Stagflation…will we be able to avoid it?

For the past week ever since we got the CPI numbers for December ’19, the word that you would have come across a lot is ‘stagflation’….the word sort of conveys what it means but not having really had to deal with it earlier I decided to dig in a little and see what it means exactly and why are the economists raising the red flag for this.

Ok, that said lets see what the word means: Stagflation refers to an economy that has inflation, a slow or stagnant economic growth rate, and a relatively high unemployment rate. With stagflation, a country's citizens are affected by high rates of inflation and unemployment.

So this makes clear the difference between Inflation and Stagflation, and really this is a strange set of circumstances if you think about it. For if your economic policy focuses on inflation this could further exacerbate unemployment. In the normal course if demand is strong and the economy is doing well, employment is up and this will all put pressure on inflation. To have high inflation at a time when growth is slow and unemployment is high is a difficult situation. And if an economy slips into such a situation then it take a long time to recover from it.

But lets look at the data that got us to this discussion in the first place.

In my earlier blog I spoke to the GDP advance estimates for this year announced by CSO on 7 th Jan 2020. This has been pegged at 5% for the year, not a great number you would agree.

On the heels of this came the CPI number on 13 th Jan 2020, the number for December 2019 was at a 64 month high – 7.35%, more than the November 2019 number of 5.54% and more importantly higher than the medium term target of 4%(+/- 2%) which the RBI had indicated.

Inflation has gone up due to the fact that vegetable prices are up 60.5% year on year – and this basket has contributed 3.7% to the headline 7.35% number. Onion prices have quadrupled on year on year basis, but that’s not the only culprit, various other categories of food inflation have trended upwards. The swing in onions has been the highest but even if you were to exclude onions from the basket overall inflation would drop from 7.35% to 5.2% – still higher than the 4% RBI target.

The bright lining to this was provided by Core Inflation which is below 4% and is probably at the lowest for this series which began in 2012…core inflation is the cost of goods and services but does not include food and energy costs. Food inflation tends to be more volatile and is therefore less troubling, for a high core inflation would be more difficult to tame and underlines a larger malaise. And it is perhaps from this that we should derive comfort.

If the inflation stays above 6% for over 8 months RBI will have to explain to the government why it has not been able to contain inflation. Most economists are of the opinion that while food inflation will stay high for next couple of months it is likely to start climbing down, bringing it back to the comfort level of RBI. The MPC in all likelihood will hold interest rates for now and its best to assume that there will be no rate cuts in a hurry. But as MPC does not have a very stringent guideline for inflation it is possible that keeping an eye on the growth data they may choose to cut rates to assist growth. While doing so they need to keep an eye on core inflation though because if that were to rise then it will be cause for concern.

In any case, stagflation is a situation that will arise if slow growth and high inflation persists for more than 8 months and it seems unlikely that this situation will last that long.

But it certainly provides a backdrop for the Budget less than 12 days away. It is most imperative that the government takes steps to bring back consumption. As it is the GDP advance estimates indicate that fiscal math is awry, it therefore does not leave the government with a lot of room to maneuver. The need of the hour points to finding some innovative ways that stimulate growth.

One hopes that stagflation just remains a concept that one read about and it stays as just that a concept. For in the 1970s when there was stagflation in the US it took years for the country to grapple with it and come out of it. And we might not be the only country who it facing stagflation type of situation – China and Thailand share our concern.

The other interesting thing in all this is that most economists who are talking about stagflation in the Indian context are pinning their hopes on inflation coming down as it is the food component that has taken the number to 7.35%, but there don’t seem to be many ideas forthcoming on how to get growth back on track. It is widely accepted that given the fiscal situation that going to be a tough one to do and one that is going to take some time.

It is perhaps because of that, that there seems to be a growing voice that suggests that this Budget would be an ideal time to for the government to acknowledge the slowdown data and then start from there. The more we try to gloss over things the less it seems to be working, if we stop debating whether the slowdown is cyclical or structural and focus on concrete action it would be of more help.