Is India's Economy Overheating?

Fears that India's economy, stock market and the exchange-traded fund (INP) that tracks it are overheated led its central bank to ramp up interest rates.

Since January 2006 the Reserve Bank of India [RBI] has raised its overnight lending rate by one and a half percentage points, to 7.75% and the rupee, in turn, has jumped 10% in value versus the US dollar during the past four months alone.

But rather than slowing down, India's economy is speeding up. An article in the Economist states that JPMorgan estimates that growth in the three months to March accelerated to a seasonally adjusted annual rate of 11.4%. Yet, despite rapid growth, wholesale-price inflation fell to 5.1% in mid-May, down from 6.7% in January. Still the signs of an overheated economy are everywhere. A sharp increase in house prices, credit growth of 28% over the past 12 months, 15%-plus average rises in wages for skilled workers, record industrial capacity utilisation rates, and 41% more imports in April than a year ago.

Plus, consumer prices still appear to be rising at an annual 8% clip which likely means that more aggressive rate hikes are on the way. The trick is to slow growth down a bit without triggering a sharp decrease in economic activity - easier said than done and what in the US is often referred to as a soft landing.

The higher rupee has helped boost returns for investors in the India ETF but valuations may be getting a bit toppy. Still you must admire the underlying growth and momentum of the Indian economy. Will higher interest rates and a stronger currency blunt this mojo?

Comments

[Nidhi]

Higher rupee might also be hurting imports from indian companies, particularly while dollar is dropping.

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[Preshit Mulay]

Unfortunately most people on the ground do not want to accept the reality. They probably havent seen down turns, and its essential to get rid of the lunch break investors. Need of correction is dire, it might strengthen the economy.

[brij srivastava]

Interesting poser Mr.Delfeld. My take is that indian economy can take a many more bouts of interest rate hikes in its stride. But is it required?..an answer to it lies with RBI.Well i hope they wait it out for another quarter or two before indulging in such an exercise. It seems they have their mind made up and we might see a hike more so on political compulsion.India has a new problem at hand....the increase in salaries of middle-class......whic... can more than handle/offset interest rates hike,if any.Some sectors will see an impact. Indian economy is definitely on a roll and rise in rupee will be there for years to come. So,any foreign investment in core sectors will reap high returns. Returns will multiply as rupee gets stronger.Subsidising exports is no answer from now on.Competition will now unleash the true character of indian exports.As of imports,indian masses do deserve cheaper foreign products and variety at their disposal.Expansion of internet and media has made indians aware of products available and worldwide flavour. So,i guess rupee needs to strengthen which incidently will have a positive political impact at ground level.

[sacsharma]

I definitely don't agree that the economy can take another rate hike in it stride. Already, one can observe slowdown in the Auto sector because of the higher interest rates.
Also the real estate sector is showing first signs of crack with realty rates dropping by 20-25% in places like Bangalore and Delhi.
Add the rupee rise of almost 10% has resulted in most IT companies feeling nervous.
It is a wait and watch situation.
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[brij srivastava]

Mr.Sharma,thank you for the feedback. Auto sector slowdown as you term it maybe a caused by various other factors (including rate hike),the auto companies would never have gone for expansion knowing fully well the imapct of interest rake hikes.
Real estate in india has always been a black money play.Now lately with increased income with families due to salaries hitting roof,real estate is now coming to terms with clean money chasing clean properties.There has to be some gestation period for maket forces to apply.The fall in property prices is very well understood and what we have seen is just a begining.The cycle could last a period of ten years.
As for IT companies,the party is nearing its end...how long can a government flog its own currency to keep a certain sector flourishing?IT companies have had tax free run for too long now.Rupee is at its begining of its rising graph....no amount of government intervention can keep it suppressed for long.Even Dubai exchange is getting ready for rupee futures,wake up call.
Still i agree with you......it is a wait and watch situation...hope not for long though.Thanks