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ExplainSpeaking: Will Soaring Oil Prices Cause “Stagflation” in India?

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Crude oil prices soared to about $ 140 per barrel, according to early reports on Monday morning.Oil prices have risen fairly steadily, but in December they were less than $ 70 a barrel, but the most direct trigger for the surge is Possible US decision to ban Russian oil purchases In response to Ukraine’s invasion, Russia is the world’s second-largest oil producer, and if oil does not hit the market due to sanctions, prices will not only rise, but will remain. Like that for a long time.

India is not directly involved in the conflict, Rising oil prices are detrimental India imports more than 84% of total oil demand. At one level, we are looking at all the stories of being Atmanilbar (or self-reliant). Without these imports, India’s economy would suddenly stop. — Figuratively and actually.

Thanks to the coercion of election politics after the parliamentary elections, Indian consumers have been protected from rising fuel prices since December. The recent surge could mean a significant rise in domestic oil prices. Rising oil prices further increase inflation and raise general price levels.

A 10% increase in crude oil prices will increase wholesale inflation by 0.9% and retail inflation by 0.5%. Looking at this further, between February 24th and March 3rd, crude oil prices rose by more than 20%. ((((See chart 1) These are worrisome numbers. Because both wholesale and retail inflation have long been a concern.

Chart 1

High inflation reduces the purchasing power of Indians and reduces overall demand. Readers recall that the biggest concern in India’s GDP growth story is weak consumer demand. That is, people do not have enough demand for the economy to grow rapidly. .. Consumer demand is the biggest driver of India’s growth. Such aggregate demand (the amount of all soap, phones, cars, refrigerators, holidays, etc. that we all spend on our personal abilities) accounts for more than 55%. Demand will decline, but this is already struggling to return to pre-Covid levels. When the number of products and services in demand decreases, companies are discouraged from investing in new capabilities, which in turn worsens. It leads to a crisis of unemployment and even lower income.

At present, even before the crisis in Ukraine, India’s GDP growth rate was showing signs of stagnation. The economy grew by only 5.4% in the quarter, according to GDP data for the third quarter (October to December) released at the end of February. It is skyrocketing due to increased demand from several festivals (such as Diwali). In addition, Covid’s case was the most subdued this quarter. Growing below 6% didn’t work. Especially in the fourth quarter (January-March, currently underway), it could be even weaker due to both the effects of Omicron and the ongoing Ukraine crisis.

Not surprisingly, analysts have revised India’s forecasts, growth is declining and inflation is rising. “Recently, we lowered our 2022 GDP growth forecast from 7.9% to 7.7% and raised our inflation forecast from 5.8% to 6.3%,” said Priyanka Kishor, Dean of Economics in India and Southeast Asia at Oxford Economics. Is writing in a recent memo.

But these are part of the mild reaction. One major concern is that such a sudden surge in oil prices could drive a relatively fragile economy like India to stagflation.

What is stagflation?

Stagflation is a portmanteau of stagnant growth and sustained high inflation, and thus represents a rather rare and strange state of the economy.

British Conservative lawmaker Ian McLeod is known to have coined this phrase in his November 1965 speech on the British economy. He states: Either side or stagnation, but both are the same. We are in a sort of “stagnation” situation. And, in modern terms, history is certainly made. “

Rising inflation usually occurs when the economy is booming. People make a lot of money and demand a lot of goods and services, and as a result, prices continue to rise. If demand is declining and the economy is sluggish, then, logically, prices tend to stagnate (or fall).

But stagflation is a state in which the economy is experiencing the worst in both worlds. Growth has been significantly stagnant (with rising unemployment), and inflation is not only high, but persistent.

How do you get into stagflation?

The best-known case of stagflation is that it happened in the early to mid-1970s. OPEC (Organization of Petroleum Exporting Countries), which acts like a cartel, has decided to reduce its oil supply. They rose almost 70%.

This sudden oil price shock not only caused inflation, especially in Western Europe, but also curtailed capacity and hindered economic growth. High inflation and stagnant growth (and the consequent unemployment) caused the stagnation.

Is India Faced with Stagflation?

