Madan Sabnavis
Chief Economist, CARE Ratings
“Those using the ‘S’ word are equating the current economic matrix to a ‘bust’ situation, when the situation is more analogous to the downward slope of a normal business cycle”
German philosopher Friedrich Nietzsche had said: There are no facts, only interpretations. This seems to apply to the situation today when there is talk of India’s economy being in a phase of stagflation. With the level of dissatisfaction in the economic barometer rising, it is tempting to make sweeping statements since it is in vogue to say negative things about the economy.
First, what is stagflation? Keynesian theory spoke of recessions as phases of prolonged unemployment and negative growth with price deflation. These could be countered with expansionary fiscal policies, and inflation took place after full capacity was achieved. This was explained by the trade-off between unemployment and inflation through the Philips Curve. As unemployment decreased, there was more spending, which was inflationary in nature.
Monetarists like Phelps and Friedman spoke of a situation in which this trade-off went backwards as wages rose with inflationary expectations, leading to wage-inflation and higher unemployment. In the seventies, when the first oil-price shock rocked the global economy causing unemployment, expansionary policies only fuelled inflation since it added to cost-push inflation. The problem was that countries expanded at a time when supplies were down not because of demand, but because of higher cost of oil. This is stagflation — recession and high inflation.
Can we term the situation in India as one in which there’s a combination of recession and inflation? The answer is a clear “no” because what we are seeing is a slowdown in GDP growth. Usually, two successive quarterly negative growth rates in industry are regarded as a sign of recession. Our growth in industry has been low but positive; and, though, the GDP growth rate has been declining over the four quarters of the last financial year and hit a low of 5.3 per cent in the January-March quarter, there is no negative growth. Moreover, recessions are characterised by large-scale job losses, which is definitely not visible in our context except in certain multinational corporations in the services sector. Also, there is little evidence to show that wages have increased in the organised sector to lead to layoffs. With India still having the second-highest growth rate in a year in which developed and emerging markets have registered low growth, the word “recession” seems inappropriate.
What about inflation? Wholesale price index, or WPI, inflation has been high but curiously came down, on average, from 9.9 per cent to 8.8 per cent in FY12. Clearly, this cannot be seen as inflation going out of control. In fact, in FY10, when growth slowed to 6.7 per cent, inflation was also at 8.0 per cent and this did not provoke the “S” word. More importantly, we are seeing high inflation in the food and fuel segments because of our farm policies and global conditions; and not because of supply constraints in the manufacturing sector.
How about policies? Stagflation has, historically, been caused by expansionary policies that exacerbate supply shortfalls. But, the grievance has been that the Reserve Bank of India has been choking growth by raising interest rates and that the government has withdrawn the stimulus. If this were so, there is again a strong case for not terming the situation close to stagflation.
Hence, the basic issue is the interpretation of data. In 2012, the World Bank talks of the euro area moving into a recession with negative GDP growth. China is to slip from 9.2 per cent to 8.2 per cent, while India is to move up from 6.5 per cent to 6.9 per cent. Those using the “S” word are equating the current economic matrix to a “bust” situation, when the situation is more analogous to the downward slope of a normal business cycle, which is not uncommon in the current global context. There is, thus, not much of a case for using the word stagflation here.
These views are personal
Dharmakirti Joshi
Chief Economist, CRISIL Ltd
“Growth slipping to 5.3 per cent in a developing economy is as worrisome as stagnation or near-zero per cent growth in advanced countries. India needs to grow faster on a sustained basis”
The Indian economy appears to be locked in a high-inflation, low-growth trap. It may be technically incorrect to refer to this situation as stagflation, which is a highly undesirable combination of stagnant economy and high inflation. It is a rare phenomenon wherein inflation is not a by-product of high demand or growth; on the contrary, inflation rises despite a stagnant or shrinking economy. The best known example of a stagflation period is when the US economy, in the seventies, went through an extended phase of high inflation accompanied by stagnancy. The situation in India has not deteriorated to that extent, though inflation has remained high in an environment of slowing growth.
India is unlikely to face stagnancy in overall economic activity. But there is little doubt that the current rate of growth is much below potential (considering the Reserve Bank of India’s assessment of potential growth at seven to 7.5 per cent), while inflation continues to be high. We should treat the current growth-inflation dynamics with the same urgency as a “stagflation like situation” because growth slipping to 5.3 per cent in a developing economy is as worrisome as stagnation or near-zero per cent growth in advanced countries. India needs to grow faster on a sustained basis to address its problems of low income and poverty, and to generate employment for its fast expanding working-age population.
The decade of the eighties saw a sharp increase in India’s growth, accompanied by a higher inflation. The eight years spanning 2004-05 to 2011-12 saw a higher rate of growth of 8.2 per year growth and also a higher-than-tolerable rate of inflation at 6.3 per cent. The period was not, however, uniform in terms of growth-inflation dynamics. GDP growth averaged at 8.8 per cent and inflation was relatively moderate at 5.6 per cent per year during the first four years of this period.
This suggests that the economy was able to overcome supply-side constraints and meet the increase in demand. Improvement in productivity, technological advances and increased globalisation helped the economy reap the benefits of competitive pricing. This improved the inflation situation, thereby, enabling a low inflation-growth trade-off.
The next four years were a study in contrast. Growth slipped but inflation surged. Growth slowed to an average of 7.5 per cent but inflation spurted to 7.2 per cent from 2008-09 to 2011-12. The economy’s ability to grow fast and maintain inflation at tolerable levels seems to have eroded. The growth-inflation trade-off worsened in 2011-12, with inflation at 8.8 per cent and growth sliding to 6.5 per cent. In the last quarter of 2011-12, growth slipped to 5.3 per cent, while inflation dipped marginally. Wholesale price index (WPI) inflation is hovering at 7.5 per and consumer price index (CPI) inflation continues to be in double digits.
If the current low growth-high inflation environment continues, incomes will not rise fast enough, while inflation will continue to erode the purchasing power of consumers, particularly those whose wages are not indexed to inflation.
Growth has been suffering owing to sagging investment sentiment, tardy decision-making and global headwinds. Global factors are outside our domain of influence, but addressing domestic issues will create an immediate upside to growth. Setting the fiscal house in order, accelerating decision making in government and reforms to raise the supply potential can help create an environment in which high growth can be sustained in conjunction with low inflation. That is the only way out of the low-growth and high inflation mix that the Indian economy is facing currently.
These views are personal
