By Manoj Kumar and Rajesh Kumar Singh
NEW DELHI (Reuters) - Tackling inflation will be a key priority, India's finance minister and central bank governor said on Wednesday, after high consumer prices contributed to painful losses for the ruling Congress Party in recent state elections.
Finance Minister P. Chidambaram also reiterated his pledge for fiscal discipline as investors worry the Congress-led minority coalition will boost spending to improve its standing ahead of general elections due early next year.
Data on Thursday is expected to show India's consumer inflation remained high at 10 percent in November from a year earlier, with wholesale prices due out on Monday expected to have risen 7 percent.
High inflation will increase expectations the Reserve Bank of India will raise interest rates for a third time in four months, even as the economy grows at its slowest in a decade.
Although rate hikes are unpopular with businesses and investors, Chidambaram said the government can ill afford to saddle Indian citizens with high prices for food staples.
"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," Chidambaram said in a speech at an event organized by the Finance Ministry.
Calling monetary policy a "blunt instrument," he added the government would ultimately need to tackle the structural bottlenecks that keep prices of food high.
"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."
Congress lost four key state elections, according to results on Sunday, as the government headed by Prime Minister Manmohan Singh has been widely criticised for policy drift and for allowing corruption to spin out of control.
Inflation has been another thorn, leaving the RBI with a tricky balance between fighting high prices or boosting growth.
So far it has chosen inflation, raising interest rates by a quarter percentage point in September and again in October. The central bank will hold its next policy meeting on December 18.
"Our effort is firmly on controlling inflation," Rajan said during his speech 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."
Whether the government can act quickly enough to tackle India's stagflationary environment is in doubt
Despite recent encouraging data, including a report on Wednesday showing the trade deficit narrowed in November as gold and silver imports slumped 80.5 percent, few analysts expect a meaningful recovery yet.
"Today the Indian situation is very 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 deficit to 4.8 percent of gross domestic product. The gap has already reached 84 percent of the target in the first seven months of the fiscal year.
Chidambaram has repeatedly vowed to meet the deficit target, but investors worry the government will succumb to the temptation to increase spending ahead of polls, similar to the $20 billion plan to provide cheap grain to the poor earlier this year.
On Wednesday, Chidambaram sought parliament's approval for 131.2 billion rupees ($2.14 billion) in extra spending to pay for items such as higher fertiliser and fuel subsidies.
Chidambaram said the additional spending would not have a "significant" impact on the fiscal deficit target, after earlier in the day vowing to stay the course.
"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 Subhadip Sircar and Neha Dasgupta in Mumbai; Writing by Rafael Nam; Editing by Kim Coghill)