Recently, the rise in retail price inflation to a nearly six-year high of 7.35% in December 2019 has led to increasing worries that the Indian economy may be headed towards stagflation.
• Stagflation is an economic scenario where an economy faces both high inflation and low growth (and high unemployment) at the same time. A word stagflation is derived by combining two words i.e. stagnant growth and rising inflation.
• The conventional view among economists is that there is an inverse relationship between economic growth and inflation.
• The idea was first proposed by New Zealand economist William Phillips, after whom the “Phillips Curve” is named, based on statistical studies of inflation and unemployment.
• The inverse relationship between inflation and unemployment was seen as a confirmation of the hypothesis that inflation helps theeconomy function at its full potential.
• The logic behind the belief is that, at least in the short term, inflation (by boosting nominal wages but not real wages) can trick workers in an economy to accept lower real wages.
• Without inflation, it is argued, workers would be unwilling to accept these lower real wages, which in turn would lead to higher unemployment and decreased output in the economy.
• At the same time, economists argue that an inflation rate beyond a certain level, at which point labour and other resources in the economy are fully employed, will have no employment or growth benefits.
• Accordingly, policymakers are often advised to maintain a certain inflation rate to ensure that unemployment is kept to a minimum and the economy is operating at full capacity.
• The simultaneous presence of high inflation and low economic growth under stagflation, however, challenges the conventional view that inflation helps an economy operate at full capacity.
• It was the stagflation in the United States in the 1970s, caused by rising oil prices after the Organization of the Petroleum Exporting Countries cut supplies abruptly, which first led many to question the validity of the Phillips Curve.
Is India Facing A Stagflation?
Over the past six quarters, economic growth in India has decelerated with every quarter. In the second quarter (July to September), for which the latest data is available, the GDP grew by just 4.5%.
With growth decelerating every quarter and now inflation rising up every month, there are growing murmurs of stagflation.
Arguments in Favor
Most economists have blamed the slowdown on the lack of sufficient consumer demand for goods and services.
Subsequently, to boost the demand the Reserve Bank of India (RBI) has cut its benchmark rates i.e. Repo rate, five times in 2019
The expectation among analysts was that these interest rate cuts would spur demand and boost the economy.
In the second half of 2019, prices of goods began to rise at a faster pace on the back of the RBI’s rate cuts.
But the growth rate of the economy continued to fall significantly.
This combination of rising prices and falling growth has led many to believe that India may be sliding into stagflation.
However, a section of economists is of the opinion that although it appears so at first glance, India is not yet facing stagflation. The reasons given are as follows:
Although it is true that Indian economy is not growing as fast as it has in the past or as fast as it could, India is still growing at 5% and is expected to grow faster in the coming years.
India’s growth hasn’t yet stalled and declined; in other words, year on year, our GDP has grown in absolute number, not declined.
Retail inflation has been quite high in the past few months, yet the reason for this spike is temporary because it has been caused by a spurt in agricultural commodities after some unseasonal rains.
With better food management, food inflation is expected to come down. The core inflation – that is inflation without taking into account food and fuel – is still benign.
Retail inflation has been well within the RBI’s target level of 4% for most of the year.
A sudden spike of a few months, which is likely to flatten out in the next few months, it is still early days before one claim that India has stagflation.
While the risk of stagflation will set in only if inflation becomes uncontrollable, it would be prudent to watch out for increased risks of such an event occurring. Emphasis should be on boosting consumer demand and structural reforms to bring the Indian economy from the gloom of economic slowdown and fears of stagflation.