India is classified as low-income economy1 as per The World Bank although India's huge population results in a per capita income of $3700 at PPP and $820 at nominal.
The economy is sizzling due to booming investment and consumption. According to survey of 32 countries by Grant Thornton, a London-based accounting firm, Indian businessmen were the most upbeat. Indians are rightly proud of the huge global success of firms such as Infosys, or of Tata Steel's 5.8 billion ($11.3 billion) acquisition of Britain's Corus this week.
Reserve Bank governor Yaga Venugopal Reddy has flagged the possibility that the Indian economy may be overheating2. In other words demand is outpacing supply and hence the pace of growth is unsustainable. Wholesale price of oil inflation has risen to 6%, which is above the 5.5% upper limit set by the Reserve Bank of India (RBI). The crude average of the rates for industrial, non-manual and agricultural workers is above 7%. Capacity utilization is higher than at any time in the past decade.
The most recent trade data suggest that the rapid deterioration in the trade deficit since H1 2004 is stabilizing and portfolio flows only account for 35 per cent of total capital flows and one of the main determinants is GDP growth. The bank expects the balance of payments to improve in FY06 / 07 and has revised its dollar: rupee forecast to 43-43.5 from 44.53.
Credit boom has concerned The RBI also. Bank lending to firms and households has expanded by 30% over the past year. Lending on commercial property is up by 84% and home mortgages by 32%. India's stock market is one of the merging world's most expensive, with a price-earnings ratio of more than 20; this shows rising more than fourfold over the past four years. Asset prices are also rising. In many big cities house prices have more than doubled over the past two years. RBI raised its overnight lending rate by a quarter-point to 7.5%, but left the reverse repo rate at 6%. Over the past couple of years interest rates have risen by less than the rate of inflation, so in real terms they have fallen.
When demand outpaces supply in an open economy it is more likely to show up in a current-account deficit than in inflation. India's deficit widened to more than 3% of GDP in the three months to September-a huge swing from a surplus of almost 4% in the first half of 2004. And the true gap between domestic demand and supply is even bigger. According to Yaga Venugopal Reddy, the RBI'S governor, India's current-account deficit is larger once you exclude the money sent home by Indians abroad. Although these remittances do not reflect domestic demand or supply, but are more like a capital inflow. Excluding workers' remittances, India's deficit is running close to 5% of GDP-larger than the equivalent deficit during India's balance-of-payments crisis in the early 1990s. the Economist is making a political judgment:
"The economic reforms of the early 1990s spurred competition, forced firms to become more productive and boosted India's trend-or sustainable-rate of growth. But the