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Economics

India’s Economic  Slowdown:: Are we looking towards Stagflation?

Why in News

The rise in retail price inflation to a nearly six-year high of 7.35% in December.

Skyrocketing unemployment is highest in the last 45 years.

 

This has led to a debate among the economists and the intellectuals that the Indian economy may be headed towards “Stagflation-A sword of Damocles that is hanging over Indian economy”.

What is stagflation?

Stagflation is an economic scenario where an economy faces both high inflation on one side and low growth (and high unemployment) on the other side at the same time.

Why is stagflation a problem?

On the one hand, the slowdown in growth could affect peoples’ incomes. On the other, higher inflation could cause a reduction in people’s standard of living as they can afford fewer things.

Economists who believe that the current slowdown is due to the lack of sufficient consumer demand prescribe greater spending by the government and the central bank to resuscitate the economy.

But stagflation essentially ties the hands of the government and the central bank from taking such countercyclical policy steps.

With retail inflation now well above the RBI’s targeted range of 2-6%, the central bank is unlikely to assist the economy any time soon by cutting its benchmark interest rate.

If the central bank decides to inject fresh money into the economy either by cutting its benchmark interest rate or other unconventional means, it could lead to a further rise in prices and make things worse.

A similar rise in inflation could result if the government engages in deficit spending that is funded by the RBI.

With both the private consumption growth and investment rate dropping below 5% in Q1 FY2020, the GDP growth rate has fallen to 5%.

Nominal GDP growth has slid to 8%, a record low. Growth in employment-intensive sectors such as manufacturing and construction has also been muted.

All this is considered to be bad news at a time when the economy, with significant unemployed resources, is not functioning at its full capacity.

Background:

Many economists believe that factors like Demonetization, hasty implementation of GST, nonperforming assets, sluggish consumer demand, leaden-footed manufacturing sector have played significant roles in the economic slowdown 

Most of them have blamed that the major contributor is the lack of sufficient consumer demand for goods and services.

The government and many analysts prodded the Reserve Bank of India (RBI) to cut interest rates to boost demand.

Eventually, the RBI obliged by cutting its benchmark interest rate, the repo rate, five times in 2019.

However, Decrease in repo rate did not lead to an improvement in the Growth rate. The growth rate of the economy continued to fall significantly. 

This combination of rising prices and falling growth has led many to believe that India may be sliding into stagflation. 

Opinions of Economists::

Opinion-1

Some economists even see the severe drop in consumer demand simply as a symptom rather than as the primary cause behind the current slowdown. 

India’s growth rate was boosted by the availability of easy credit over the last decade, or even longer. According to this view, it is natural for spending to drop after the end of a credit-fuelled boom.

Opinion-2

Other economists argue, that monetary easing in the last one year has only raised prices without leading to higher growth rates. So, injecting further liquidity into the economy may only stoke higher inflation without boosting economic growth. So further credit expansion by the central bank and debt-fuelled government spending, will not lead to genuine and sustainable economic growth rather another unsustainable boom will follow. So, they instead advocate supply-side reforms to bring about genuine economic growth.

Conclusion:

Supply-side reforms:

Supply-side policies are government attempts to increase productivity and increase efficiency in the economy. If successful, they will shift aggregate supply (AS) to the right and enable higher economic growth in the long-run. These can contribute to reducing structural, frictional, and real wage unemployment and therefore help reduce the natural rate of unemployment.

1.Free-market supply-side policies involve policies to increase competitiveness and free-market efficiency. For example, privatization, deregulation, lower income tax rates, and reduced power of trade unions.

2.Interventionist supply-side policies involve government intervention to overcome market failure. For example, higher government spending on transport, education, and communication.

3.      Improved trade and Balance of Payments, by making firms more productive and competitive, they will be able to export more. This is important in light of the increased competition from an increasingly globalized marketplace.

Other  reforms:

1. Clean-up of Banks and Financial Institutions:: Acceleration of clean-up of the banks, other financial institutions, and corporate balance sheets and enhance governance of public sector banks to revive bank credit and enhance the efficiency of credit provision, while monitoring closely emerging risks from the liquidity stress in non-banking financial companies (NBFCs) and enhancing supervision and regulation of the NBFCs.

2. Fiscal Consolidation:: Continuation of fiscal consolidation both at the Centre and State levels - to lower elevated public debt levels, supported by further steps to increase tax compliance and to improve fiscal transparency.

3. Labour Reforms:: labor, land, and product market reforms aimed at enhancing competition and governance, along with infrastructure investment, should be a priority to create more jobs for India’s young and rapidly growing labor force.