In the last couple of days, we have seen the word “Stagflation” come back to haunt the Indian news headlines. The debate on stagflation has taken off after the inflation for November came in sharply higher at 5.54%. This was accompanied by negative IIP growth for the third month in succession. It is this combination of high inflation and weak growth that has revived this debate.
What exactly is stagflation?
Stagflation is normally a situation where the inflation is going up sharply and the growth in GDP is below average. It is a normal warning signal ahead of a full-fledged recession hitting the economy, which is why economies need to be cautious of stagflation. Stagflation has a number of reasons. For example, in the Indian context, there is a sharp rise in inflation due to structural factors. India has struggled to manage its food logistics effectively, leading to runaway food inflation when the balance is upset, as in the current scenario. The high inflation leads to weak consumer confidence and that result in a sharp fall in demand. This is first visible in discretionary spending and later spreads to all types of spending. The outcome of this compression in demand is that manufacturers are forced to cut supply and at the same time, they also lose their purchasing power in a competitive market. There is fall in income, rise in joblessness and all this happens in the midst of rising prices in the economy.
Time to smell the coffee
For the Indian economy in general and for economic policy makers in particular, this is a moment of truth. The GDP growth has fallen to 5% in Q1 and 4.5% in Q2. The third quarter, as per high frequency estimates, could be worse than 4.5%. In the last 3 months, the core sector growth and the IIP growth has been deep in the negative. That is officially a manufacturing slowdown. These are the pressures coming from the demand side. Even on the supply side, there are concerns. The weak logistics link in food supply is keeping inflation at high levels. Also, India’s overt dependence on monsoons and on imported oil is only making matters worse for the stagflation scenario. What is the way out from here?
Address stagflation fiscally
Most structural issues will take time to address and they cannot offer a solution right away. What the government can do is to give consumers a host of fiscal incentives. Firstly, the government can cut GST on a host of products that are price sensitive. Revenues can be always compensated with higher growth. This is the time to incentivize spending with greater tax breaks to people. Thirdly, corporate spending needs to pick up and that needs incentives. Above all, the government must not relent on public spending. If fiscal deficit does go out of control for a year; so be it! ©