India acts to quash inflation, guard food supplies

MUMBAI/NEW DELHI (Reuters) - India unveiled measures on Tuesday to tame inflation and guard food supplies, slapping export taxes on basmati rice and some steel products and tightening monetary policy.

In its second move this month to drain liquidity from the banking system, the Reserve Bank of India is raising the cash reserve ratio (CRR) by 25 basis points to 8.25 percent, its highest level in seven years, with effect from May 24.

It signaled it was ready to act again if price pressures continued to build.

"It is critical at this juncture to demonstrate on a continuing basis a determination to act decisively, effectively and swiftly to curb any signs of adverse developments in regard to inflation expectations," it said in its annual policy review.

Finance Minister Palaniappan Chidambaram put various measures before parliament, including the export taxes on basmati rice and steel products and a duty cut on imports related to steel production. India has already banned non-basmati rice exports.

India's annual wholesale price inflation was at three-year highs above 7 percent in mid-April, as policy planners the world over grapple with soaring food and raw material prices.

India, which has about 260 million poor, is sensitive to rising prices because food often accounts for a much higher proportion of people's expenditure than in developed economies.

Part of the price pressures have stemmed from supply constraints at home as well as rising prices abroad, and the central bank, aware continued investment and growth are needed to fix those constraints, left its key interest rates unchanged.

The stock market, relieved borrowing costs were not going up, rose 2.1 percent and the 10-year bond yield fell 20 basis points on the day to 7.94 percent. The rupee touched its lowest in six weeks on dollar buying for oil and a large defense-related order.

NOT ENOUGH

India's move comes just as U.N. agencies and the World Bank called on nations not to restrict food exports to secure home supplies. The Asian Development Bank has also said banning exports is no different from hoarding at a national level.

Fighting inflation has become a top priority for India's government as it heads towards an election due by May 2009.

Prime Minister Manmohan Singh told a group of businessmen on Tuesday the world community had not done enough to bring down food and fuel prices.

"The diversion of land from food crops to biofuels and increasing use of available food grains and vegetable oils for the production of biofuels have greatly contributed to the rising food prices," Singh said.

He said he was deeply dismayed by the global response to soaring energy prices, as world oil demand had risen by just 1 percent annually over the past two years while crude oil prices had shot up by over 90 percent in dollar terms.

Oil hit a record high just under $120 a barrel this week.

Singh said the steps taken by the government -- mostly export bans and duty cuts -- to ease price pressures would show results in "the weeks and months to come" and that the normal monsoon rains predicted by the weather department should help.

CENTRAL BANK PITCHES IN

With inflation pressures largely coming from the supply side, economists say there is a limit to what the central bank can do with monetary policy, especially as growth is slowing.

They did not rule out an interest rate rise ahead, but nine out of 11 polled by Reuters after Tuesday's decision saw the central bank preferring to use the CRR, the proportion of funds banks must park with it, to control cash in coming months.

The Reserve Bank raised the CRR earlier in April. The second half of that 50 basis point increase takes effect on May 10.

The central bank forecast economic growth would slow in the fiscal year that began this month to a range of 8.0 percent to 8.5 percent from an estimated 8.7 percent in 2007/08.

The central bank said managing liquidity would continue to take priority and it aimed to push inflation back to "around 5.5 percent" this fiscal year, but with the goal of lowering it close to 5 percent as soon as possible.

It said threats to growth and stability from global uncertainties had increased, and while the capital inflows that pushed the rupee up last year might continue, there was a risk they could reverse suddenly.

Economists polled by Reuters had expected no change in rates, although the decision was seen as close.

The key lending rate remains at 7.75 percent and the reverse repo rate, the rate at which the central bank absorbs excess cash from banks, remains at 6.0 percent.

(Additional reporting by Rajkumar Ray, Unni Krishnan and Nigam Prusty in NEW DELHI and Saikat Chatterjee, Sahar Ahmed, Anurag Joshi and Catherine Bosley in MUMBAI)

(Writing by Charlotte Cooper; Editing by Gerrard Raven)

((Reuters Messaging: ramakrishnan.venkataraman.thomsonreuters.com@reuters.net; +91 22 66369039)