India’s capacity constraints may come in the way of sustaining an annual economic growth rate of 9 per cent despite the fact that the economy is showing signs of overheating, ratings agency Moody’s Investors Service said on January,16. Moody’s said fast growth meant inflation was likely to stay above the central bank’s end-March projection of 5.0-5.5 per cent.

Moody’s Vice President Kristin Lindow estimated the economy’s long-term potential growth rate at 6.5 per cent but said it could grow faster than that for the next year or two. Asia’s fourth-largest economy has averaged 8.1 per cent over the past three years and in the first half of the fiscal year that began in April it grew 9.1 per cent, backed by about 30 per cent growth in credit.

The Reserve Bank of India began tightening policy more than two years ago and recently increased the amount of cash banks have to hold on deposit with it as a way of draining excess funds from the system. But Moody’s noted that ample portfolio and capital inflows had diminished the efficacy of the monetary policy measures. The main share index, which hit a succession of record peaks in 2006.

So far, liquidity has been favourable to India and therefore policy tools have been less effective. Inflation based on wholesale prices is above 5.5 per cent while consumer price inflation is close to 7 per cent. Moody’s, which left the outlook for India’s credit rating at ‘stable’, said India’s large public debt was keeping its domestic currency rating at a speculative grade.

The government expects the federal fiscal deficit to be 3.8 per cent at the end of this financial year. A central bank panel has recommended India move towards fuller capital account convertibility by 2011 and Moody’s suggested a cautious approach. If capital controls were eased hastily, the government’s deficit and debt situation could spill over to its external accounts, it said.