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Inflation may poop growth

With high investment and low savings, the Indian economy is getting overheated, reports DH Pai Panandiker.

india Updated: Dec 23, 2006 16:43 IST

The mid-term review of the Ministry of Finance convincingly brings out the widely known fact that the economy is in fine fettle.

All relevant signals, except one, are blinking a bright green, and it can be reasonably expected that the trend will continue for the rest of the financial year. Even the external constraints, like crude oil prices, seem to have eased.

Growth has been picking up gradually. It crawled up to 8per cent last year and to 9 per cent in the first half of the current year. There are indications that the economy will be pushed up even further. For instance, new investment proposals in industry alone in the quarter ending October were over Rs 6,57,343 cores, about three times the new investment proposals in the same quarter last year. Investment is really what is driving the economy, though it can also create pitfalls that may hold up growth.

Almost every sector of the economy is performing better than it did last year, except agriculture. Last year production of wheat was down; this year production of rice will fall. In the first half of the year, income generated in agriculture was up a mere 1.7 per cent and, for the year as a whole, growth may not show any improvement.

Agriculture generates a fifth of the national income. A faster growth would have enhanced the GDP and, even more important, held back inflation.

It is the rest of the economy that is really on the bounce. Industrial production in the first half of the year was up 10 per cent. The manufacturing sector which is a major contributor to growth is performing even better. The other activity which is crazily expanding is construction. Contributing nearly seven per cent to the GDP it grew at 10 per cent in the first half of the current year. Services, particularly trade and commerce, have been the backbone of the strong GDP growth.

Comparing the half-yearly performance of different sectors in this yearlast, it would appear that the rate of growth of agriculture in 2006-07 will be 15 per cent lower than in 2005-06. On the contrary, growth will be higher by 16 per cent in industry, 27 per cent in construction and seven per cent in services.

Taken together the GDP in 2006-07 should be 12 per cent higher or grow at over 9 per cent.

There is, however, a catch. Inflation is one signal that is flashing red. With excessive investment and low savings, the economy is getting overheated. The RBI did raise the reverse repo rate and the CRR to mop up excess liquidity but without much success. If inflation continues and the fiscal deficit is not curbed, both of which are likely, RBI may be forced to go in for harsher measures. The first to be hit will be construction followed by industry. To move too fast too soon has its problems. These need to be taken care of even before they become visible.

The writer is president, RPG Foundation


First Published: Dec 23, 2006 16:43 IST