With GDP over FY21-22 likely to almost flatten out and CPI inflation being close to RBI's upper band of comfort for two consecutive years, the narrative of stagflation is making a strong comeback

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Jul 28, 2021

QuantEco MACRO Tidings The return of stagflation?

The genesis of stagflation is rooted in a negative aggregate supply shock, akin to the one induced by the COVID-19 pandemic in recent times. An objective assessment of consequent inflation, tells us that bulk of it is supply driven which could turn out to be transitory as supply disruptions ease. But a swift progress on vaccination may trigger a demand pull inflation as we near the end of 2021, with growth recovery gathering pace. For stagflation to take hold, inflation must seep into the economy via a wage-price spiral. We argue that this may be difficult to transpire in India in the near term owing to a restrained but well targeted fiscal response along with a persistent labour market slack and undermined bargaining power of workers. Having said so, we need to be mindful that a possible breakdown of free market forces via – rise in market power of larger firms as smaller ones succumb to the pandemic, and an import substitution policy that may have an unintended impact of upward price adjustments in the post COVID economy. Amidst such dynamics, RBI will have to attend to higher inflation perhaps sooner than later. Thus, the baton of restoring growth via a push to aggregate supply will have to be passed on to the Government without much delay.