RBI Reports Current Stagflation Risk in India at 1% is Subdued

21 Dec, 2023

RBI Reports Current Stagflation Risk in India at 1% is Subdued

In its latest monthly bulletin for December 2023, the Reserve Bank of India (RBI) underscores stagflation as a significant worry, emphasizing its potential to disrupt the macroeconomic landscape with uncertainty. Stagflation, a blend of recession and inflation, typifies a scenario where inflation escalates while growth stagnates and unemployment persists.

The central bank, committed to maintaining price stability while balancing growth objectives, expresses concerns over global stagflation risks post-pandemic. The surge in commodity prices and the strengthening of the US dollar have amplified apprehensions about stagflation. Delays in the monetary normalization process following the COVID-19 crisis have further compounded these concerns.

The bulletin, authored by Deba Prasad Rath, Silu Muduli, and Himani Shekhar, highlights the RBI's approach to assess stagflation risk in India through the integration of the "Inflation at Risk" (IaR) and "Growth at Risk" (GaR) frameworks. Their analysis pinpoints financial conditions and the depreciation of the Indian Rupee against the US Dollar as two pivotal risk factors.

The report notes a lower current stagflation risk of about 1%, attributing this decline to various factors. Unlike historical episodes, commodity price shocks in India are not as severe or persistent. Additionally, the focus of central banks on maintaining global price stability, coupled with healthier financial institution positions, has anchored long-term inflation expectations to the target, unlike the volatile expectations observed in the 1970s.

While typically stemming from supply shocks like abrupt commodity price hikes, stagflation risks can also propagate through knock-on effects on other macroeconomic variables, such as exchange rate depreciation or tightened financial conditions.

The RBI's analysis of the past two decades reveals heightened stagflation risks during global financial crises, including the Asian Crisis (1997-98), the Global Financial Crisis (2007-09), the Taper Tantrum (2013), and the COVID-19 pandemic. However, post-COVID-19, the risk has subsided due to improved financial conditions, stabilized exchange rates, and steady domestic fuel prices.

Moreover, the gradual post-pandemic recovery in demand and a moderation in CPI headline inflation align with the RBI's assessment of a decreased stagflation risk of about 1%. Looking ahead, the inflation outlook remains uncertain, primarily influenced by volatile food prices. High-frequency indicators point to increased prices of essential vegetables, potentially elevating CPI inflation in the near term. Global sugar prices also remain a concern, adding to the complexity of the situation, according to the RBI's analysis.