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Is the India Economy Overheating?

By Vipin Agnihotri
There is a complete integration of the Indian capital market with the rest of the world, in particular the US market. While this development has its antecedent benefits as well as problems, it is certainly heartening to note that in the growth sphere, leading global economies have seemingly managed to de-couple themselves from the US economy, despite greater liberalization and integration via trade; India is no exception. The question now arises: Why is this relevant? For, India continues to post healthy growth rates in the current year, its economy having expanded at a record 9.4 percent in the financial year 2006-07 on a base of 9 percent clocked in the 2005-06, despite tighter monetary policy by the central bank to cool inflationary pressures. No doubt, sterling performances by services and manufacturing sectors helped, with the latter growing at 12.3 percent as against 9.1 percent in the previous year. Though, the threat of a overheating of the economy continues to loom large, exacerbated by the high rate of inflation and the continuous inflow of foreign capital, which is making the monetary policy tools ineffective and putting pressure on the rupee. Reserves have risen rapidly in recent months on the back of rising foreign investment, higher remittances and increased overseas borrowing by Indian companies. The Indian government is now working on a scheme to refund local taxes and levies to labour intensive industries with little import content, to offset the impact of the appreciating rupee. With the dollar threat threatening to become a deluge, however, from the single-minded focus on tinkering repo rates and the CRR, the RBI, in its latest annual monetary policy statement has turned its attention to measures that could arrest capital inflows, which complicate both exchange rate and liquidity management. How successful it will be, only time will tell. The rising rates have been a dampener on both the consumer and investment sentiments within the country. The Indian economy has been witnessing a paradigm shift and is all set to enter the high growth phase. But there are concerns on the levels it can attain. ADB estimates an 8 percent rise for this year, while IMF projects an 8.4 percent growth, which is further expected to slow to 7.8 percent in 2008. Single digit growth in exports, slowdown in production of consumer durables and power generation are some leading indicators for the likely slowdown of the Indian economy in 2007-08.

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