Tuesday, February 13, 2007

Incredible India or an Overheating India


Tata’s Corus takeover, Infosys getting listed on the NASDAQ, the roar from Delhi is echoing across not only Asia but across the globe. An economy once famous for the “Hindu growth rate” of 3% in the 1960-80’s, has since been replaced by one growing at 9.2% (real GDP), just a few points behind China’s 10.4%. When it comes to PPP India will soon overtake Japan and become the third largest economy behind America and China.

However the economy is displaying alarming symptoms of overheating (Demand is outpacing supply resulting in an unsustainable pace of growth) Capacity utilization is higher than at any time in the past decade. This coupled with a severe skill and employability shortage amongst the labor force is leading the wages going sky high. Real estate and property prices look bubbly. The stock market is one of the most expensive in the emerging world with PE’s of more than 20. Over the past couple of years interest rates have risen by less than the rate of inflation (6-7%) which has actually led to them falling in real terms.

From a surplus of 4% in the current account deficit in FY 04, India’s deficit has actually widened by 3%. If we exclude remittances, India’s deficit further widens to 5% of GDP which incidentally is larger then the equivalent deficit during India’s balance of payment crisis of early 1990’s.

The cushion of $180 billion foreign exchange reserves (equivalent to 11 moths of exports) and a small external debt does provide some solace but the main culprit is India’s overdependence on short term portfolio capital inflows rather than FDI. This makes India venerable to rising interest rates triggered by a reversal in risk appetite in the international market.

A quick solution to prevent overheating would be either to curd demand or to increase supply. Cooling demand could be detrimental to India's rapid growth to create jobs and reduce poverty. Boosting supply is however feasible by spending more on infrastructure, public services and improving the educational system of the country. However these are big ticket items requiring deep pockets to fulfill. India’s fiscal finances are far from healthy. Oil and power subsidies amount to 1.8% of GDP putting the deficit for state and central govts close to 8% as compared to the IMF forecast of 6.2%. India also has the highest public debt to GDP ratio of 80%.

India’s favorable young demography may be a bane if we cannot nurture it with proper jobs and provide it proper civic amenities such as water and ‘employable’ education. Indians are eager for our economy to sprint like a tiger rather than amble along like an elephant. Yet few animals have an elephant’s stamina or travel as far in a day – provided its path is not blocked

ref: The Economist feb 3rd 2007

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