Modi Boosts Odds of India Rate Cut With Curbs on Crop Prices

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The door to another interest-rate cut in India has cracked open an inch.

Prime Minister Narendra Modi’s government on Wednesday limited gains in guaranteed prices for rice to levels not seen since 2006 and kept a lid on lentil costs. That will please central bank Governor Raghuram Rajan, who this month stressed the “strong correlation” between Asia’s second-fastest inflation and guaranteed agricultural purchase prices.

“The RBI had been quite explicit this is what they were looking for,” said Surjit Singh Bhalla, a former World Bank economist and chairman of Oxus Research and Investments in New Delhi, referring to the Reserve Bank of India. “They had put the ball in the government’s court -- now the ball has come back into the RBI’s court.”

Rajan on June 2 lowered borrowing costs for the third time this year and said he’d wait to assess the monsoon before acting again as rising oil prices heighten risks to his inflation target. More easing, he said, depends in part on better-than-forecast rains and the government’s management of the world’s largest food procurement program.

Interest rate swaps show that investors expect Rajan to keep the benchmark repurchase rate at 7.25 percent for the rest of 2015. That view is shared by most economists in a Bloomberg survey published last month.

Modi, who swept to power last year partly on a pledge to rein in inflation, resisted pressure to compensate rural voters disgruntled by a slowdown in wages and an executive order that makes it easier to seize land for commercial projects.

With state elections coming later this year, the opposition Congress party has accused Modi of being anti-farmer and slammed him for reining in guaranteed crop prices.

Inflation Impact

The guaranteed prices “emphasize commitment to low inflation, incentivize pulses production and respond to farmers’ concerns at time of stress,” Arvind Subramanian, the administration’s top economic adviser, wrote on Twitter on Thursday.

The government sets agricultural prices twice a year to cover two harvests and more than 20 food crops. Modi raised the minimum price for rice by 3.7 percent, maize 1.1 percent and tur dal, a type of lentil, by 6.3 percent.

The inflationary impact of the decisions will probably be “nil to modest,” according to Pranjul Bhandari, chief India economist at HSBC Holdings Plc. It also points to the government’s “prudent policy making over populism,” she wrote in a report on Wednesday.

Increases for rice, a staple in the Indian diet, ranged from 5 percent to 32 percent under former Prime Minister Manmohan Singh, government data show. The largest increase was before national elections in 2009, when wholesale food inflation was nearly three times as fast as the previous year.

‘Positive Signal’

Singh showed more restraint toward the end of his decade-long rule, and Modi continued to put the brakes on when he took power. Economists credit the moderation as an important reason for the slowdown in inflation over the past year.

Consumer prices, the RBI’s benchmark, rose 5.01 percent in May, staying below Rajan’s 6 percent target for a ninth straight month. Wholesale prices dropped for a seventh month.

“They are giving a positive signal that they’re not going to do anything that is inflationary as far as food is concerned,” said Dharmakirti Joshi, an economist at Crisil Ltd. Even so, the RBI will also take into account other factors such as oil costs, the U.S. rate outlook and the monsoon, he said.

While the weather office forecast June-September rains will be lower than average for a second straight year, this month’s rainfall has been 11 percent above normal so far. The monsoon waters more than half of India’s farmland, and about 50 percent of India’s 1.2 billion people are employed in agriculture.

Rate Prediction

That leaves the world’s second-most populous nation vulnerable to the weather, undermining an economy that policy makers say is still only recovering.

Limited increases in the guaranteed prices will probably allow Rajan to cut the benchmark repurchase rate to a four-year low of 6.5 percent by March, UBS Group AG analysts Gautam Chhaochharia and Sanjena Dadawala wrote in a June 9 report. That would push the yield on the 10-year sovereign bond down to 6.5 percent from 7.85 percent now.

“Inflation in India is not structural and the strong disinflation process underway will keep surprising positively in inflation data prints ahead,” they wrote.

(Updates with government’s comment in seventh paragraph.)
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