Wednesday, April 20, 2011

mint artilce: Why India overheats

Continuing my postings on "Indian economy overheating" articles, today I read an article in mint so thought of sharing with you guys.

Highlights of the article...

There is a structural element in the inflation trend, as higher incomes have raised demand for fruit, meat, vegetables and milk. Some inflation has also been imported, as global oil and commodity prices have shot up thanks to the strong economic recovery in emerging markets and loose monetary policies in most Western economies. But domestic cyclical factors are undoubtedly a big part of the story as well.

High inflation expectations could fuel demands for higher wages as well. Whether these two factors have an effect on final prices depends on the ability of Indian companies to pass on higher costs to consumers.

RBI will have to raise interest rates far more aggressively than it has till now. The government has already announced a fairly ambitious plan to cut the fiscal deficit. Higher interest rates will weigh down on private demand and less red ink in the national budget will keep government demand under control. Both strategies will mean that some economic growth will have to be sacrificed.

Demand management can work only in the short term. Further, it will involve sacrificing some growth. The more sustainable response will have to come from the supply side, through more investments and higher production capacity in farm and factory.

A final point: the Economic Survey released by the finance ministry in February used simple calculations to show that the Indian economy is quite capable of growing at 9% a year. India has an investment rate of around 36% of gross domestic product. India requires four units of capital to produce one extra unit output.

For full article click here.

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