Active Stocks
Thu Mar 28 2024 15:59:33
  1. Tata Steel share price
  2. 155.90 2.00%
  1. ICICI Bank share price
  2. 1,095.75 1.08%
  1. HDFC Bank share price
  2. 1,448.20 0.52%
  1. ITC share price
  2. 428.55 0.13%
  1. Power Grid Corporation Of India share price
  2. 277.05 2.21%
Business News/ Opinion / Online-views/  Flashing amber
BackBack

Flashing amber

Flashing amber

Premium

The amber lights have started flashing, an indication that the Indian economy is likely to slow down in the new financial year that starts this week. And this incipient slowdown, as long as it is moderate, is welcome.

There’s anecdotal evidence supporting this claim. Bankers are saying that credit growth will fall from 30% a year to around 20%, partly in response to the rise in interest rates. The Asian Development Bank has said in its annual outlook that the construction boom seems to be ending. Companies and equity analysts too have been informally predicting a drop in sales growth in 2007-08. These can be major brakes, since credit, construction and corporate expansion have been key drivers of growth in recent years.

Of course, this is not the whole story. There are other bits of data that show that the economy continues to scorch the turf. Money supply growth is still roaring ahead at over 20% a year. The latest balance of payments numbers (for the October to December 2006 quarter) show that the trade deficit has widened further, a sign that excess domestic demand continues to spill over into the global economy, pushing up imports. And there’s little sign of wage increases getting more muted.

On balance, however, there are clear reasons to believe that GDP growth in 2007-08 will be slower than in the previous year. Most economists are forecasting a headline number of around 8%—a good 1% less than what we have seen in the past two years.

But why should a moderate slowdown be good news? The answer lies hidden under the two stress lines currently running through the economy—inflation and a growing current account deficit.

Core inflation, which excludes volatile items such as oil and food, has been inexorably climbing in recent months. Thus we do not agree with the contention that higher inflation is only because of problems on the farm. Prices of industrial goods too have contributed to it. The problem here is the lack of domestic capacity to meet soaring credit-induced demand. Most companies are running their factories at nearly full capacity, and can’t crank out more output that easily. This pushes up prices. Meanwhile, a lot of the planned capacity has yet to come on stream. The recent capex boom will show results only after a year or two, as new factories start humming and more steel, cement, cars, television sets and suchlike reach the market. Till then, the choice is between keeping a lid on demand growth through higher interest rates and tolerating high inflation.

The other big worry is the current account deficit which, in simple accounting terms, is the difference between domestic savings and investment. While the Indian savings rate has risen dramatically in the past five years (from around 24% of GDP in 2002 to around 32% of GDP today) investment has grown even faster. True, the current account deficit is nowhere near the danger mark and is being financed fairly easily by portfolio investors, foreign direct investment and remittances from overseas Indians. But it should not be treated lightly.

While there is little doubt that India is in the very early stages of an expansion phase that could last for decades, policymakers need to focus on the short-term blips. The spikes in inflation, asset prices and the current account deficit have to be managed. The more the delay, the sharper will be the ensuing slowdown.

Therefore, the Reserve Bank of India is justified in gradually nudging interest rates up. But the sheer force of foreign capital flowing into the economy makes its task difficult. The finance ministry would do well to get into the fray, by aiming for a far lower fiscal deficit. The battle to cool an overheated economy needs to be fought by tightening both monetary and fiscal policy.

Are the signs of a slowdown a cause for concern? Write to us at views@livemint.com

Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!

Catch all the Business News, Market News, Breaking News Events and Latest News Updates on Live Mint. Download The Mint News App to get Daily Market Updates.
More Less
Published: 02 Apr 2007, 12:18 AM IST
Next Story footLogo
Recommended For You
Switch to the Mint app for fast and personalized news - Get App