Rising inflation, low growth and high unemployment—perfect conditions for what economists term stagflation. It was a term first coined by Nobel Prize winner Paul Samuelson in context with rising unemployment and high inflation in the USA in the 1970s. Latest inflation and industrial production released this week suggests that a stagflation-like scenario, albeit temporary, could well be looming ahead of India, according to securities firm Nomura.
“Spike in November CPI (consumer price index) inflation and contraction in October IP (industrial production) have set the stage for a temporary stagflation phase,” said Sonal Varma, chief India economist at Nomura.
India’s retail inflation last month spiked to an over three-year high of 5.54 per cent, versus 4.62 per cent in October and 2.33 per cent in November 2018. The spike in inflation, well beyond the Reserve Bank’s medium-term target of four per cent, was largely driven by higher vegetable prices.
At the same time, India’s industrial output shrank 3.8 per cent in October, its third straight month of decline. The October IIP data, though-better-than-expected, continues to indicate lacklustre growth outlook, noted Varma.
At the same time, inflation in December is expected to increase further due to the tariff hikes announced by telecom companies this month. Supply-side pressures could further “pile on” through the first quarter of 2020, if additionally the government decides to hike GST rates to shore up public finances, Varma added.
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“December is likely to see the inflationary situation significantly worsen. We are increasingly concerned that the unseasonal escalation in vegetable prices is refusing to abate and risks spilling into December. Beyond December too, the inflation trajectory continues to look inconvenient to us. Even if vegetable price inflation starts abating on a month-on-month basis in January, the escalation of the index from supply-side shocks in Q4 2019 increases the risk of headline inflation picking up further in January,” said Varma.
Beyond the first quarter of next year, things are expected to stabilise as once vegetable supplies normalise, big correction in prices should follow. Also consumers cutting back on spending, should ameliorate core inflation pressures.
“We expect inflation to eventually revert to 4 per cent levels in Q2 2020, before subsiding to 2.2 per cent by Q4,” said Varma.
The rise in inflation comes at a time India’s economic growth has slowed sharply. In the July-September quarter, India’s GDP grew at just 4.5 per cent and most economists and global ratings agencies are expecting a slowly recovery.
The Reserve Bank of India’s monetary policy committee, which has so far cut its benchmark Repo Rate by 135 basis points to try and lift the slowing economy, surprisingly left interest rates unchanged last week, with Governor Shaktikanta Das insisting they wanted the earlier rate cuts to play out fully.
The central bank also slashed its GDP growth forecast for the year-ending March 31, 2020 to 5.0 per cent from its earlier projection of 6.1 per cent.
Analysts say, the RBI had a chance to cut interest rates in the recent MPC meeting, which it let go. The spike in inflation as well as a likelihood of a fiscal slippage, may make cutting rates more difficult in the next meeting in February.
“Not only will headline inflation likely be trending beyond RBI’s comfort zone, but confirmation of fiscal slippage in the Union Budget (on February 1), alongside possible further stimulus measures—will likely discourage the MPC from easing,” said Varma, who expects a rate cut possibility now only in the second quarter of next year.
Sujan Hajra, chief economist at broking firm Anand Rathi also sees RBI holding interest rates for now.
“Despite the RBI’s resolve to support growth, given the inflation target of 4 per cent, the recent flare in inflation, the likelihood of inflation being high in 2020 and the fiscal slippage-led further inflationary pressure build-up pose serious challenges,” said Hajra.
Kruti Shah, economist at Emkay Global Financial Services, also feels the RBI missed a chance to cut rates in the last MPC meeting and now there is a limited possibility of a rate cut in the next policy meet in February 2020.
Suvodeep Rakshit, senior economist at Kotak Institutional Equities also feels the space for additional monetary support will be further restricted next year and more structural solutions may be needed to revive the economy.
“Beyond some cyclical reversals, India’s growth recovery will be sluggish. We expect FY2021 GDP growth to improve modestly to 5.5 per cent as against 4.7 per cent in FY2020,” said Rakshit.
Nomura also sees a “sub-par and rocky road” to recovery in India’s growth, with GDP growth averaging around 4.7 per cent in the financial year ending March 2020 and 5.7 per cent in the next year.
