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Wednesday, November 29, 2006

Growth Without Reforms - Magical UPA

IEB's Edward, an ardent demographic dividend proponent, argues that Economist and Ajay Shah may be wrong to say India is over heating and that there may not be a real worry for a crash or a recession anytime soon. Does second quarter growth of 9.2% prove that Edward is right? I am not so sure.

The current growth is not based on structural reforms of Indian economy. It's most likely based on easy money. With a conducive RBI governor, Dr. Reddy, Chidambaram has been talking up the economy and talking down any action to control easy money. What's wrong with easy money especially if the economy is going strong? Easy money generally hides lot of problems in the economy. Because consumers and companies are highly leveraged, if there is any slow down in the buying binge (from consumers, companies, or exports) the economy will go into a tail spin with a recession at hand. Economist:

In contrast, India's economy displays an alarming number of signs that things have gone too far. Consumer-price inflation has risen to almost 7% (see chart), well above Asia's average rate of 2.5%. A recent report by Robert Prior-Wandesforde at HSBC finds many other signs of excess. For example, in a survey of 600 firms by the National Council of Applied Economics Research, an astonishing 96% of firms reported that they were operating close to or above their optimal levels of capacity utilisation—the highest number ever recorded. Firms are also experiencing a serious shortage of skilled labour and wages are rocketing. Companies' total wage costs in the six months to September were 22% higher than a year earlier, compared with an average increase of around 12% in the previous four years.

India's current account has shifted to a forecast deficit of 3% of GDP this year from a surplus of 1.5% in 2003—a classic sign of excess demand. Total bank lending has expanded by 30% over the past year, close to the fastest growth on record. (Link)

If growth went from mid-8% to low-9% in the past few quarters, it may indicate that the economy is actually heating up increasing the likelihood of bigger slowdown - proving Edward otherwise.
In fact, with no structual economic reforms, slow (to no) infrastructure buildup since UPA came to power more than two and half years ago, it pretty much indicates that the main driver of growth is free/easy credit. And that has consequences.

Economist and Ajay Shah argument is about sustainable growth - ie long term growth. And they may still be right. It appears Manmohan and Chidambaram will enjoy the easy money laurels without taking any hard decisions (there are fellow Communists to please and blame) and pass on the coming economic mess to the next government to clean up.

Cross posted on INI Signal