India's drive to replace imported oil with home-grown biofuel faces a setback as the lowest monsoon rainfall in more than a decade hits corn and sugarcane crops, forcing New Delhi to prioritise food security over ethanol production.

The proportion of ethanol in Indian petrol is poised to fall below the official 20% target in the supply year that began this month, industry insiders say, reversing gains made after the government achieved the milestone some five years ahead of schedule.

A sustained drop in ethanol use would undermine one of Prime Minister Narendra Modi's signature energy-security programmes and leave India more reliant on overseas crude at a volatile time for energy prices amid persistent geopolitical uncertainty.

The E20 initiative has saved nearly 2 trillion rupees ($21.1 billion) in oil import costs since Modi came to power in 2014, according to government data, with annual savings estimated at 430 billion rupees at the 20% ethanol blending rate.

However, a severe El Niño this year cut India's monsoon rainfall by nearly 13% from normal levels, and concerns about crop shortages sent corn and sugar soaring some 40% to hit record highs, while rice — another ethanol feedstock — climbed 20%. Retail food inflation accelerated to 7.74% in September from 5.97% a month earlier.

The scarcity of feedstocks could push India's ethanol blending rate down to around 15% in the current supply year from the previous period's 20%, said G.K. Sood, chairman of agribusiness company KN Agri Resources and one of India's top food policy experts.

"India is the world's most populous country, so food has to take priority over fuel, more so in a drought year," he said.

India's ample rice stockpiles offer an alternative to sugar and corn, but one that would be expensive for the government, which sells the grain to ethanol producers at roughly half the price it pays to buy and store it. A government spokesperson did not respond to a Reuters request for comment.

Lower blending would squeeze producers who borrowed heavily to expand capacity to about 20 billion litres a year in anticipation of rising ethanol demand, resulting in significant overcapacity.

Four producers, who spoke on the condition of anonymity, told Reuters they expect blending to fall to 15% to 17% in the current supply year, with the extent of decline depending largely on corn prices.

Food inflation is a politically sensitive topic with several states due to hold assembly elections in early 2027, including Uttar Pradesh, the country's most populous.

Modi suffered a setback in the state - a bellwether of national politics - in the 2024 general election, with opposition parties winning more seats than his Bharatiya Janata Party.

The E20 initiative is not without controversy, with motorists and some automakers expressing concerns about fuel efficiency and engine wear. The public backlash prompted the government to stress that it had no plans to increase the ratio above 20%.

New Delhi quadrupled ethanol blending over six years to hit its target, helped by successive good monsoons.

But the government last month signalled a shift in priorities by directing oil companies not to procure any ethanol made from sugar-based feedstocks for the new supply season.

It also cut the purchase price of corn-based ethanol to 68.86 rupees per litre from 71.86 rupees the same month, squeezing distillery margins and curbing use of the crop.

Ethanol producers have increasingly turned to damaged grains to make the biofuel, which has raised worries about animal feed availability, said C.K. Jain, president of the Grain Ethanol Manufacturers Association.

Corn production is likely to fall by as much as 15% from this year's record of 55 million metric tons, according to industry estimates.

Record prices would normally be a draw, but "winter acreage is unlikely to pick up," said Harish Galipelli, director of ILA Commodities Pvt Ltd, a Hyderabad-based trading house. "Drought-hit farmers across several states simply don't have enough water to go for corn."