Indias Economy on the verge of Overheating

With breakneck growth, an outsourcing industry that leads the world and hundreds of millions of consumers demanding more class and comfort, India has an economy many countries would envy.

But now, after three years of near double-digit growth, signs of a potentially dangerous inflationary spiral are beginning to emerge. Prime Minister Manmohan Singh and his closest economic advisors gathered just last weekend over fears that India’s extraordinary economic expansion was starting to overheat, an issue they labeled as a “key short-term priority.”

They may have waited too long. Food prices are climbing for everything from lentils to onions, squeezing the poor. Apartment rents and prices are rising steeply, especially in large cities. Factories that make the country’s increasingly ubiquitous motorcycles are running at full tilt and have still fallen weeks behind in meeting orders from dealers.

Inflation in India remains much lower than in many developing countries. But prices are rising more than twice as fast as in China, India’s archrival for foreign investment and economic leadership among emerging markets. Prices are also increasing considerably faster than in industrialized countries.

That has put the onus on government leaders to try steering the economy, which is expected to expand by as much as 10 percent this year, away from a possible escalation of inflation pressures that could derail some of their achievements and temper the country’s climb in living standards.

“There is a recognition of these pressures and there is virtual unanimity that these have to be managed,” Y. Venugopal Reddy, the governor of the central bank, said in an interview this week. On Jan. 31, the central bank raised an important short-term interest rate by a quarter-point, to 7.5 percent, to help stem inflation.

Mr. Singh, Mr. Reddy and other senior officials have repeatedly reaffirmed their commitment in recent days to the market-oriented policies that have helped to triple the economy’s growth rate since the early 1990s.

But rising prices are starting to rekindle some nostalgia for the 1980s, when India had one of the world’s most highly regulated economies. “You have to ensure some amount of price regulation,” said Suhel Seth, a prominent political commentator and marketing consultant. “Under the guise of a free market, you’ve created a free fall for the poor.”

Some of the largest increases in food prices have been here in Mumbai. This is an industrialized peninsula where food is brought in over long distances by truckers who have had to pay much more for diesel fuel over the last year as the Indian government has passed on part of the increase in world oil prices.

Navalben Nagda, a retired shopkeeper in northern Mumbai, shopped for milk this week in a green sari but complained that she and her husband had been forced to change their purchasing habits.

“We buy lower-quality food now because that’s all we can afford,” she said. “It doesn’t taste as good.”

Wholesale price inflation has accelerated to 6 percent from 4 percent last spring. Consumer price indexes have risen nearly 7 percent in urban areas over the last year and almost 9 percent in rural areas, where more than two-thirds of the population live and where higher food prices are having the biggest effect.

Government economists attribute rising food prices in India to global factors like a poor harvest in Australia, the growing use of crops to produce ethanol and a higher cost of diesel for tractors. But many here link the increase to the government’s encouragement of futures trading in agricultural commodities, and the government has responded this winter by limiting a few types of transactions involving food.

Mr. Reddy said he felt “some justifiable optimism” about inflation and the Indian economy. He pointed to the lagged effects of interest rate increases over the last year that had not yet fully worked their way through the economy. He also noted that Indian companies were investing in additional capacity and that new roads, loading docks and other infrastructure were being built.

Still, the central bank’s surveys show that practically all of India’s manufacturers are operating at full capacity, as consumer demand has risen first and companies have been slower to respond. Many factory expansions and new factories will be ready in 18 months to two years, Mr. Reddy said, describing the time until then as a transitional period for the economy.

Awash with deposits derived from foreign investors, Indian banks have been lending aggressively, particularly to consumers. That has led to a wave of buying on credit.

Rahim K. Premji, the manager of Allibhai Premji Tyrewalla, a motorcycle store here, said that there had been so many buyers nationwide that for the last six months, motorcycle factories had typically been 15 days late in filling orders.

“It used to be you’d place your order and they’d dispatch it right away,” he said. “They’ve constantly been expanding capacity, but not as fast as demand.”

The panoramic view from the 25th floor of India’s central bank provides clear evidence of supply shortages. Across a wide swath of four-story buildings, stretching for many miles, not a single construction crane was in sight, not in the nearby historical district nor in the poor and rich neighborhoods alike all the way to the edge of the warm waters of the Indian Ocean.

That stands in stark contrast to Chinese cities like Beijing, Shanghai and Yantai, which have used rising property markets to help finance the bulldozing of many square miles of crumbling housing.

But India has very strong rent control laws and other tenant protection legislation. Along with extensive litigation and backlogged courts, these rules have made it extremely difficult to demolish and put in high-rise complexes to replace the tens of thousands of acres of moldering buildings that clog large cities.

The scarcity has sent prices even higher for existing housing. In fashionable neighborhoods of South Mumbai, apartment prices have jumped close to 60 percent just since last spring. Foreign investors, including oil-rich investors from nearby Middle East countries, are joining the market, bidding aggressively against members of India’s increasingly affluent business elite.

Rushabh S. Mehta, a partner at the Royal House Agency, walked through a 2,000-square-foot apartment that had a cheap-looking concrete floor and flimsy wooden closets. But it is in the chic Malabar Hill neighborhood. The asking price is nearly $1.5 million.

“It’s the location, basically — there’s no view,” he said, looking out a window at the white wall of a neighboring apartment building.

Demand for everything from housing to beer is outpacing supply in part because white-collar salaries are rising faster in India than anywhere else in Asia, climbing 13.7 percent on average over the last year, said Sharad Vishvanath, a labor cost analyst at Hewitt Associates. Wages for junior managers and technical employees are rising fastest of all. Meanwhile, new factories and offices take time to build. But analysts and executives say that productivity gains could allow India to wring more output from the businesses it already has, helping avoid the bottlenecks that can feed an inflationary spiral.

Big gains could come from modern telecommunications and the growing flexibility of India’s labor force, as shown by workers like Selvi Partipan in Chennai.

Ms. Partipan, a 40-year-old who gave birth to the first of her five children when she was 13, used to work as a street vendor. She fried samosas and other fare for passers-by, earning just $2 a day.

But six years ago, after partial deregulation of the leather industry, Mrs. Partipan found a leather factory job. She sewed everything from handbags to jackets and earned $3 a day. She learned that she could earn as much as an additional $7 a day by doing extra sewing at home in the evening and on weekends, when other factories were desperate to finish orders.

The difficulty lay in figuring out when a leather factory manager somewhere else needed workers. So last summer, she gave $80 to her son, a security guard who works a morning shift, to buy a mobile phone. When work became available, factories sent text messages to her son and others in English — Mrs. Partipan speaks only a local dialect — and he quickly told her and she raced to the factory gate.

“I’ve already gathered some orders by phone,” she said, wearing a maroon sari and sitting on a plastic stool as a daughter cooked samosas at the same location where Mrs. Partipan used to cook. “It is paying for itself.”

But while such adaptability helps to explain the long-term optimism of most government and business leaders in India, people in the streets are more worried about the continuing rise in prices. Mukesh Maru, a shopkeeper in Mumbai, pointed to a steel basin of moong dal, a popular type of small yellow bean in especially short supply now, and said that the price had risen to 58 cents a pound from 23 cents a year ago.

In the 35 years his family’s shop has been in business, he said, “it’s only in the past year the prices have jumped so much.”