Stagflation worries haunt India: What is it & how it really hurts?

Stagflation worries haunt India: What is it & how it really hurts?


Inflation is often considered as an economic villain. By definition, inflation refers to the general rise in the price level in an economy. An increase in inflation leads to a fall in the purchasing power of a currency as the commodities and prices gets dearer. In simple words, we would be able to purchase only fewer items for the same money.
The impact would be far greater when rising inflation is accompanied with a stagnant output. In such a scenario, the economy would be facing the situation of ‘stagflation’.

In the mid-1970s, the oil price shock had pushed many economies into stagflation. Stagflation is a very risky affair, as there is no consensus on the policy mix needed to deal with the situation. For instance, on the wake of a falling aggregate output, the immediate policy response from the government/central bank would be to follow a loose fiscal/monetary policy. However, when the economy is also dealing with rising price levels, a policy mix of loose monetary and fiscal policy could further push prices upwards.

On the other hand, a tight monetary policy to control inflation would result in higher borrowing cost, negatively impacting consumption and investment demand. This, in turn, would pull down the aggregate output in the economy.

Currently, discussions are going around on whether the Covid-19 induced economic crisis would push the major economies to a stagflationary shock. The debate is getting stronger in India, with the release of GDP data for the first quarter of FY21. The Indian economy contracted 23.9 per cent in Q1FY21. The major components of GDP — viz consumption demand and investment demand – contracted 27 per cent and 47 per cent, respectively. In the second quarter also, the economy would be in the negative territory, though the contraction wouldn’t be as deep as in the first quarter.

On the other hand, the inflation rate as measured by Consumer Price Index (CPI) breached the upper band of 6 per cent for the fifth consecutive month at 6.69 per cent in August. The major contributor to the rising inflation rate was the surge in food prices. Food inflation rate registered a growth rate of around 9 per cent in August. Similarly, core inflation i.e., inflation excluding food and fuel also remained high at 5.4 per cent, despite the falling demand in the economy. The contraction of GDP along with the rising inflation rate ignites the fear of stagflation in the Indian economy.
However, wholesale price index (WPI) has been in the negative territory for the last four months before climbing to 0.16 per cent in August. In January 2020, when retail inflation rate was high at 7.5 per cent, wholesale inflation rate stood at 3.5 per cent. In the current scenario, there is inflationary pressure only at the retail level, and not at the wholesale level. And, this could be attributed to the supply-side disruptions caused by lockdowns. Once the restrictions are eased, there could be some cool off in the inflation rate. Yet, the rising number of Covid-19 cases remains a challenge.

Similarly, the heavy rains during August could limit supplies, pushing food prices upwards, both at the wholesale and retail levels. It is in this background, that as a precautionary step the government has banned the export of onions. Lockdown restrictions and erratic rainfall are playing spoiler in controlling the inflation rate. And, the inflation rate governs policy decisions at the central bank.

Though it is early to say of the economy has entered a phase of stagflation, the growth-inflation conundrum will surely get more prominent in India in the days ahead.

Credit: Stocks-Markets-Economic Times

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