Dear Readers, Early reports on Monday morning suggest that crude oil prices soared and touched almost $140 per barrel mark. While oil prices have been going up quite steadily — they were less than $70 a barrel in December — the most immediate trigger for the spike is the possible decision by the United States to ban the purchase of Russian oil in response to the invasion of Ukraine. Russia is the world’s second-largest oil producer and, as such, if its oil is kept out of the market because of sanctions, it will not only lead to prices spiking, but also mean they will stay that way for long. While India is not directly involved in the conflict, it will be badly affected if oil prices move higher and stay that way. India imports more than 84% of its total oil demand. At one level, that puts into perspective all the talk of being Atmanirbhar (or self-reliant). Without these imports, India’s economy would come to a sudden halt — both metaphorically as well as actually. Thanks to the compulsions of electoral politics following the Assembly elections, Indian consumers have been shielded from the rise in fuel prices since December. The more recent jumps might imply domestic oil prices going up significantly, presuming the governments — both Centre and state — do not cut taxes. Higher oil prices will further increase inflation and raise the general price level. A 10 per cent increase in crude oil prices raises wholesale inflation by 0.9 per cent and retail inflation by 0.5 per cent. To further put this into perspective, just between February 24 and March 3, crude oil prices went up by more than 20 per cent (see CHART 1). These are worrying numbers because inflation — both wholesale and retail — has been a matter of concern for a long while now. 
Higher inflation would rob Indians of their purchasing power, thus bringing down their overall demand. Readers will recall that the biggest concern in India’s GDP growth story is the weak consumer demand. In other words, people are not demanding enough for the economy to grow fast. Private consumer demand is the biggest driver of growth in India. Such aggregate demand — the monetary sum of all the soaps, phones, cars, refrigerators, holidays etc. that we all spend on in our personal capacity — accounts for more than 55% of India’s total GDP. Higher prices will reduce this demand, which is already struggling to come back up to the pre-Covid level. Fewer goods and services being demanded will then disincentivise businesses from investing in new capacities, which, in turn, will exacerbate the unemployment crisis and lead to even lower incomes. As it is, even before the Ukraine crisis, India’s GDP growth gave signs of faltering. The Q3 (October to December) GDP data, which was released in February-end, suggested that the economy grew by just 5.4% in a quarter which typically enjoys a bump because of the increased demand due to several festivals (such as Diwali). What’s more, Covid cases were most muted during this quarter. To grow at less than 6% did not augur well. Especially since Q4 (Jan to March, which is currently underway) is likely to be even weaker — both because of the Omicron impact as well as the now unfolding Ukraine crisis. Unsurprisingly, analysts have been revising their forecasts for India — down for growth and up for inflation. “We recently lowered our 2022 GDP growth forecast to 7.7 per cent from 7.9 per cent, while raising the inflation forecast to 6.3 per cent from 5.8 per cent,” writes Priyanka Kishore, Head of India and South East Asia Economics at Oxford Economics in a recent note. But these are some of the milder reactions. One big fear is that such a sudden and sharp spike in oil prices may push a relatively vulnerable economy like India into stagflation. What is Stagflation? Stagflation is a portmanteau of stagnant growth and persistently high inflation. It, thus, describes a rather rare and curious condition of an economy. Iain Macleod, a Conservative Party MP in the United Kingdom, is known to have coined the phrase during his speech on the UK economy in November 1965. He reportedly said: “We now have the worst of both worlds—not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of “stagflation” situation. And history, in modern terms, is indeed being made.” Typically, rising inflation happens when an economy is booming — people are earning lots of money, demanding lots of goods and services and as a result, prices keep going up. When the demand is down and the economy is in the doldrums, by the reverse logic, prices tend to stagnate (or even fall). But stagflation is a condition where an economy experiences the worst of both worlds — the growth rate is largely stagnant (along with rising unemployment) and inflation is not only high but persistently so. How does one get into Stagflation? The best-known case of stagflation is what happened in the early and mid-1970s. The OPEC (Organisation of Petroleum Exporting Countries), which works like a cartel, decided to cut crude oil supply. This sent oil prices soaring across the world; they were up by almost 70%. This sudden oil price shock not only raised inflation everywhere, especially in the western economies but also constrained their ability to produce, thus hampering their economic growth. High inflation and stalled growth (and the resulting unemployment) created stagflation. Is India facing stagflation? In the recent past, this question has gained prominence since late 2019, when retail inflation spiked due to unseasonal rains causing a spike in food inflation. In December 