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As Growth Recovers in India, Inflation Surges


The Central Bank is trying to keep prices down, but a drought and supply bottlenecks have spurred increases

Movie night and restaurant meals are out for Vinod Kumar. As prices for sugar, onions, and other staples have surged after poor monsoon rains damaged harvests, Kumar has been forced to cut back to keep food on the table for his family of four. "It's never been so bad in my working life," the 35-year-old mechanic says as he shops at Bangalore's Johnson Market, a century-old tangle of food stalls.

It's not just food that's getting more expensive. Inflation in India is at a decade high, with consumer prices rising faster than in any other major economy. Industrial output in January increased at the fastest pace in 17 months, pushing up prices for raw materials. Cotton has jumped by 13% since October, while other commodities are rising fast. The benchmark wholesale price index, up 7.3% in December, could hit double digits within two months, predicts brokerage CLSA. That would spur even higher consumer prices and dent the spending power of ordinary Indians.

India's central bank governor, Duvvuri Subbarao, is trying to cool things down. To lower the amount of capital available for lending, the Reserve Bank of India on Jan. 29 increased the cash reserve ratio for banks (the minimum they have to keep on hand) by 0.75 percentage points, to 5.75%. Tighter interest rates are probably next. The bank has moved from "managing the crisis to managing the recovery," Subbarao told reporters on Jan. 29.

Despite India's thriving tech sector, it remains beholden to the vagaries of the monsoon. Less than half of India's fields have irrigation, so a drought last summer led to food shortfalls in several states. Poor railroads and highways make it tough to transport food, leading to shortages and higher prices in many cities. "You don't have enough roads, you don't have enough railroads, you don't have enough ports," says Nikhilesh Bhattacharyya, an economist with Moody's (MCE) Economy.com. "That amplifies any price shock."

Rising prices are a big headache for Prime Minister Manmohan Singh. In the past 15 years, Indians have ousted two national governments after inflation eroded spending power. Higher interest rates will make it harder for companies to expand, and with the budget deficit at a 16-year high, the government can scarcely afford to boost spending on infrastructure. Indian companies meanwhile, fear higher labor costs. "The rise in food prices will have a cascading effect," says M.S. Unnikrishnan, managing director of Thermax, a Pune-based maker of heating and cooling equipment. "We can't keep paying people the same amount if their cost of living is increasing."

With Natalie Obiko Pearson

Einhorn is Asia regional editor in BusinessWeek's Hong Kong bureau. Thomas is a reporter for Bloomberg News.

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