Overheating Indian economy

‘Indian economy is overheating’, the quote I have read in many articles, but never really understood what it actually means. Following are the excerpts from an article which clearly explains
1) What does ‘overheating’ of a economy mean ?
2) How does it affect the economy ?
3) Steps taken to solve the problem.
4) Reasons for Indian Rupee getting stronger.
(All in Indian context)

What does ‘overheating’ of a economy mean ?

In somewhat simplistic terms, ‘overheating’ occurs when excess demand in the economy pushes up prices because supply falls short of demand. This phenomenon is most likely to occur when an economy is growing very fast, and that too over a sustained period.

How does it affect the economy ?

A very likely consequence of this sustained high rate of growth is that industries begin to operate at close to full capacity, and so are not able to increase supply in the short run even though they realise that there is sufficient demand in the economy to mop up additional quantities. Even in sectors where industries operate below capacity, infrastructural cons-traints may prevent any expansion of output.

In short high rate of inflation.

3) Steps taken to solve the problem.

Governments and central banks have limited policy options in correcting an overheated economy. Since an excess of demand over supply is the root cause of overheating, corrective measures must either reduce demand or increase supply. But, if it is the absence of adequate capacity that is constraining supply, then there is very little that government can do to increase supply, at least in the short run.

In recent months, the surge in food prices accounts for a large component of the overall inflation. Government has adopted some limited steps to augment food supply. The ban on export of food items will have some beneficial impact on domestic food supply, although the quantitative effect may be limited since current wheat exports have not been very high in any case. In addition, only the more expensive varieties of wheat are typically exported, and hence there may not be any increase in domestic supply of the more common varieties of wheat.

Government has also taken some direct steps to abate the price rise. Most important of these has been reduction in the prices of petroleum and diesel. Fuel is an important component of the overall price index, and so any reduction in fuel prices has an immediate direct impact on prices. Moreover, any reduction in their prices has an important indirect effect since this reduces transportation costs. This in turn brings down the cost of a wide variety of items of common consumption. The RBI‘s recent efforts have focused on controlling aggregate demand.

And it is here that some fine-tuning becomes necessary. Efforts to reduce the availability of credit are the textbook remedy to curtail aggregate demand. However, a large reduction in credit supply may constrain the expansion plans of entrepreneurs and thereby have a negative effect on the prospects of long-run growth.

4) Reasons for Indian Rupee getting stronger.

Increasing globalisation also creates its own problems for monetary policies designed to curb inflation. Indeed, Reddy has identified the surge in net inflows of foreign exchange as the main concern of monetary policy today. We have now accumulated an excessively large stock of foreign exchange reserves. The continuing inflow of foreign exchange essentially means that the world demand for rupees exceeds its supply.

If theRBI does not intervene in the foreign exchange market, this excess demand would cause the rupee to appreciate relative to other foreign currencies. Any appreciation in the external value of the rupee makes Indian exports less competitive in foreign markets, and hence reduces exports. As readers probably know, the rupee has appreciated almost 10 per cent against the dollar in recent times. Not surprisingly, the Indian export sector has not been doing too well during this period.


3 Responses to Overheating Indian economy

  1. Firestarter says:

    More on the rupee appreciation affecting Indian outsourcing companies

    Q&A: ‘Rupee appreciation has hit Indian outsourcing companies’

  2. subhash says:

    it is such a nice site by which i could understand the very basic of it.thank u

  3. riathareja says:

    The real estate sector in India is on a high growth path. Several government initiatives have contributed to this high-growth environment – liberalisation of foreign direct investment norms in real estate in 2005, introduction of the SEZ Act, and allowing private equity funds into real estate.The key driver of demand for office space in India remains the ITITeS sector, which accounts for about 75% of the total demand. Over the past decade, India has emerged as a leader in the global economy. It is a magnet for foreign direct investment (FDI), and has displaced Mexico as the third most preferred country for foreign investment. FDI in India is expected to increase to US$15 billion this year, triple the 2004 figure. Many foreign companies are starting or expanding operations in India.The Real Estate industry has significant linkages with several other sectors of the economy and over 250 associated industries. One Rupee invested in this sector results in 78 paise being added to the GDP of the State. A unit increase in expenditure in this sector has a multiplier effect and the capacity to generate income as high as five times.Real estate boom in India is supported by its own flourishing economy on a sustainable basis. Here, growth of the property market is not a result of renovation and overhauling; but rapid development that witness for India riding the high growth wave. In the present day scenario, if there is any powerful investment tool that brings burgeoning financial returns, it is INDIAN REAL ESTATE!!! Investors should consider the parameters minutely and meticulously to find out why investing in Indian real estate now is the best viable option.For more view- realtydigest.blogspot.com

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