The International Monetary Fund (IMF) has warned India against signs of overheating. However, ironically, it has also scaled down growth projections for India in 2011 and expects inflation to be lower this year compared to 2010. To indicate a scenario in which demand outpaces supply, inflation should be high.
IMF scaled down India’s economic growth by 0.2 percentage points to 8.2 per cent for 2011. The Indian economy grew 10.4 per cent in 2010 and is expected to grow by 7.8 per cent in 2012, lower than IMF’s earlier projections by 0.2 percentage points.
IMF uses a different methodology to calculate economic growth. It uses gross domestic product (GDP) at market prices (which include indirect taxes), not GDP at factor prices (excluding indirect taxes) that is used by the Indian government.
IMF also expects retail price inflation in India to be lower at 7.5 per cent this year, compared with 13.2 per cent last year. For 2012, it has pegged the rate of rise in retail prices at 6.9 per cent.
Overheating refers to the inability of an economy to keep pace with rising aggregate demand and is generally accompanied by a high economic growth rate. Boom periods, if not accompanied with rising productive capacity, leads to overheating, which in turn, lead to skyrocketing prices. “The challenge for many emerging and some developing economies (is) to ensure that present boom-like conditions do not develop into overheating over the coming year,” IMF said in its World economic Outlook report.
IMF also took note of high inflation in India, recorded at 8.31 per cent in February, even as the Reserve Bank of India expects it to come down to 8 per cent by March-end. “Signs of overheating are starting to materialise in a number of economies. Most of the increase in headline inflation in recent months has been due to a spike in food prices. But core inflation has also been increasing in a number of economies, most notably India,” IMF said.
Despite a moderation in food inflation, overall inflation rose from 8.23 per cent in January, since core inflation (manufactured prices sans food products) went up to a two-year high of 6.21 per cent.
A very initial sign of overheating was demonstrated by IIP data released yesterday. Industrial growth, at 3.6 per cent in February, continued to be sub-5 per cent for the fourth month in a row, despite the consumption story going strong. The growth declined because investment is on the downswing, as reflected from capital goods, whose production fell for the third month in a row --- this time by 18.4 per cent.
“Slowing investment and rising demand is a recipe for overheating. If we do not address the supply-demand gaps quickly, inflationary pressures will continue to build,” said Yes Bank Chief Economist, Shubhada Rao.
IMF also cautioned rising commodity prices and disruptions to oil supply could pose new risks to economic recovery. “Commodity prices have increased more than expected, reflecting a combination of strong demand growth and a number of supply shocks. These increases conjure the spectre of 1970s-style stagflation, but they appear unlikely to derail the recovery,” IMF said.
