The Financial Times has an article today which draws attention to the preoccupations they have over at the Reserve Bank of India that the Indian economy might be overheating:
The Reserve Bank of India raised the repo rate by 25 basis points to 7.5 per cent and doubled bank provisioning requirements for loans for real estate, credit cards, stock market purchases and personal expenditures to 2.0 per cent. It said: “Demand pressures appear to have intensified, reflected in rising inflation, high money and credit growth, elevated asset prices, strains on capacity utilisation, some indications of wage pressures and widening of the trade deficit.”
Now what follows here represents something more like working notes than a regular post, since the issue is so complex, and even those of us who are economists are pretty perplexed at this point, so please don’t expect any kind of authoritative assessment right now from anyone. The first step to knowledge, however, is recognizing that there is something which you don’t know, so here goes.
I think there are two necessary points of departure here:
1/ The Indian phenomenon is a huge one. India will quite simply become the biggest developed economy ever (the only real debate is about when), and since India is the planet’s most populace country, and global population sometime later this century will start to turn south, India will become a unique phenomenon, there will never be the like of this again. This is of course what leads to all those China comparisons, and Nanubhai is currently working something up on this angle.
2/ The global context. Quite simply it is impossible to look at what is happening in India at simply the country level. In particular getting hold of trends in global liquidity is going to be vital for understanding what happens next in India, and what is sustainable and what is not. With this in mind (here comes the plug) some of us have recently started a global economics blog (Global Economy Matters) and in some ways this offers a complementary perspective to the one we have here on IEB, since the focus of the new blog is the contextualisation of local economic phenomena in terms of global trends. Another good reason to bookmark the blog might be that four of the contributors are Indian (Nanubhai, Artim, Arjun and Venkat) and beyond the issue of the blog I feel this representation is only a realistic reflection of the vast economics talent which there is knocking around in India. This may seem a detail, but arguably good economists are a scarce commodity, and evidently India is comparatively rich in this scarce commodity, so my feeling is that the rest of the world had better watch out :)
Incidentally, it is strange how people sometimes note data points like this, but seem unable to join up the dots sufficiently to be able to think clearly about what the implications of this might be – IT engineers, writers, economists……
So returning to the main topic to hand, I had a brief post on GEM yesterday where I took a quick look at the arguments which Deepak Parekh has been advancing across various media outlets of late. He seems to think that there is a significant danger of an imminent correction coming in India, and I tend to doubt this, but one of the reasons I doubt it is a strange one, since I tend to doubt the imminence of any generalized correction in India for the simple reason that Japan is unable to raise interest rates. Now why should this matter? Well it matters due to the existence of what is known as the ‘carry trade’, where people borrow money in countries with ultra-low interest rates like Japan or Switzerland, and then invest the funds borrowed in financial instruments which pay a higher rate of return, like US treasuries or emerging market debt. So the big news from Japan this month has been that the carry trade show is set to go on and on, and this means that funds will be available to India more cheaply and in greater volume than might have been previously expected. The G7 central bankers are of course seething about this, since they would like to ‘normalize’ interest rates, and eliminate the carry trade. Some indication of the problems all this is causing has been observed recently in Thailand, and Eddie Lee has a go at putting this in some sort of perspective here.
So the debate really is, how fast can India grow without precipitating excess inflation? Well, as I am saying, the funding is going to be there, and the labour is certainly there, maybe the big constraint is the resource one, namely the pressure that India’s (and China’s etc) rapid growth puts on oil and other commodity prices.
Of course there are other elements, like the bottleneck in highly skilled, highly educated workers for the high value services sector. But this may not be the bind it seems to be, if India now moves – as I feel sure it must – away from a middle class consumption driven model, and towards and investment driven export-oriented one (how else do you imagine the trade deficit is ever going to correct?). The difficulty here lies in India’s poor urban infrastructure which is surely going to do more than simply creak at the edges if this whole process opens up the internal migration floodgates. But that topic, like so many other touched on here, will simply have to await a subsequent post, as will the Economist’s somewhat dubious use of the productivity data, which either Nanubhai or I will explicitly address in the very imminent future.