Current status of indian economy 2006


The Reserve Bank of India said of late that India’s economy, currently the third fastest growing in the world after China and Vietnam, could be overheating, but hedged the statement saying that evidence is inconclusive.

As consumer appetite for home, commercial real estate and retail loans continues to fuel credit expansion at an uncomfortably fast rate of 30% for the third straight year, RBI governor said that they will keep excess demand pressures under check firmly.

Rising production capacities and improving productivity has made it difficult to assess whether the economic growth in a structurally changing country is optimum or too high for comfort.

The RBI’s dilemma is typical of a central banker in a developing country where monetary measures do not immediately impact all segments of the economy. In such economies, it also becomes difficult to precisely assess the demand and supply when many sectors such as construction are highly unorganized and use informal labor and resources. However, the central bank has to keep an eye on them to know the pulse of the economy.

The combination of high growth and consumer inflation coupled with escalating asset prices and tightening infrastructural bottlenecks underscore the need to reckon with dangers of overheating and the implications for the timing and direction of monetary policy setting said the central bank in their mid-term review of its annual policy.

Admitting that there is no conclusive evidence of over-heating, the RBI nevertheless says it is wary of everything that points to excess demand. The property and retail loans sector are some such.

Chief economist at ABN Amro Bank said that there is very little doubt that some pockets of the economy are overheating. The very fact that RBI chose to raise the repo rate yet decided to leave alone other rates indicated that the central bank is expecting the liquidity to tighten.

Repo is effectively the refinance rate of the economy. However, asset prices like those of equity and commodities and food price inflation, which is mainly caused by supply constraints should not overly concern the central bank. Usually you use the metaphor of overheating only when prices are rising out of control said A V Birla group’s chief economist adding that it was the first time that the central bank has actually used the term.

The RBI admits that much though in a different context. For a developing country like India, the concept of overheating is less of a guide for monetary policy than in advanced economies on account of the existence of large unemployment and under employment of resources and the absence of a clear assessment of potential output. The repo rate hike was a signal to keep the economy prepared for quick actions from the central bank should the need arise.