PM Modi puts inflation goals at risk in a bid to meet farm pledges

Inflation may be easing in India, as data on Thursday is set to show, but there are mounting risks.

At the top of the list is Prime Minister Narendra Modi's plan to raise the prices of food crops to help distressed farmers, a key voter base.

His government is seeking to pay farmers at least 50 per cent more than the cost of their produce, boosting the retail prices of about a dozen monsoon-sown crops, due for harvest in October. Details of the initiative, which was first announced in the February budget, are expected soon.

The plan will help Modi fulfill his promise of raising incomes to placate farmers saddled with higher debt amid falling commodity prices, and shore up his support ahead of federal elections early next year. But it’s expected to fan prices at a time when oil is surging, putting further pressure on bond yields.

Data due on Thursday will probably show India's retail inflation eased to 4.1 per cent in March from 4.4 per cent in the previous month, according to the median estimate of 39 economists surveyed by Bloomberg. That will be the lowest in five months and below the central bank's projected 4.5 per cent level for the fourth-quarter of fiscal year 2018.

The softening in inflation in March may be temporary and due to a decline in food prices, particularly vegetables and pulses. Pulses and rice are among crops that are eligible for the minimum support price announced by Modi’s administration.

Putting a floor under food prices will directly feed into food inflation, said Sonal Varma, the Singapore-based chief India economist at Nomura Holdings Inc., projecting a 60 basis points increase in consumer price inflation because of an increase in support prices this year.

“A lot of rural wages and government salaries are linked to CPI,” she said. “That can have second round effect.”

The central bank last week held its benchmark interest rate and lowered its inflation projections for the fiscal year that began on April 1, while listing the plan to provide minimum support prices for monsoon-sown crops as a risk to inflation.

“The exact magnitude will be known only in the coming months,” the rate-setting Monetary Policy Committee said.

Already, a jump in oil prices has spurred concerns about inflation and is pushing bond yields higher. The yield on the benchmark 10-year debt climbed 16 basis points to 7.54 percent on Wednesday after rising 25 basis points in the previous three trading sessions.

Inflation usually inches up in the year before national elections in India as governments and political parties start pumping in more money to improve their electoral prospects.

Modi’s decision to put more money in the hands of farmers, along with boosting spending on rural infrastructure and job programs, is bound to stoke consumption. Expectation of normal monsoon rainfall, the main source of irrigation for the nation’s 263 million farmers, will also help drive up income of farmers.

“It will have repercussions for higher inflation,” said Sameer Narang, chief economist at Vadodara, India-based Bank of Baroda. “The Reserve Bank will become slightly more hawkish if the hike in minimum support prices is higher than expected.”