|Demand of the question
Introduction. Contextual Introduction.
Body. Discuss various causes of looming stagflation situation in India. Steps needed to control stagflation in Indian economy.
Conclusion. Way forward.
Stagflation is a situation in which the inflation rate is high, the economic growth rate slows and unemployment remains steadily high. With recent 7.35% rise in consumer price inflation in December, India is entering a period of slow growth accompanied by high inflation, in other words stagflation. This is happening because with stalled economic growth, unemployment is increasing and existing incomes are not increasing fast enough with rising prices.
Causes of looming stagflation situation in India:
- Reduced consumption: Ongoing stagflation is caused by a decrease in consumption. Consumption makes up about 60% of GDP and spending has reduced due to less income and less jobs. Consumer sentiment remains in the doldrums.
- Volatile Oil: The recent volatility in oil prices led to a further decrease in spending. US-Iran tussle has led to rise in oil prices. This has led to an increase in transportation cost and thus led to an increase in general prices especially of food products.
- Decreased credit availability: The RBI’s interest-rate cuts and liquidity pumped into financial markets have done little to spur lending. This is because banks who are already facing the worst stressed-asset ratios, are neither lending much nor transmitting rate cuts to borrowers. This has led to reduced investment and spending leading to reduced industrial activity impacting economic growth.
- Unemployment: Unemployment is all time high and has impacted the buying ability of individuals. The increased automated production and inability of the manufacturing sector to boost up the growth has impacted job growth of the country.
- Inflation: With rising input costs and reduction in the aggregate supply, price of various products and services are increasing. Poor monsoon has led to a lower area under cultivation. This, in turn, has led to lower output and consequently lesser supply. As aggregate supply is reduced, there is a fall in output and employment and the price level rises.
Steps needed to control stagflation in Indian economy:
- Tax measures: The best policy measure is to reduce income tax and corporate taxes as they tend to reduce labour costs and raise demand for labour. Similarly, GST should be reduced in order to prevent the price level from rising. To encourage state and local governments to reduce state and local sales, the central government should sanction additional grants-in-aid to them.
- Wage control: A policy of wage control should be adopted with government intervention to limit wage rises. When wages rise, firms are forced to reduce production and employment. Consequently, there is a fall in real income and consumer expenditure. Limiting wage increases can break the cycle of wage inflation and help to improve the economic situation.
- Supply-side solutions: One solution to stagflation is to increase aggregate supply through supply-side policies, for example, privatisation and deregulation to increase efficiency and reduce costs of production. Private sector must be incentivised to invest more and to increase supply through tax measures.
- Monetary policy: The primary macroeconomic objective should be to reduce inflation. Reducing inflation may cause higher unemployment and lower economic growth in the short-term. But, this unemployment can be targeted once the price level is controlled.
- Labour reforms: Frictions in the labour market should be reduced by reducing the time and cost involved in obtaining information about employment opportunities. Barriers which either limit entry into a profession or maintain wages at artificially high rates should be removed.
Stagflation needs to be controlled at earliest. With the government aiming to become a $5 trillion economy it is important that slowdown and inflation must be arrested. Meanwhile, the government should engage all stakeholders to address the supply-side issues, a calming down of food prices will help the government to prevent stagflation in the economy.