Is the economy overheating? There’s little evidence now

MUMBAI: Ron Subbaraman, economist at Lehman Brothers, on Thursday said it is unlikely that India’s policymakers would want to end this demand-driven boom.

“Our base case is that India’s economic boom will continue, with growth around 10% in 2007-08, probably outpacing China.”

In a note, he said demand will continue to exceed supply, causing rising inflation, financial imbalances and, possibly, asset price bubbles. “But the concern is that demand is running ahead of supply, creating bottlenecks. This is because essential reforms have been neglected, including the lack of physical infrastructure, shortages of skilled labour, an inflexible labour market and weak government finances.”

As a result, Subbaraman  said, symptoms of overheating are emerging: inflation has risen to over 6%, credit is growing at about 30%, and India is the only Asian country whose current account has slipped into deficit (about 2.5% of GDP in 2006).

Valid arguments? Ashok Lahiri, India’s chief economic advisor, begs to differ.

“Is 9%  too high? I don’t think so,” Lahiri said in New Delhi on Thursday. “If the question is whether high growth entails overheating, my answer is an emphatic no.”

Sucheta Mehta, chief economist with Standard Chartered Bank, said strong growth has no doubt led to inflationary pressures, but it is still very early to say if the economy is overheated.  “There are areas that have not grown the way they should have. Agriculture, from which 60% of the country earns its livelihood, is supposed to grow at 4%, but is doing around 2%. There are many bottlenecks in rural infrastructure. These need to be addressed. Then there are also areas that have grown faster than others.  But we would refrain from saying the Indian economy is overheated,” says Mehta.

D K Joshi, senior economist with rating agency Crisil, said the current growth looks more sustainable than in previous cycles because it is backed by a high investment rate, good consumption and export demand.

But he and other analysts expected growth to moderate in coming quarters and some said Wednesday’s figure could be revised down to just below 9% later on.

Joshi also saw the central bank continuing to raise interest rates to cool inflation.

“The numbers mean further monetary tightening is in store,” he said.

Subbaraman of Lehman concurs. “We expect interest rates to rise by a further 75 basis points this year, but only in line with inflation, keeping real rates very low.”

Growth in the $854 billion economy is also being spurred by a higher savings rate, spending on roads, ports and other infrastructure and more foreign direct investments, Morgan Stanley chief global economist Stephen Roach said in a note to investors this week (See graphic).

“The takeoff phase of economic development has long been associated with saving and investment rates in excess of 30% of GDP,’’ Roach said.

“India is now on the move and could well be one of the world’s most exceptional economic development stories over the next three to five years.”

Potentially, such growth can spin inflation out of control. The solution, said said N R Bhanu Murthy, an economist at the Institute of Economic Growth in New Delhi, is simple.

“Supply of goods and services must expand at a faster pace than demand.”

Indranil Pan, chief economist of Kotak Mahindra Bank said flying prices of primary articles are the main culprits.

He agrees it is too early to say if the economy is overheated “though there could be some signs hinting at it”.

With inputs from agencies