Asia's third-largest economy has been caught in a situation which some analysts define as akin to stagflation for the past three quarters with economic growth stuck below 5 percent and prices rising at a fast clip.

According to a Reuters poll, wholesale prices probably rose 6 percent in September, slightly below a six-month high of 6.1 percent in August. The inflation data comes on the heels of Friday's disappointing industrial output numbers. Output grew a much-slower-than expected 0.6 percent in August, compared with an upwardly revised 2.75 percent expansion in July, hurt by weak investment and consumer demand.

The government is hopeful the economy will start to recover by the end of the year on higher farm output and exports. But the latest industrial production data has dampened that hope.

Output grew just 0.1 percent between April and August, the first five months of the fiscal year 2013/14.

That will be a worry for Prime Minister Manmohan Singh's Congress party as it campaigns for five state elections starting in November, a warm up for national elections due by May 2014. The opposition Bharatiya Janata Party has gained momentum in recent months thanks in part to the weak economic performance of Singh, a veteran economist and reformer.

"India is likely to face low growth and high inflation for some time," said Daniel Martin, Asia Economist at Capital Economics in Singapore, who expects the Reserve Bank of India (RBI) to increase its repo rate by another 25 basis points later in September 2013.

"A higher repo rate will hold up the economic recovery. It is a difficult situation for the central bank."

Economic growth has averaged 4.6 percent between the fourth quarter of 2012 and the second quarter of 2013. Headline inflation, measured by wholesale prices, averaged around 7 percent in the same period, way above the central bank's perceived comfort level of 5 percent.

Inflationary worries

Worries over high inflation led new RBI chief Raghuram Rajan to surprise markets in his policy review in September 2013 with an interest rate hike. Economists are now split over whether Rajan will hike rates again at the next review on October 29.

If inflation data does come in line with expectations, the odds for another hike at the October review will only increase.

Even though India is stumbling through its worst economic crisis since 1991, Rajan has clearly signaled he would focus on price stability, which he sees as a necessary condition for lifting economic growth from a decade low.

Inflation is expected to come down in coming months as a slowing economy is likely to keep demand-driven price pressures in check and as this summer's strong monsoon rains may eventually cool food prices.

Yet, price risks persist. Adjustments in domestic prices of subsidized fuel and other imported items following a sharp depreciation of the rupee are still incomplete.

Although the rupee gained 5 percent in September 2013, it is still down around 10 percent in 2013 against the dollar, meaning higher import costs for items such as oil, fertilizer, pulses and edible oil in rupee terms.

The rupee hit record lows in late August, pressured by the country's gaping current account deficit and a general exodus of global investors from emerging market assets.

Recovery in sight?

In its bid to revive the economy ahead of polls, Manmohan Singh's government has decided to inject capital into banks so they can offer cheaper loans for purchases of items such as bikes, fridges, washing machines and televisions.

The move is aimed at boosting production in the consumer durables sector, which has failed to register growth since last November.

A pick-up in merchandise exports, aided by a recovery in global economy along with the rupee depreciation, has bolstered the government's hopes for an economic rebound in the quarter to end-December.

Manmohan Singh is also counting on the prospect of strong farm output for an economic boost. The sector is expected to post annual growth of about 5 percent this fiscal year, which should lift rural incomes and increase demand for goods and services.

"Strong exports and a rebounding farm sector will only help at the margins," said Martin of Capital Economics. "India's recovery largely depends on a revival in investments."


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