Is India moving towards a stagflation-like situation? Business Standard, 4th July 2012

“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.