The Hindu Business Line : Overheating of economy more imaginary: Review

The figures
Inflationary pressures due to commodity-specific supply problems.
The review has drawn attention to "several instances" in recent history where economies have grown at 8-9 per cent or high annual rates for years on end.
Macroeconomic policy responses have to be prospective rather than retrospective

New Delhi , Dec. 19

The Finance Ministry does not seem to fully share the Reserve Bank of India's concerns of the economy experiencing signs of overheating.

In its Mid-Year Review of the economy for 2006-07, tabled in Parliament here on Tuesday, the Finance Ministry has attributed a "large part" of the current inflationary pressures on "commodity-specific supply problems related to products such as wheat and pulses".

According to the review, "a durable solution to the price rise problem has to be found in increasing yields and domestic output of such products". This view is seen as being somewhat in variance with the RBI's more monetarist approach to inflation, which has led to recent measures such as 50 basis point hike in the cash reserve requirement for banks in order to suck in excess liquidity from the system.

The Finance Ministry, almost in contrast, has held that as long as investments remained buoyant and efficiency (productivity) levels in the economy were improved, "the problem of overheating may turn out to be less real and more imaginary".

The review has drawn attention to "several instances" in recent history where economies have grown at 8-9 per cent or high annual rates for years on end. "Japan grew at an annual average of 10.4 per cent between 1960 and 1970. China has grown at above 8 per cent in 14 out of the 19 years since 1987", it has noted, adding that this has come "despite routine concerns of overheating in China".

The Finance Ministry has also highlighted the fact that overheating of some economies in the past were associated with speculative debt flows through the balance payments leading to excess liquidity expansion and a sharp real appreciation of the exchange rate.

"While net foreign inflows have driven the growth of money supply in India in recent times, such flows have been of the non-debt creating variety and orderly conditions have prevailed in the exchange rate market of the rupee," the review noted.

Besides tackling the supply-side problems, the Finance Ministry is of the view that the simultaneous macroeconomic policy responses have to be prospective rather than retrospective. "A tightening, for example, will have to be in response to an inflationary problem anticipated in the future, not an inflationary bout that has already taken place," the review noted.

Another point in the context of the `overheating' debate relates to the buoyancy in India stock markets relative to some-other well-performing markets such as Korea, Malaysia and Thailand. "While passing a judgment about appropriate valuation of stock market is a hazardous venture, the increase in the price-earning ratio of the BSE Sensex from 20.92 at end-March 2006 to 21.34 at end-September 2006 suggests that a part of the increase in stock valuation may be because of higher corporate earnings and the higher growth expectations in the economy," the review said.