'Overheating abating, power still a concern'

Days after he first warned about signs of cyclical overheating in the Indian economy, C Rangarajan, chairman of the Prime Minister's Economic Advisory Council, today told Business Standard that previous signs of overheating which were visible through a rise in the wholesale price index-based inflation and merchandise trade deficit "are abating".

The council has also estimated that the current account deficit for 2006-07 is 1 per cent of GDP, down from 1.1 per cent of GDP in 2005-06.

"To some extent there has been an abatement of overheating. What has been happening now is that the growth has been driven not only by consumption demand but also by investment. With new investments being made and new production coming out, cyclical overheating is abating," Rangarajan said.

The investment ratio as a proportion of GDP for 2006-07 has been estimated at 35.2 per cent, while the savings rate is pegged at 33.8 per cent, with both ratios being nearly 1.4 percentage points higher each than in 2005-06.

"If growth is only driven by consumption demand, then when full capacity is reached, it leads to further overheating. But in case of India, a greater part of growth is now being driven by investment. Initially, it may create a situation in which the prices will rise, but subsequently as the capacity is being created, it will have an impact on inflation and overheating," Rangarajan said.

"When an economy operates at full capacity, a situation develops where the prices tend to rise. Overheating is a phenomenon where demand is striking hard on the available supply. This shows up in two ways "" in an increase in the prices and the balance of payments. When overall demand exceeds supply, then it spills into the balance of payment," Rangarajan added.

"This is what we saw last year when prices rose faster than what we considered to be acceptable or desirable. The overall balance of payments continues to remain comfortable. In fact, our recent calculations indicate that the current account deficit for the last year is 1 per cent of GDP. But the merchandise trade deficit, that is import and export of goods alone, constitutes 7 per cent of GDP. However, the remittances and service exports were high enough to keep the overall current account deficit under 1 per cent of GDP," Rangarajan added.

However, the chairman of the PM's Economic Advisory Council cautioned that cyclical overheating should not be allowed to turn into structural overheating.

"The point I want to make is that a structural imbalance should not develop in the economy. In many sectors of the economy the investment may be adequate to create additional capacity, one area where probably it is not happening is infrastructure, more particularly in the case of power. That is where the structural imbalance comes in. If this structural imbalance is not taken care of then this overheating may continue. So one area which needs more focus is infrastructure in general and power in particular," Rangarajan observed.

He added that many power projects where work was under process would come into effect in the third year (2009-10) of the Eleventh Plan period.