Is our economy over heated?

Indian economy is overheating…I hear this statement almost daily. When I think and analyze, I realize that we are over reacting. We Indians don’t have appetite to digest more than 8% growth probably we haven’t witnessed this type of growth before and therefore, we are trying to find out what is wrong.

Why Indian economy is overheating? Because Credit growth is more than 30% or real state value has more than doubled in metro cities in last two years or sensex’s P/E ratio is 20.

I would have agreed to the argument that India is overheating if we had more house than the number of families or if an overwhelming connection of roads or more than 2-3 airports in each city. As far as I know this condition doesn’t exist as of now. Our middle class families are searching for flats/homes; we don’t have enough good quality roads; our airports are clogged and flights are regularly delayed…so why we are making so much noise.

As I understand, credit risk, particularly real estate lending leads to widespread a banking problem which percolates to a nation economy. We have witnessed this unfortunate sequence of events in Switzerland, Spain, UK, Norway, Japan and US. A period of financial deregulation resulted in rapid growth in lending, particularly in real state related lending. Rapidly rising real state prices encouraged more lending, abetted by lax regulatory systems in many cases. When economic recession occurred, inflated real estate prices collapsed, leading directly to the failures, which affect banking system and economy adversely.

I don’t foresee it happening in India because we have excellent banking regulations in place and RBI modifies and puts a ceiling on different type of lending based on need. Second, 30% credit growth rate is being sustained by manufacturing, capital goods, real state and retail customer loans. Also, we all agree that India is short on demand side and needs to build capacity in each sector. Therefore, I don’t find anything fundamentally wrong with our economy and disagree about over heating.

We have to avoid being paranoid and stop behaving if there is something wrong. We have to look at things in right perspective. India needs 50 cities with world class infrastructure to cater to need and demand of 1 billion people. We need airports, both to carry passengers and cargo, we need to add to our existing railway Network and Road network to carry goods and promote tourism, we need power generation stations, we need car manufacturing units, etc. It all takes money and that’s why we have 30% sustained growth in lending.

Therefore, I agree to Mr. Reddy and he took a balanced approach on last credit policy review. However, he sent a mild warning signal and suggested not to go overboard although there were enough signals to make him wary. One of those signals was that 5 million mobile handsets were sold on Deepawali this year. It was the largest sale of handsets on a single day. His message is loud and clear to banks – Manage your deposits for loans. If you (Banks) come to me (RBI) for money, I will charge you 25 basis points more.

Let’s be confident. India is doing well and all these signals suggest and reinforce that India is going to sustain more than 8% GDP growth.