Sunday, January 23, 2011

Is Indian Economy Overheating?

Many people might be wondering why I am talking about overheating of an economy in the midst of recovery from present financial crisis. Particularly many people may not agree with the Indian Economy overheating concept that too when November IIP numbers are below 3% (2.7% to be exact), Stock market corrected almost 10% in last two months compared to its peers which gained 5%-10% at the same time and etc...

But if you see the inflation number what India is facing from last two years is above RBI's comfort zone of 5% to 6%. For the year 2009 Indian Consumer Price Index was of 8.3% averaged and where as 2010 CPI was 10.9%. Where as from 2003 to 2008 Indian consumer price index moved between 3% to 6% on average basis. So in these last two years Indian inflation went up by 4% points in the consumer price index level. In this inflation CPI or WPI, food inflation has been major contributor towards the both indexes.

Many analysts say Inflation is the problem of supply side constraint not demand side. And their point is supply side constraint is because of the structural issues we have in India (apart from abnormal rain inside India and outside of India). But what my point is "all these structural issues were in India from last 50 odd years or so, but we never faced such a consistently long inflation particularly on food side!". Now I feel we as a country might be growing much faster than we ourselves can't handle the growth!

I feel India is facing wage inflation, it is condition where in higher wages or increased wages chase little goods available in the market and causing increase in the prices of the goods and in turn putting pressure on wages to hike. Its like a spiraling or vicious circle. Here I would like to mention just one example of this wage inflation putting pressure on food or overall inflation. When I was posting about Decoupling theory, I mentioned about National Rural Employment Guaranty Scheme (NREGS), which government announced in 2005 and implemented fully in the midst of financial crisis. Under this scheme rural households are guaranteed for 100 days work in a year with the minimum 100 rupees wage per day. This has been the biggest contributor to the rural income and expendable amount in rural hand considering more than half of the Indian population is in rural areas. And most of the NRGS' works are related to infrastructure works, which is causing a real shortage of people in the agricultural fields, which in turn causing increase in the wages of the people who are ready to come for agricultural related.

So all this is leading to more spending from rural India, causing increase in the overall demand side also! Otherwise all these years whole India was divided into two parts like Demanding-Urban and Supplying-Rural. First part, that is urban (demanding side) is same or we can say it increased more, but more importantly rural (supply side) is also facing a demand pressure making it (inflation) look like a supply side constraint! That does not mean that we don't have supply side constraint, we do have supply side constraints, structural issues to reform for longer term solution and etc.

But are we ready to face the current situation and upcoming situations???

1 comment:

Sumanta said...

Nice informative article...
Are you suggesting that the major reason for soaring inflation in India is supply-driven?