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India's overheated economy


The spectacular growth of India’s economy during the last decade has stunned many people worldwide. Currently, India’s annual growth rate of over 9 percent is surpassed only by China in Asia. However, it is widely believed by many experts that this pace of expansion may not be sustainable in the…


The spectacular growth of India’s economy during the last decade has stunned many people worldwide. Currently, India’s annual growth rate of over 9 percent is surpassed only by China in Asia. However, it is widely believed by many experts that this pace of expansion may not be sustainable in the foreseeable future. This has largely been attributed to the widespread inflationary fears prevalent in the country which threaten to impair the economy’s strong growth momentum. In fact, this has put the central bank of the nation, the Reserve Bank of India, in a predicament of attempting to prevent prices from soaring without slamming the brakes on the economy.

Inflationary woes: An impediment to growth

The biggest challenge for the Reserve Bank of India’s governor, Mr. Y.V. Reddy, is to take adequate measures to curtail the inflation which is slowly taking root in the domestic economy. This is problematic, since India’s monetary policy is still in the experimental stage, according to the former central bank governor, Mr. Bimal Jalan (1). In India, interest rate changes can take up to two years in order to have an effect on the economy (2). This is in sharp contrast to the developed countries where the time span needed to achieve the requisite results is much shorter. Despite the recent interest rate hikes initiated by the central bank, the results are not particularly encouraging. In fact, the wholesale-price index (WPI), the most commonly used measure of the price of food, rose to an annualised 6.6 percent in the week ending January 27th, which is a two-year high and sharply above the ceiling of 5.5 percent set by the Reserve Bank of India (RBI) (3). It has prompted the government to take necessary precautions to prevent the economy from getting derailed from its present growth. However, it is widely recognised that the modest monetary tightening alone by the RBI is not going to achieve the desired results. Far more stringent long-term measures are needed to sustain the current pace of the country’s growth.

Other ominous signs

Experts who closely track the Indian economy share the view that there are several signs of overheating displayed by the country. This is indicative of demand outpacing supply in the country resulting in an unsustainable pace of growth. Also, capacity utilisation is higher than at any time in the past decade and the resultant severe shortage of skills have caused wages to rocket (4). Another factor to be considered is the fact that the tremendous economic growth rates achieved by the nation have attracted a huge amount of ‘hot money’ coming from foreigners seeking quick returns on their investments. This is in sharp contrast to India’s closest competitor in the region, China, which receives a greater percentage of its foreign investment in the form of assets such as factories thereby making it much harder for foreign investors to back away from them (5). The credit boom brought about by the relatively relaxed credit policies adopted by the banks and other financial institutions in the country have made matters worse. Lending on commercial property is up by 84 percent and home mortgages by 32 percent and asset prices are tremendously over-priced at present (6). The boom in the financial markets in recent times are a well-documented fact and have made India’s stock markets one of the most expensive in the world with an extraordinarily high price-earning ratio exceeding 20 (7). In order to prevent a potential financial crisis from wreaking havoc in the economy, a lot needs to be done to ensure that supply keeps pace with the sharp rise in the demand.

The road ahead: Opportunities for development

One alternative to slowing down the demand would be to speed up reforms, improve the country’s physical infrastructure and overhaul the archaic educational system. However, these are long-term solutions which not only involve substantial outlays of money, but would produce the desired results only after a stipulated period of time. This is also worrisome since the budget deficits of the central and state governements of the country are currently close to 6.2 percent of GDP (8). Also, the budget deficit would widen if there was a slowdown in the domestic economy or if the interest rates rose in a bid to attract and retain the foreign players investing money in the country. The current efforts of the government in the above mentioned reforms can at best be classified as meek and insubstantial. The government has to take extremely comprehensive and rigorous steps especially in the areas of infrastructure spending, public services and labor law reforms if it truly aspires to translate its long-term potential into a sustainable pattern of growth for the future generations.

Source: www.asiaecon.org |

 

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