From hefty pay hikes and foreign vacations to new houses bought with cheap mortgages, India’s middle class had never had it so good, riding the past four years’ unprecedented economic boom.
But now, a spike in inflation is playing party pooper.
High economic growth, averaging more than 8.5% annually since 2003, has spurred demand and caused prices to rise so much that consumers are starting to get squeezed. That could make it more difficult for people to repay loans, which have grown at a faster rate than incomes have risen.
With real-estate and stock prices at record highs, fears are growing that a financial crisis might be brewing if borrowers can’t repay loans. If that were to happen, it would dash hopes that India’s rapid growth would lift millions out of poverty.
Overseas investors, who have been dumping billions into the economy, would also be hurt.
To cool growth, the central bank has raised interest rates several times over the last year, forcing commercial banks and housing lenders to increase lending rates, in turn causing consumers with adjustable rate loans—popular among the urban middle class—to see their monthly payments balloon.
Sushil Aaron, a researcher at a diplomatic mission in New Delhi, bought an apartment last summer even as housing prices soared. But now he has put off plans to replace his old car and has stopped buying books because his monthly mortgage payment has jumped more than 20% to $1,000 (Rs41,000).
“It’s a double whammy,” he said, referring to surging housing prices and rising rates.
People like Aaron are complaining despite forecasts from consulting firm Hewitt Associates that salary increases at Indian companies will average 15% in 2007, topping Asian countries for the fourth straight year.
But the millions of poor labourers, who have seen only meagre pay hikes, have been hit particularly hard as costs of basic commodities such as cooking oil and vegetables have nearly doubled in the past three years.
The inflation rate, based on wholesale prices, touched a two-year high of 6.73% on 17 February and has since mostly stayed above 6%, but retail prices have risen as much as 10% from a year ago.
Virender Negi, a driver for a New Delhi-based export firm, has stopped buying milk for his two children because his monthly salary of $130 is no longer enough to pay for grocery and house rent. “At this rate, I will never be able to make my ends meet,” Negi said.
The Reserve Bank of India (RBI), the nation’s central bank, first spotted what it called “signs of overheating” in November. But officials in the government brushed it off until the ruling Congress party lost elections in two states because of voters’ resentment over rising prices.
The government then reduced import duties and banned futures trading for several commodities to ease supplies. It also ordered state-run oil firms to cut fuel prices.
But the impact of those moves, which some analysts saw as coming too late, has been limited, and much of the inflation-fighting task is left to RBI, which has raised rates three times since December.
Exacerbating the central bank’s problem are the billions of dollars in foreign investment and remittances that have flowed into India in recent years, leaving banks flush with funds.
In the past two years, bank loans have surged nearly 30% annually. Loans to commercial real-estate grew as high as 80% last year.
If asset prices crash, borrowers could begin to default on repayments, setting off a chain reaction that could plunge the banking system into a crisis.
Some of the country’s largest banks have already started reviewing what could potentially turn into risky assets.
“If you don’t worry now, then you will end up with a price bubble,” said Shankar Sharma, head of Mumbai-based brokerage firm First Global. “And when the bubble bursts, you will have a problem that will last for years.”
Top officials no longer talk about accelerating economic growth, although until recently the government believed India’s growth rate could move close to China’s 10% rate.
Announcing the latest rate increase on 30 March, the central bank said its focus has shifted to “reinforcing price stability” from the previous stance of balancing growth with moderate inflation.
Last week, Moody’s Investors Services said India was showing “classic signs of an overheating economy,” and urged far-reaching reforms.