Is India heading towards Stagflation?

By | 4 Apr, 2013 11:00 PM |


I have remained a keen follower and a witness of what can be called (if it really was) the Indian economic miracle- a high growth period with growth rate nearly touching the double digit mark. But couple of years down the line and last few months especially, watching the performance of Indian economy, what I thought to be a miracle merely seems more or less a mirage!  With growth rate tumbling down and inflation remaining stubbornly high, India appears to be treading unwillingly the path of stagflation. Stagflation= stagnation + inflation. It is a situation which all economists and policy makers wish to avoid; when growth takes a downturn and inflation refuses to come down.

This situation typically goes against the general economic logic where low growth is accompanied by lower inflation due to slump in demand. High unemployment is associated with stagflation. Once started it is hard to tame since policies targeting inflation harbor excess unemployment. Stagflation may occur due to a supply shock which not only raises prices but results in reduced output giving rise to the combination of recession and inflation. Excessive growth of money supply during the recession attempted at reviving the economy can backfire and produce stagflation instead by creating demand pull inflation. Supply of output may not increase as real(output) expansion is slower than monetary expansion and takes time.
In 2011, GDP growth rate fell to 6.9% only to continue its journey downwards. In the last quarter of 2012, growth rate touched its decadal low of 4.5%. In the same quarter, inflation was nearly 7%, above the trend rate of 5%. Inflation has been on a high level for last several quarters with very few exceptions while growth rate has kept plummeting.

As I said above too, it is very hard to tame stagflation. High interest rates to check inflation hurt growth. Stagflation induced by excessive money growth may be controlled by tighter monetary regime. Though India still has not fallen into the trap of stagflation, it seems to heading towards the same. Government will have to pay attention to the widening budget deficit as it limits government’s fiscal maneuvering aimed at boosting growth statistics. Unless policymakers take measures to revive growth and horsewhip inflation, stagflation would become inevitable. It is therefore clear that economists at helm of economic policy making in India have ahead of them a really tough task and a challenge they cannot ignore.

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Views presented in the articles are those of the author and not of ED.

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