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IMF signals overheating of economy

IMF signals overheating of economy
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First Published: Tue, Apr 12 2011. 01 15 AM IST
Updated: Fri, Apr 15 2011. 07 29 PM IST
New Delhi: The International Monetary Fund (IMF) cautioned on Monday that emerging markets such as India are exhibiting signs of overheating, which if not immediately addressed could result in a sharp reversal in the growth momentum.
Overheating of the economy happens when the productive capacity is not able to keep pace with aggregate demand. IMF is, therefore, regardless of the impact on economic growth, making a case for steeper rate hikes by central banks to contain demand and thereby curb inflationary pressures.
The IMF advisory came on the same day that showed industrial growth in February slowed more than expected.
Data released by the Central Statistics Office on Monday showed industrial production slowed to 3.6% in February from a revised 3.9% in January, due to lower growth in manufacturing and mines. Capital goods continued to fluctuate, contracting 18.4% during the same month.
HDFC Bank chief economist Abheek Barua said there are “severe signs of overheating” in the economy. “We need to move to permanent slower growth for some time,” he said.
Yes Bank chief economist Shubhada Rao said growth below 9% is not unduly perturbing. “Nine percent growth is possible when supply-side economics improves. At present, 8-8.5% growth is good enough, given the current supply-side dynamics,” she said.
A slower growth rate would have implications for the country’s fiscal numbers, especially since revenue projections are based on it.
Finance minister Pranab Mukherjee has estimated growth at 9% during the current fiscal.
IMF in its latest World Economic Outlook reduced the growth projection for India for 2011 to 8.2% from its earlier forecast of 8.4%. In 2012, it expects economic growth to further soften to 7.8% from its earlier projection of 8%.
“Growth in India is expected to moderate, but remain above trend, with GDP (gross domestic product) growth projected at 8.25% in 2011 and 7.75% in 2012,” it said.
The composite leading indicator for India for February continued to point towards a slowdown, the Organisation for Economic Co-operation and Development said in a release on Monday.
Analysts believe the Reserve Bank of India (RBI) will be more focused on containing inflationary pressures and would hence stay focused on rate hikes to curb aggregate demand. Wholesale Price Index-based inflation stood at 8.31% in February, which is still higher than RBI’s target of 8% by March.
The central bank has already hiked policy rates eight times by a total of 200 basis points since March 2010. One basis point is one-hundredth of a percentage point. RBI’s next monetary policy announcement is scheduled for the first week of May.
Rao said the central bank’s dilemma will be more pronounced now as in the coming months manufacturing growth is expected to further slow until it improves in the second half of the fiscal year. “Higher commodity and oil prices, and rising interest rates will have a deeper impact on the investment cycle,” she added.
Barua said factory output data showing deceleration in capital goods is corroborated by ground-level data. “Many government projects are stalled. Private investors are delaying their projects,” he said.
Flagging inflation as the main concern, IMF said: “Inflation has become more generalized and is projected to remain high, averaging 7.5% this year.”
Barua echoed IMF’s assessment. “After the state elections (which end on 10 May with the last phase of elections in West Bengal), there is a high probability of a diesel price hike (which may further stoke inflation). Overall, this is a very difficult situation for the economy,” he said.
Rao expects RBI to increase policy rates by 50 basis points depending on how inflation behaves, while Barua sees 75-100 basis points further tightening during the current fiscal.
IMF said in most economies, including India, further removal of monetary accommodation appears indispensable, as does prudential tightening in sectors such as real estate. “Economies with high public debt should take advantage of strong cyclical conditions to improve their public balance sheets (for example, Brazil, India),” it said.
It said core inflation in India has been increasing even though most of the increase in headline inflation in recent months has been due to a spike in food prices.
“Signs of overheating are starting to materialize in a number of economies. Continued high growth has meant that some economies in the region are now operating at or above potential. Credit growth is accelerating in some economies (Hong Kong, India, Indonesia), and it remains high in China,” it said.
IMF said in India, credit growth has just begun to increase again, after a boom through much of 2007 was followed by a sharp slowdown during 2008–09.
“Nonetheless, from a five-year perspective, per capita real credit growth has been very buoyant, with much flowing into real estate and large infrastructure projects,” it added.
Commercial loans rose 23% from the previous year as of 11 March, more than the 20% rate prescribed by RBI.
Bloomberg contributed to this story.
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First Published: Tue, Apr 12 2011. 01 15 AM IST
More Topics: IIP | Industrial output | Manufacturing | GDP | Economy |