2019, it was also becoming difficult for the government to deny that India’s growth rate was witnessing a secular deceleration. As revised estimates, released in January end, now show, India’s GDP growth rate decelerated from over 8% in 2016-17 to just 3.7% in 2019-20. However, the answer to this question in December 2019 was a clear no. For one, in absolute terms, India’s GDP was still growing, albeit at a progressively slower rate. At that time, the government was convinced that things would turn around soon after a lull of 2-3 years. Two, while inflation was high, it was seen to be transitory — only caused by unseasonal rains. Stagflation requires inflation to be not just high but also persistent over a long period. Then in late 2020, this question again reared its head because by October that year it was clear that India’s GDP was actually going to contract in the wake of the Covid pandemic. India did go into what is called a technical recession. Making matters worse was the fact that inflation had still not abated. On the contrary, everyone, including the RBI, was getting unpleasantly surprised by the sustained surge in prices despite considerable destruction in demand. The answer, however, was still no as this piece explains. Since December 2021, again, there have been several notable voices — such as former World Bank Chief Economist Kaushik Basu and former West Bengal Finance Minister Amit Mitra — claiming that India is facing stagflation. In fact, last week, Sergi Lanau, the Deputy Chief Economist at the Institute of International Finance (which is the global association of the financial industry, with more than 450 members from more than 70 countries) tweeted with two sets of data to argue that India was already in stagflation. “India is in stagflation. Consensus growth of 7.8% in FY23 implies a big gap relative to pre-covid pre-shadow banking crisis trend output. And yet core inflation is running at more than 5% net of base effects. An ultra-dovish RBI seems to worry about output the most,” he stated. In Chart 2, Lanau showed how even core inflation, which typically removed the effect of food price spikes and fuel price spikes, has been persistently high in comparison to the RBI’s target of 4% for the headline (which includes the higher fuel and food prices) retail inflation. 
In Chart 3, he shows how, since 2018, India’s actual GDP (blue line) is on a trajectory that pales in comparison to even a 4% GDP growth rate — infamously referred to as the Hindu Rate of Growth. 
But even now not everyone is convinced. Rathin Roy, currently managing director of ODI (a global think tank) in London and formerly the Director and CEO of the National Institute of Public Finance and Policy (NIPFP) in New Delhi, dismisses the talk of stagflation. He argues that the Covid disruption was a shock to the trend growth of India’s economy. “You can’t talk about stagflation when there has been a trend shock. The entire theory (of stagflation) rests on the economy not achieving the trend because all these things are measured with reference to that trend. So if the trend growth rate itself has changed as a consequence of Covid then how can you talk about stagflation?” he asks. Still, can the latest spike in oil prices send India into stagflation? While it may be debatable whether India is already in stagflation or not, it cannot be denied that if oil prices stay high and for long, the inflation situation will worsen considerably. According to some reports, crude oil prices could go up to $185 by the end of the year. Even if they do not go that high, the average prices will perhaps hover at levels above $100. Since oil is such a basic cost in our economy, this spike will likely ensure that Indians suffer from high inflation especially since it would be coming after two years of already raised prices and reduced incomes. The other requirement is stalling growth. The Unemployment rate (or in India’s case the Employment rate) is a good marker of whether the current levels of growth have been adequate or not. India is facing the most acute unemployment crisis it has seen in the past five decades — even government own data shows this. High inflation will most likely further inhabit any broad-based recovery in demand. Of course, the tiny sliver of rich Indians will continue to consume but the bulk of India could continue to struggle. So, yes, unlikely as it may be, it can be argued that if crude oil continues to spike and stays high for long even as India’s GDP growth momentum fails to gather pace, we could be looking at stagflation in the near future. What do you think the government should do to avert a stagflation kind of situation? Share your views and queries with me at udit.misra@expressindia.com. Lastly, do keep watching the weekly episodes of The Express Economist — a new video series from The Indian Express where I interview an economist of repute on a question of current relevance. The last two episodes featured Madan Sabnavis (Chief Economist, Bank of Baroda) explaining the impact of the Ukraine crisis on India’s economy and D K Joshi (Chief Economist, CRISIL) making sense of India’s latest GDP data. This week we will feature Sergi Lanau of IIF and ask him why he is convinced India is already in stagflation. Save this playlist to never miss an episode of The Express Economist. Stay safe Udit If you received this newsletter as a forward, you can subscribe to it, here. Do read our other Explained articles, here | To subscribe to our other newsletters, click here | 
No comments:
Post a Comment