Analysis of India and Stagflation - Literature review Example

? India and Stagflation Every economy in the world goes through cycles of highs and lows. There could be inflation markedby a price rise and a fall in the value of money. At times there could be a deflationary trend where there is a decrease in the price level of goods and services. A disinflation occurs when inflation reduces to lower levels. Stagflation, on the other hand, coined from “stagnation” and “inflation,” is characterized by high inflation, low growth rate and high unemployment. It is a peculiar situation where measures to curtail inflation could aggravate the unemployment level, and vice versa. It is caused by cost-push inflation according to new Keynesian economic models. Such inflation occurs when certain factors increase the cost of production. These include government policies, e.g., fiscal ones, or the paucity of resources. Radhika Rao, a Singapore-based economist with DBS Bank, opines that “The economy might be trapped in a stagflationary-type environment, as growth is at the cusp of moving another leg lower while inflation bottoms out” (qtd. in Kala). There is less local and foreign demand for Indian industrial goods. Even the borrowing costs have gone up. The automobile industry which drives manufacturing growth has forecast that auto sales will fall for the second continuous year. However, as Kala notes, exports grew on stronger global demand as the weak rupee makes Indian exports more competitive; and consequently, the imports into India become costlier, thus bringing down the deficit. Globalization is greatly responsible for stagflation, with the effects felt in most other countries. The question that Shrivastava asks is whether the Indian economy should have been opened up in a more selective manner. The global financial markets are volatile, which affects the Sensex, for instance. Moreover, the demand for Indian goods and services has reduced due to recession in the US. Inflation has been growing due to a rise in commodity prices and a steady rise in the price of oil. Because the Indian economy is dependent on those of the US and other rich countries, a home market for products is no longer a prerogative of the government. The US recession has led to fall in exports, whereas the rise of the rupee against the dollar (till recently) cost many job losses. Indian companies are finding it difficult to raise capital abroad due to the decisions taken by the Federal Reserve, the central bank of USA. The rise in prices of steel, cement and oil has increased the costs in all industries. Due to the hike in interest rates to keep inflation under check, the cost of interest has also gone up. Uncertainties at the global level have slowed down the growth of industrial investment. Oil prices have increased due to futures trading in oil because of excess liquidity in the hands of big speculators. Another reason for this was the low value of the dollar (before the Indian rupee went into a free fall). Food prices have increased for various reasons. The demand for food has changed greatly. Since industrial agriculture is based on the use of fossil fuels, price hikes in oil directly affect food prices too. Climate change is another reason for raised food prices. With the increase in globalization, there is constant pressure on India to globalize the food sector and to bring the prices in line with those abroad. The US decision to push biofuels has led to a rise in food prices. The US government started giving subsidies to farms for growing corn to make ethanol for use in cars. And according to Shrivasthava, this was done to curtail the carbon emissions and the reliance on oil from West Asia. This culminated in a steep rise in the food prices all over the world. Besides, a few dealers in food grains control the prices by means of a central agency such as the Chicago Board of Trade in the US. Due to the lobbying of transnational agribusinesses and the stringent conditionalities applied by the IMF and the World Bank on poor countries, there had been a significant increase in the concentration of power of such organizations. They dominate not only marketing and consumption but also the production and supply of food inputs. The extension of intellectual property rights to cover agricultural inputs has worsened the situation. The small farmers and consumers, especially the poor, bear the brunt. The currency can be devalued and maintained in such a manner for a long period. However, this will increase the cost of fuel and subsidies. The IMF could be approached for a package, but this could be at the cost of subsidies and the Food Security Bill. If such measures are not taken, foreign lenders will become more cautious about India and portfolio investments will drop (Datta). The government should instil confidence by removing restrictions on foreign investment. It also needs to hasten the approvals for industrial projects. Kala insists that infrastructure and industry can be financed through the corporate market for bonds. The Reserve Bank of India cannot lower interest rates due to inflation but it can increase bank lending by reducing the portion of deposits banks must park in liquid assets such as government bonds or gold. The positive aspect that would “improve the macro environment is a reversal in the bad growth mix, which could be accomplished by global and local factors” (Morgan Stanley Research 6–7). Globally, a quick sharp decline in crude oil prices due to addressing supply issues is immediately required. This helps to reduce the stress on the current account deficit and inflation. Moreover, more capital will flow in due to a better environment for the international capital market. Hence, we can bring down the risk of funding. On the domestic front, the need of the hour is an aggressive and persistent policy action which restores private investment sentiment. A simultaneous decrease in government expenditure and subsidies is also called for. These will hold the key to reversing the bad mix of growth. According to Morgan Stanley Research, the macro environment will continue to be a problem for India since the likelihood of these key factors manifesting themselves is very low. Works Cited Datta, Devangshu. “Is India Facing Stagflation?” Business Standard. New Delhi. August 24, 2013. Web. Sept. 27, 2013. http://www.business-standard.com/article/pf/is-india-facing-stagflation-113082400616_1.html. Kala, Anand Vijay. “India Struggles to Avoid Curse of Stagflation.” Real Time Economics. The Wall Street Journal Sept. 19, 2013. Web. Sept. 27, 2013. http://blogs.wsj.com/economics/2013/09/19/india-struggles-to-avoid-curse-of-stagflation/ September 19, 2013. Morgan Stanley Research. “A Stagflation-Type Environment Emerging.” India Economics. June 1, 2012. Web. Shrivasthava, Aseem. “Poised for Stagflation.” InfoChange Globalisation. Web. Sept., 27, 2013. http://infochangeindia.org/globalisation/related-analysis/poised-for-stagflation.html.   Read More