A spurt in retail inflation beyond the Reserve Bank’s tolerance levels in December presents yet another challenge for the government. Higher inflation is the last thing the government would expect, especially as economic growth plunged to 4.5 per cent — lowest in over six years — and unemployment is at a 40-year high. The 7.35 per cent retail inflation in December has pulled the country into an undesirable stagflation. This is an extraordinary event as it runs counter to accepted economic theory — that inflation or rise in prices happens only when demand is high. And higher demand invariably leads to growth. In stagflation, however, inflation is induced by shortage of supply when the demand is more or less constant. The current stagflation in India is due to higher vegetable prices driven by short-term supply shortages. As vegetables have shorter harvest seasons, the supply could be restored soon to arrest rising inflation. However, the government should be mindful of the threat posed by rising pulses prices to inflation. Unless the Centre takes steps in consultation with states — which have on-ground infrastructure — to curb hoarding or artificial shortages, the country could see inflationary expectations spilling over to other goods and services, making economic revival much harder.
Stagflation has also made it harder for the RBI to boost economic growth by using monetary tools like interest rate cuts. The RBI window for indirect deficit financing through the purchase of sovereign bonds will also shut as it would create new money in the market. It puts the onus entirely on the Centre to pull the economy out of the mess created by GST and demonetisation. One solution is to attract foreign money into job-creating sectors like infrastructure and restore consumer confidence to make people shop once again, and restart the virtuous economic cycle.