates -- targets demand. Rising food prices in India remain largely a supply-driven problem.
That complicates the calculus of how quickly rates in India should rise.
A big jump in rates will dampen speculation in physical and futures markets and manage inflation expectations, but it won’t have impact price gains driven by supply shortages. Plus, it could put India’s broader economic recovery at risk. Moving too slowly, though, could have food price gains spilling over into broader inflation measures.
Leaving food inflation fighting to New Delhi is not a reliable solution.
The government has taken some steps recently -- selling wheat out of its stockpiles, lifting import taxes on sugar, and capping allowable stockpiles by food producers -- but many doubt that these moves will be effective. Poor policy coordination between federal and state governments, and limited stockpiles of some foods will see to that, naysayers argue.
For now, economists expect a steady response from the RBI, perhaps a quarter point increase in rates from historic lows at next week’s policy meeting, leading to a total 3% increase over the course of 2010. That would still leave interest rates below their peak in 2008 -- the last time food price gains challenged India.
But the persistence of high prices is casting some doubt on these assumptions. DBS economist Ramya Suryanarayanan expects wholesale price inflation in the fiscal year ending March 2011 to average out to about 5%, but says “that’s on the assumption food prices will fall.”
“Seeing the way food prices are rising, it’s kind of worrisome that they may not come down that much,” she said.
To be sure, a decent harvest of the winter-sown crop could ease pressures. But that won’t be clear until May.
Weather, as always, is India’s wild card.
(Source: wsj.com)