Fear of stagflation: no need for knee-jerk reaction


By DM Deshpande

There is palpable anguish, well almost everywhere in the economy. First came the bad news that the nation’s economy is growing at the slowest pace in forty years! And worse, last week official data relating to retail inflation was released. At 7.35 per cent  it is the steepest rise not seen since July 2014.

  So here we are, on the one hand, we have GDP growth rate which has plummeted continuously for over a year now and on the other, we have retail inflation which is clearly above the comfort level of RBI, in the band of  two-  six per cent. Isn’t this typical onset of stagflation with economic stagnation and spike in prices-both plaguing the economy at the same time?

  Next month in February, the next review of monetary policy of RBI is due. In the previous review, the apex bank held that it is not done with reduction of interest rate cycle, though it did not reduce lending rates. Considering this fresh data, it may be tempted to adopt hawkish stance- not only do away with rate reduction option but also abandon quantitative easing methods. That would be a kneejerk reaction and cause more harm than good to

the economy.

  A deeper analysis of data is in order. First, it is not clear why the RBI is mandated to track retail inflation which besides being temporary, also tends to be highly volatile at least sometimes, if not always. It is not a good index of price movements and fails to capture the big picture. Wholesale price has hardly moved up by 2.6 per cent and just 0.6 per cent from November 2019. It is patently wrong to set our monetary policy principles on retail inflation. In a globalized economy, trillion of dollars flow across continents seamlessly. This has a huge bearing on interest rates, foreign exchange rates among the other economic variables.

  Be that as it may, sudden spike in rate of inflation is due to rise in food prices, especially vegetables. Food inflation rose to

14.2 per cent with all its sub categories increasing in tandem; vegetables registering the highest rise of 60 per cent. Onion prices almost touching the Rs 200/kg is a part of this phenomenon. Why food prices shot up suddenly? Actually, they did not shoot up overnight. As usual the government and its

agencies were caught napping.

  Monsoon rains arrived late and continued beyond the normal four months period. So, the summer crop was destroyed. The silver lining was that the extended rainfall helped recharge water levels in several areas in a country that is facing severe over exploitation of ground waters over a long period of time. Now, the winter crop is progressing well and with some exports about to arrive, retail inflation could well be pulled back. Typically, vegetable crops cycles are short. Farmers can quickly adapt to changes in market demands. Seeing sudden spike in prices of some, supply of those would be sought to be strengthened.

  On balance, slow down is greater threat, not inflation, to the economy. But the government has limited options to arrest the economic slowdown. Dwindling revenues has already meant restricted fiscal support from the government side. Surge in inflation has tied the hands of RBI. Possible hike in global oil prices is an added headache, thanks to President Trump. In any case lower rates is not likely to kick start the economy quickly. Look at the greatest pile up of NPA’s and widespread prevalence of risk aversion among bankers. But other things being equal, lower rates are better than rising rates at a time when the economy is striving for recovery.

  The government has already initiated measures for the economy to pull out of current impasse. It has given away nearly US $20 billion in the form of reduced corporate taxes. It is well on course to traverse big time in to road to privatize public sector undertakings. Unlike the price spurt in UPA 2, this time the rise in retail inflation is accompanied by a fall in core inflation. This is inflation without taking in to account food and fuel; over the last one year it has declined by about two percentage points to present level of 3.5 per cent. Actually, falling core inflation is a huge cause for worry.

It has led to an unprecedented slowdown which is now 18 months old, something which has never happened in Indian economy. Hence, top priority

of all, the government and the RBI, should be reviving the growth in the economy. This is no time for strict fiscal prudence nor tightening

of the belt.        

The author has four decades of experience in higher education teaching and research. He is the former first vice chancellor of ISBM University, Chhattisgarh.