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Is India staring at stagflation?

Numerous international and domestic institutions have estimated economic growth to contract in 2020-21. If there’s no respite from the pandemic in the near future, the adverse impact on the economy would persist, and the recovery would be uneven

September 04, 2020 / 10:37 AM IST
Representative Image (REUTERS/Jayanta Dey)

Representative Image (REUTERS/Jayanta Dey)

The deliberations over whether the economy is on the brink of stagnation has been gathering pace among economists, especially after data indicated high inflation and historic contraction in GDP in Q1 2020-21. The unrelenting Coronavirus infection cases and the recent penetration in the rural areas have dampened expectations of quick economic recovery. Low growth, coupled with rising inflation and high unemployment, is the perfect conditions for what economists term ‘stagflation’.

What is stagflation?

Stagflation is the extreme economic situation, a portmanteau of stagnant growth and rising inflation. It was a term first coined by Nobel Prize winner Paul Samuelson in the 1970s in context with five quarters of negative growth, increasing unemployment and high inflation after the oil price shock in the United States. Generally, rising inflation is a sign of a fast-growing economy. Low unemployment leads to increase in income and subsequently demand that pushes inflation upwards, a phenomenon well-established by the Phillips curve (low unemployment, high inflation). Conversely, when the economic growth stalls, unemployment increases and inflation goes down.

However, stagflation occurs when an economy faces stagnant growth coupled with persistently high inflation. With stalled economic growth, high unemployment lowers the income of the individual eroding the purchasing power of consumers.

Economic Growth Conundrum


Even before the outbreak, the Indian economy was grappling with inherent problems of low economic growth and high unemployment. In 2019-20, the economic growth was at a decadal low (4.2 percent) while in Q4 2019-20 it was the lowest in the past 44 quarters owing to the nation-wide lockdown announced towards March-end halting economic activities. The pandemic and subsequent nation-wide lockdown for nearly two months dragged the economic growth to a historic low of -23.9 percent in Q1 2020-21. It was the steepest contraction for the quarter among all the major global economies. Such a deep contraction has abated expectations of early economic recovery.

Building Inflationary Pressures

In H1 2019-20, the price pressures in the economy remained muted allowing the Reserve Bank of India (RBI) to cut the policy repo rate by 135 basis points. Since October, however, retail inflation began to pick up surpassing 4 percent inflation target of the RBI. In fact, from April onwards it breached the upper tolerance level of inflation targeting (6 percent) with rising food and non-food prices. In spite of that the RBI cut policy rates by another 115 basis points in March and May to provide credit support to the pandemic-battered economy.

In August, however, a status quo was maintained citing high inflation despite economic growth concerns. While the minutes of MPC meeting flagged uncertainty over inflation trajectory going ahead, households’ one-year ahead inflation expectations climbed to 10.5 percent in July suggesting persistent high inflation for the next couple of months.

Unemployment Issue

Over the past few years, the employment situation has remained stressed. A private employment survey conducted by the Centre for Monitoring Indian Economy (CMIE) shows that for all quarters in 2019-20, the unemployment rate was around 7.5-8 percent. Owing to nation-wide lockdown, the unemployment rate zoomed past the 20 percent-mark in April and May. Given subdued economic growth prospects, employment won’t improve immediately even after the pandemic is behind us.

The Diagnosis

Numerous international and domestic institutions, including the RBI, have estimated economic growth to contract in 2020-21. In case of no sooner respite from the pandemic, an adverse impact on the economy would persist and recovery would be uneven. The pandemic has left a deep scar on employment with layoffs and salary cuts announced by companies. The employment situation, thus, would remain worrisome over a short-to-medium term.

The only upside would be that inflation could moderate in the second half of 2020-21 after the Kharif crop entry and lack of pricing power of the firms with expected muted demand. Besides, crude oil prices are unlikely to cross the $50-mark in the near term due to global demand concerns capping imported inflation.

Thus, are we in a stagflation? Not just yet. It would be premature to say that we have already entered the stagflationary situation as more incoming data needs to be assessed before jumping onto any conclusion. Are we staring at it? Perhaps, if the economic adversities erupted from the pandemic turned out to be more prolonged and deep-rooted than are being anticipated.

 Rucha Ranadive is an economist with CARE Ratings Ltd. Views are personal.
Rucha Ranadive
first published: Sep 4, 2020 10:37 am

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