😯 India at Risk of Stagflation?

The World Bank and the RBI are both worried about stagflation. Here’s why.

The world now seems like a video game. As soon as we beat one difficult level, we’re faced with the next impossible one.

So far, we had been dealing with two possible demons: inflation and recession.

But now it turns out we may have to battle a combination of the two: Stagflation.

Both the World Bank and the RBI have now raised concerns about possible stagflation in the coming months.

So, we’re here to take a look at what stagflation is and how it can be tackled.

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🧐 What is Stagflation?

Stagflation is the unholy child of inflation and recession.

It is when growth is declining but inflation is still rising.

So, not only are people losing jobs in this scenario, the world around them is becoming increasingly more unaffordable for them.

In short, it is the worst of both worlds: an economic scenario so scary that economists didn’t even think it was possible till the 1970s (when stagflation first hit the US).

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📉 Why Stagflation Seemed Impossible?

Technically inflation happens when there is more money in the economy.

More money = High prices + More growth (as businesses have more resources to grow their capacity and hire more people).

This is exactly why the RBI had kept interest rates low for so long despite rising inflation – to allow us cheap access to money to grow.

But inflation is now too high to maintain this “accommodative” stance toward growth.

So, RBI and around 50 other central banks have raised their interest rates: the world’s most common response to inflation.

Now, usually, when rates are raised, the supply of money in the economy is reduced (Since fewer people would want to borrow money at higher rates to grow their business).

So, the prices should go down but so should growth.

This is what fuelled fears of recession (a period of low growth when people usually lose jobs).

Now, for the longest time economists believed that recession and inflation are mutually exclusive. That is they cannot happen at the same time.

And by the above logic, their reasoning makes sense.

But the real world does not follow our logic and our rules.

You see, sometimes inflation can also take place despite less money in the economy.

Wait, how?

Due to global events.

In the 1970s, the US saw stagflation because of a ban on oil imports to the country from Arab countries.

This increased the price of oil (which in turn raises the price of other products as well) and impacted the country’s growth as well.

Cue: Stagflation.

Right now we are also in a similar situation.

Thanks to the Russia-Ukraine war and lockdowns in China, we are seeing a shortage of multiple crucial items, especially oil and food.

This is raising inflation, despite the rising interest rates.

Instead, the rising interest rates will impact growth and lead to job losses.

And since this inflation is spurred by the shortages, it won’t fully calm down until things are normal.

So, should we not raise interest rates then?

No, because the rising interest rates will help calm inflation at least a little. So, that’s important.

Then what can we do to stop stagflation?

Well, there is no foolproof way but some methods are:

•  Price controls (freezing the price of key materials like food and oil)

• Reducing dependence on oil and imports.

• Reducing people’s wages (yes, we know that seems counterproductive but it helps reduce the supply of money in the economy).

However, you don’t need to lose sleep over stagflation worries just now.

The last time stagflation took place was when inflation was at 11% and unemployment was at 33%.

We’re far from that mark right now.

Plus, despite everything India is seeing strong growth.

Our credit disbursal rates are at a 2-year high, showing that there is demand for loans among businesses.

Also, our Manufacturing Purchasing Managers' Index was at 54.6 in May, which shows the manufacturing sector is going strong.

The infrastructure sector is also booming.

However, consumer demand is drying (trade volume for FMCG firms fell by 4.9% due to rising prices), which could become a major problem for companies especially as India is set to raise interest rates further.

Only time will tell, if India will manage to balance inflation and growth or if it will see its first stagflation.

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⚡In a line: India and the world is worried about the unholy combination of recession and inflation as the Russia-Ukraine war and China’s lockdowns cause supply chain issues.

💡Quick question: Do you think the RBI’s actions are enough or does the government need to step in with more interventions?

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