Effect of Stagflation on the Indian Economy

Topics: Inflation, Keynesian economics, Macroeconomics Pages: 2 (612 words) Published: September 7, 2012
India is now at a stage where we will see slow growth and high inflation for some time—GDP growth has slowed to a 9-year low of 5.3% in January-March 2012, with WPI inflation staying sticky near 7.5% in May and CPI inflation in double digits. Ideally, it should have been the reverse: GDP growth should have been 7.5% plus and inflation near 5%. Clearly, the growth-inflation dynamics have reversed.

As it stands now, we are in a low growth and high inflation trap. Getting out of this will require coordinated fiscal and monetary policy action to bring inflation within the comfort zone. Pushing up growth will require steps to overcome policy-related bottlenecks, to improve the investment climate. Since much of the inflationary pressure is structural—food inflation is back to double-digits mainly due to supply-side constraints, and fuel inflation stayed near 14% even though energy prices have not been fully passed on to consumers—monetary policy alone cannot be fully effective. It has to be supported by actions to reduce fiscal pressures and supply-side bottlenecks. Not surprising, RBI has left policy rates unchanged at its mid-quarter policy review on June 18 and flagged concerns over the lack of fiscal and administrative initiatives to curb inflation.

Coming back to the economic outlook for 2012-13, Crisil expects GDP growth to stay flat at 6.5%, same as last year. The average WPI inflation is expected to stay at about 7%. The current economic expansion certainly appears to be well below the country’s potential growth. Potential growth is defined as one which is tolerable and does not stoke inflationary pressures. RBI regards India’s potential GDP growth as about 7.0-7.5%. We may not grow at the potential rate all the time, but as long as it is accompanied by benign inflation, that will be acceptable. The worry today is the provenance of higher-than-acceptable inflation when growth has materially slowed below its potential.

In the past few quarters,...
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