Policymakers vow to tackle inflation after poll drubbing

By Manoj Kumar and Suvashree Dey Choudhury

NEW DELHI/KOLKATA (Reuters) - Tackling inflation will be a priority, the finance minister and RBI governor said on Wednesday, after high prices contributed to painful losses for the ruling Congress Party in state elections.

Finance Minister P. Chidambaram also reiterated promises of budget discipline as investors worry the Congress-led minority coalition will boost spending to improve its standing before general elections due in May.

Data on Thursday is expected to show consumer prices were up 10 percent in November from a year earlier, with wholesale prices due out on Monday expected to have risen 7 percent.

Inflation will increase expectations the Reserve Bank of India will raise interest rates for a third time in four months at its policy review next week, despite the slowest economic growth in a decade.

Although rate hikes are unpopular with businesses and investors, Chidambaram said: "It is common knowledge that the government of the day will pay a price for high inflation, especially if inflation persists over a long period of time."

Speaking an event organised by the Finance Ministry, he called monetary policy a "blunt instrument".

"The answer to inflation, therefore, especially inflation in food articles, is to increase supplies and to radically transform the manner in which commodities and food articles are stored, transported, distributed and sold in the various markets, especially urban markets."

Chidambaram has repeatedly vowed to honour budget deficit limits, but investors worry that the polls will prompt spending on the lines of the $20 billion plan to provide cheap grain to the poor earlier this year.

The government headed by Prime Minister Manmohan Singh has been widely criticised for policy drift and for allowing corruption to spin out of control. Congress lost four key state elections, according to results on Sunday.

Inflation has been another thorn, leaving the RBI with a tricky balance between fighting high prices or boosting growth.

So far it has tried to squeeze inflation, raising interest rates by a quarter percentage point in September and again in October. Its next policy meeting is on December 18.

"Our effort is firmly on controlling inflation," RBI governor Raghuram Rajan said at the same conclave.

"We can spend a long time debating the source of inflation. But, ultimately, inflation comes from demand exceeding supply and can be contained only by bringing both in balance."

Although India's current account deficit has narrowed, easing some pressure on the currency and economy, the RBI governor acknowledged in a separate speech in the afternoon that it was too early to be confident.

"The prospects of growth are a little better. I would say growth is stabilising. It is still too early to say we are in the midst of a strong recovery," Rajan said in a speech at an industry function in the eastern city of Kolkata.

Data on Wednesday showed the trade deficit narrowed in November as gold and silver imports slumped 80.5 percent, but the pace of exports of goods slowed from October.

Rajan said no single data point would drive the next monetary policy decision.

STAGFLATION

"Today the Indian situation is unique. In all developed and developing countries, nobody has as high an inflation rate as India has despite the fact that we have slowed down so acutely," said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai.

"It's a politically sensitive issue and the government is in the election frame of mind," she added.

The government also faces the challenge of delivering on its promise to keep the fiscal gap to 4.8 percent of gross domestic product. The deficit has reached 84 percent of the fiscal year target in the first seven months.

On Wednesday, Chidambaram sought parliament's approval for an extra 131.2 billion rupees to cover costs such as higher fertiliser and fuel subsidies, saying this spending would not have a "significant" impact on the deficit.

"There can be no compromise, and I speak for the government when I say there will be no compromise, on the decision to walk on the path of fiscal prudence and contain the fiscal deficit, step by step, year by year, until we reach the goal of 3 percent of GDP in 2016-17," Chidambaram said.

(Additional reporting by Rajesh Kumar Singh in New Delhi, Sujoy Dhar in Kolkata, and Subhadip Sircar and Neha Dasgupta in Mumbai; Writing by Rafael Nam; Editing by Kim Coghill/Ruth Pitchford)