India and Brazil are overheating: IMF

India and Brazil are overheating: IMF

New Delhi: Emerging economies such as India and Brazil are showing signs of overheating, the International Monetary Fund (IMF) indicated on Wednesday.

“Among some major emerging economies, capacity constraints are beginning to boost prices: Brazil, for example, has experienced gradual increases in inflation pressure, while India has seen a sharp rise in inflation," the IMF said in its latest world economic outlook report.

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India’s wholesale price inflation stood at 8.5% in August, while food inflation has been in double digits for more than a year.

Planning Commission deputy chairman Montek Singh Ahluwalia recently denied that the economy is overheating—which happens when the country’s productive capacity is unable to keep pace with growing demand, leading to high levels of inflation.

Reserve Bank of India (RBI) deputy governor Subir Gokarn said on Tuesday that inflation is well above the comfort zone and is a cause of concern. RBI’s medium term inflation target is 4-4.5%.

IMF’s senior resident representative in India, Sanjaya Panth, said the inflationary situation in India is complex, driven by both supply and demand factors. “While food supply shocks have transmitted to core inflation quite rapidly, demand pressure has also become an important factor to explain the situation," he said.

In its outlook, IMF retained the growth projection for India’s gross domestic product (GDP) at factor costs at 8.8% for the fiscal year to 31 March 2011. It raised the projection for the economy based on market price to 9.7% from its July projection of 9.4% for calendar 2010.

GDP at market prices measures output at the prices that consumers and firms pay for goods and services, while GDP at factor costs is the same output valued at producers’ prices. The difference between the two consists of indirect taxes and subsidies.

Finance minister Pranab Mukherjee’s expectation that the country will grow at 8.75% in the current fiscal year is based on GDP at factor costs.

For fiscal 2011-12, IMF expects growth to slow to 8.1% calculated on factor costs. Based on market prices, growth is projected to grow at 8.4% in calendar 2011.

Asked why the Fund expects the economy to grow at a slower rate in next fiscal, Panth said its growth projection of 8.8% for the current fiscal is over a rather lower base, as the economy grew at only 7.4% in 2009-10 due to the economic slowdown.

“Following the bounce back from the crisis, growth is expected to resume broadly along the potential growth rate next year, which could of course increase in the medium term," he added.

The Asian Development Bank (ADB) recently said India’s economy will grow faster in 2011-12 than in the current fiscal on robust consumer demand and private investment, even as China and most other Asian economies slow down.

In its revised Asian development outlook, ADB said the Indian economy will grow at 8.5% in 2010-11 and 8.7% in 2011-12. Finance minister Mukherjee expects India’s economy to return to the trend growth rate of 9% in 2011-12.

“Our growth projections are based on what is happening so far. To achieve a higher rate of growth, India needs to unlock bottlenecks in the economy, including specially by investing in infrastructure," Panth said.

The IMF said industrial production and retail sales have been powering growth in India and China. “A massive fiscal stimulus and credit expansion has boosted domestic demand in China. In India, low reliance on exports, accommodative policies, and strong capital inflows have supported domestic activity and growth," the report said.

The Fund added that robust corporate profits and favourable external financing will encourage investment. The contribution from net exports is projected to turn negative in 2011, as the strength in investment further boosts imports.

The world economy expanded at an annual rate of about 5.25% during the first half of 2010––about 0.5% higher than in the July world economic outlook update. IMF has now increased its projection for world output to 4.8% as compared to 4.6% in July.

Graphic by Ahmed Raza Khan/Mint;