India Overheating?

The Economist is currently running a series of articles on whether India's economy is showing signs of overheating; eco-talk for demand outstripping the country's productive capacity, leading to inflationary pressures.

Its been interesting for me to see some of my classmate's reaction to this. Some are convinced and others aren't. Even more interesting has been to see some of the reactions in the Indian media and blog community, much of which as one can imagine has not been very receptive to the articles.

My 2 cents on this is the following. It is too early to say at this point in time whether India’s economy is over-heating. There is no doubt that several sectors today are facing severe inflationary pressures. In fact, over the last 3 weeks, the RBI has raised interest rates twice, but with increasing inflation, real interest rates are still quite low and the economy will continue to remain flush with liquidity. This certainly raises the prospect of an overheat, at least in the short-term.

However, I dont think this is the bigger concern. The large concern is going to be how we bridge this demand-supply divide in the long run. India is a developing economy, but our current GDP per capita, even when adjusted for PPP, is low. This is a boon today as it will allow us to grow for the next 5-10 years, in spite of the crippling infrastructure, poor education and health levels, etc. Once the GDP gap begins to narrow, further growth will need to be squeezed out, basis-point for basis-point. And this will only come from increased productivity --> tighter governance, better public services, a massive education drive, infrastructure investment and strong and independent institutions. This perhaps, more than any immediate inflationary concern, is our biggest challenge.