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Stagflation: What is it, why it hurts, and how bad is it now?

With India's retail inflation reaching an astronomical 7.35%, a word that will begin doing the rounds is stagflation. Inflation, especially food inflation is deadly, especially for the folks at the lower end of the economic strata, because it has a direct bearing on their ability to make ends meet. This combined with an economic slowdown which is generally accompanied by wage stagnation and job loss, worsens the problem because not only does it pose further pressure on purchasing power, but also restricts the options available with the central bank or government to address the issue. In today's post we understand what stagflation is, the real and economic repercussions it has, and how serious the current situation is in India.

What is stagflation?

Stagflation is a unique scenario where you have rising inflation combined with a slowdown (slower growth, higher unemployment). With India's growth rate for FY20 at 5%, we were definitely in slowdown territory. What we had working for us however was that the inflation number was relatively under control. Yesterday's announcement with the December inflation number at 7.35% changed that. Stagflation scares most regulators and policyholders because of the combination of pain it is capable of causing and the inherent dilemma it poses to solve it. A slowdown generally comes with layoffs and wage stagnation/cuts that hurts both the ability and willingness of people to spend. Inflation further eats into purchasing power, hurting the masses further. The traditional monetary policy solution (steps the RBI can take) of rate management doesn't work here, because the traditional solution to falling growth is to drop rates (cheaper credit disincentivizing saving, and incentivizing both consumer spend and corporate investments) while the traditional solution to rising inflation is increasing rates (incentivize saving, disincentivize consumer spend). On the fiscal front (steps the government can take) as well a slowdown is generally met with an expansionary policy while rising inflation is met with a contractionary policy.

So where do we go from here?

Like all things, it helps to understand both the nature and severity of the issue at hand before we delve into the solutions. Food inflation, which stood at around 14% was the major upward driver of inflation. Even in food, vegetables rose an astronomical 60.5% based on a temporary demand-supply mismatch, with soaring onion prices amongst the strongest drivers. The good news is, while still inflated, channel checks seem to indicate that vegetable prices softening a bit. With the newly harvested crop set to hit the market, the inflation here should ease significantly. The shorter cultivation, and hence faster supply cycles, combined with a largely vegetable price-driven inflation means that the number will in all likelihood come down from the current highs to well within the RBI targets of 2.0%-6.0%.

We now have two major events coming up in the next month: The budget which will be out on the 1st of Feb, and the RBI's next meeting scheduled to happen on the 5th of the same month. With the RBI making it amply clear that their focus will be on inflation and putting their money where their mouth is with a stay on rates after the last meeting, the onus to pull up a falling economy will fall on the government, which will certainly try its best given its falling popularity both due to economic and non-economic pain leading to electoral losses in what were once fortresses of the right (Nagpur!). With limited bandwidth, however, barring an overly ambitious divestment plan, most benefits that the government gives out will be at the expense of cuts elsewhere.

So that's where we stand now. A bad place without a doubt, as we've covered in some of our other posts covering Indian macro. but not as bad as the headlines would lead you to believe atleast on the inflation front. We will be tracking the determinants of the recovery process closely, and keep the readers of the GSN Invest community updated on the same.

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