Recently, this question has become prominent since late 2019, when retail inflation surged due to food inflation spikes caused by unseasonal rain. In December 2019, India’s growth rate slows over time As revised estimates released at the end of January show that India’s GDP growth rate has risen from over 8% in 2016-17 to 2019-20. It slowed to just 3.7% in the year.

But the answer to this question Revealed in December 2019For one thing, in absolute terms, India’s GDP was slowly slowing, but still growing. At that time, the government was convinced that things would improve shortly after a few years of decline. , It was seen as temporary — caused only by unseasonal rain. Stagflation requires not only high inflation, but also long-term sustainability.

Then, in late 2020, this question was raised again. By October of that year, it was revealed that India’s GDP would actually shrink in the wake of Covid’s pandemic. India has entered a so-called pandemic. Technical recessionTo make matters worse, inflation hasn’t diminished yet. On the contrary, everyone, including RBI, was unpleasantly surprised at the continued rise in prices, despite a significant drop in demand. This work will explain..

Since December 2021, there have been some notable voices, including former World Bank Chief Economist Kausik Basoo and former West Bengal Finance Minister Amit Mitra, who once again claim that India is facing stagnation.

In fact, last week, Sergiranau, Deputy Chief Economist of the Institute of International Finance (a global association in the financial industry with more than 450 members from more than 70 countries), tweeted with two sets of data: Insisted. India was already in stagflation.

“India is in stagflation. Consensus growth in 2011 means there is a big gap compared to the output of the pre-shadow banking trend. Still, core inflation deducts the basic effect. It is running at over 5%. The RBI seems to be most worried about the output. “

of Chart 2Ranau said that even core inflation, which normally removes the effects of food price spikes and fuel price spikes, is the RBI headline target of 4% retail inflation (including fuel and food price spikes). In comparison, it was shown to be persistently high.

Chart 2

of Chart 3He shows that India’s actual GDP (blue line) has been on a poor track since 2018 compared to 4% GDP growth (called Hindu growth). ..

Chart 3

But even now, not everyone is convinced.

Ratsin Roy, now managing director of the ODI (Global Think Tank) in London and former director and CEO of the National Institute of Public Finance and Policy (NIPFP) in New Delhi, has dismissed the story of stagflation.

He argues that the Covid turmoil was a shock to the trend growth of the Indian economy. “If there is a trend shock, we can’t talk about stagflation. The whole theory (of stagflation) is based on the economy not achieving the trend. These are measured with reference to that trend. So, if the trend growth rate itself changes as a result of Covid, how can we talk about stagflation? “He asks.

Still, can the recent rise in oil prices put India in stagflation?

It may be arguable whether India is already in stagflation, but it is undeniable that oil prices will remain high and inflation will worsen significantly over the long term. Crude oil prices are at the end of the year, according to some reports. Even if it doesn’t get too high, the average price will probably stay above $ 100. This surge could cause Indians to suffer from high inflation, especially since then, as oil is the fundamental cost of our economy. It will come two years after the price has already been raised and income has declined.

Another requirement is stagnant growth. The unemployment rate (or employment rate in the case of India) is a good indicator of whether the current level of growth is appropriate. India faces the most serious unemployment crisis ever seen. Fifty years — even the government’s own data shows this. High inflation is likely to further inhabit a widespread recovery in demand. Of course, small pieces of wealthy Indians will continue to be consumed, but most of India can continue to struggle.

So, as it may be, even if India’s GDP growth cannot keep up, it is possible that stagflation will occur in the near future if crude oil continues to skyrocket and remain high.

What do you think the government should do to avoid situations like stagflation? Share your thoughts and questions with me at udit.misra@expressindia.com.

Finally, continue watching the weekly episodes of The Express Economist. This is a new video series from The Indian Express that interviews reputed economists about current relevance issues.

The last two episodes featured Madansab Navis (Bank of Baroda Chief Economist) Explaining the impact of the Ukrainian crisis on the Indian economy, DK Joshi (Chief Economist, CRISIL) Understand the latest GDP data in India.

This week we’ll feature IIF’s Sergi Ranau, asking why he’s convinced that India is already in stagflation. Save this playlist Never miss an episode of The Economist.

Take care
Udit

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