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Dial O for overheating

We would have thought it is too early to use the O word, but there it is, staring us in the face.

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Some things, alas, seem too good to last. Just when the economy is cheering the second successive year of a gross domestic product (GDP) growth exceeding 9 per cent, matching China’s levels, there were some worrying signs that the Reserve Bank of India had to take note of. Inflation based on wholesale prices shot up to 6.6 per cent in the latest week for which data is out and it came within two weeks after the worried central bank raised its repo rate — the short-term lending rate at which banks borrow from RBI — by 0.25 percentage points.

There have been four rate increases in the current fiscal year so far. With the inflation rate not tamed despite such rises, the RBI on Tuesday raised the cash reserve ratio (CRR), the share of deposits that banks are forced to park with it, to 6 per cent from 5.5 per cent. That will suck out Rs 14,000 crore from the banking system, making that much money unavailable to borrowers. But its underlying message is more significant. The RBI is not going to tolerate high inflation. In effect this means that lending is not going to be cheap. The truth is that the government wants to boost industrial growth and agriculture, but a strong inflow of foreign exchange remittances and foreign direct investment (FDI) and portfolio funds have swollen the amount of cash sloshing about in the banking system. Banks have been lending easy for home, car and personal loans. This is certainly a matter of concern for the RBI because it can drive speculative demand. The sad part is that the latest spike in inflation has added spice to emerging talk of the economy overheating.

We would have thought it is too early to use the O word, but there it is, staring us in the face. Even if that word is unjustified, it would be prudent to remember that sustainable high growth is possible only with better infrastructure, stronger agriculture and a more stable macroeconomic policy. Since all those things are not in place, the latest round of inflation and the RBI action are there to tell us that there is still a long way to go for India before it can catch up with China.

First Published: Feb 16, 2007 17:34 IST