*****Stagflation: View: Recession may be avoided, but stagflation may be on the cards – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-commentary/view-recession-may-be-avoided-but-stagflation-may-be-on-the-cards/articleshow/91925674.cms

Synopsis

The outlook is clouded by the possible impact of geopolitical tensions on commodity prices, particularly oil, and hence on inflation and growth. This has upended all the FM’s carefully worked-out budget calculations. As against an oil price of roughly $75 a barrel assumed in GoI’s budget calculations, oil presently hovers at over $120 a barrel.

Worries about inflation have long displaced growth concerns. With consumer price and wholesale price inflation at an eight-year and nine-year high, respectively, that’s not surprising. The problem is, we cannot afford to take our eyes off growth either. After all, it is the ultimate elixir for inflation control. So, what do GDP estimates released by the National Statistical Office (NSO) yesterday tell us?

One, despite the veneer of recovery – at 8.7%, GDP growth in 2021-22 is not only the fastest in close to a decade, but it also puts India among the fastest-growing economies in the world – recovery is still fragile. Two, the improvement is more apparent than real, as it is driven largely by base effects. A granular look at disaggregated numbers shows crucial job-providing sectors such as manufacturing and construction are still lagging behind, as is investment.

Three, the numbers underscore just what we are up against. After close to a decade, the dreaded twin deficits – fiscal and current account – are back to haunt us. While the high fiscal deficit was, perhaps, inevitable, given the havoc wrought by the pandemic, the high current account deficit (CAD) is, partly, a consequence of policy errors. The net result is that today both monetary and fiscal policy are severely constrained in their ability to ward off the looming threat of a growth slowdown and rising inflation – stagflation.

But, first, a look at GDP numbers. In contrast to 2020-21, when each successive quarter saw a steady improvement, 2021-22 saw a decline in each successive quarter. While this is largely explained by the fading base effect, the reality is, recovery is still highly tenuous. True, India is not an outlier here. Globally, the pace of recovery has slowed as inflation and geopolitical uncertainties – war in Ukraine, lockdown in China – begin to bite.

Fortunately, it’s not all bleak. Despite the disappointment on the investment front in the last fiscal, with both private and government capex faltering, GoI seems committed to spending on infrastructure. This should help create much-needed low-skilled jobs in the construction sector. The pandemic is now pretty much behind us, and the prediction of another normal monsoon – even though the harsher-than-normal summer combined with power shortage is likely to impact agriculture output – bodes well for recovery.

Many of GoI’s earlier moves like GST and digitisation have reached a critical mass and have begun to yield dividends, as evident from the record GST collection in April. The

LIC

IPO has finally happened, making this year’s disinvestment target look much more manageable. Asset monetisation has picked up steam. Schemes like the production-linked incentive (PIL) scheme and the phased manufacturing programme (PMP) should create jobs.

However, the outlook is clouded by the possible impact of geopolitical tensions on commodity prices, particularly oil, and hence on inflation and growth. This has upended all the FM’s carefully worked-out budget calculations. As against an oil price of roughly $75 a barrel assumed in GoI’s budget calculations, oil presently hovers at over $120 a barrel.

A swollen bill for inelastic imports (80% of our oil requirements are met through imports) has already worsened our CAD, and brought it dangerously close to the tipping point of 3% of GDP. Meanwhile, capital outflows have quickened from a trickle to a flood in response to higher US interest rates, weakening the rupee and adding to inflationary pressures.

In a bid to tame inflation, GoI has announced various tax giveaways, all of which are bound to impact government finances adversely. The resultant increase in the fiscal deficit can only mean one of two things: either GoI will have to borrow more, or it will have to cut back on capital expenditure. Neither is good news.

Higher borrowing will crowd out private investment, raise interest rates, dampen animal spirits, and add to cost pressures and to inflation. A cut in capex, on the other hand, means less job creation, even as lower government spending fails to crowd in private investment, resulting in lower growth.

GoI’s plans of infrastructure spending giving a boost to investment – and through its multiplier effect, to growth – could come to naught if higher oil prices and inflation continue to make a mockery of GoI’s budget calculations. On the monetary policy front, far from supporting growth, RBI’s easy monetary policy has now become an impediment to growth, thanks to excess liquidity feeding into higher prices. Especially if, as is likely, RBI is forced to hike interest rates sharply to try and make up for lost time.

On balance, India may be able to avoid a recession. But stagflation seems very much on the cards. As Bob Dylan may have put it, a hard rain’s very likely to fall.

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