Risk of stagflation receding: RBI officials

Contact Counsellor

Last Updated27/12/2023

Reserve Bank of India (RBI) officials believe that the risk of stagflation in India has decreased from 3% in August to 1% based on available data, using two approaches.

A situation characterized by simultaneous increase in prices and stagnation of economic growth.
It is described as a situation in the economy where
- The growth rate slows down
- The level of unemployment remains steadily high
- The inflation or price level remains high at the same time.
It is dangerous for the economy.
- In a usually low growth situation, central banks and governments try to stimulate the economy, but they tend to elevate prices and cause inflation.
- So, it cannot be adopted when inflation is already running high, which makes it difficult to break out of the low growth-high inflation trap.

First Approach: Stagflation risk was assessed based on phases of lower economic growth coinciding with high inflation.
Second Approach: Used the ‘at-risk’ frameworks i.e. “Inflation at Risk” (IaR) and “Growth at Risk” (GaR) by employing quantile regression to assess the likelihood of stagflation.

Major determinants of stagflation risk in India: Supply-side shocks coupled with tighter financial conditions and relatively higher depreciation of the domestic currency.
- This is based on data from Q1:1996-97 to Q2:2023-24
Stagflation risks were higher during specific episodes like the Asian Crisis, Global Financial Crisis, taper tantrum and the COVID-19 pandemic.
Tight domestic monetary policies and sluggish global growth led to economic slowdowns in certain periods.
Stagflation risks post-COVID-19 have subsided due to eased financial conditions, contained currency depreciation, and stable domestic fuel prices.
Latest estimates, assign a very low probability of only 1% to the risk of stagflation

Globally, higher commodity prices and the US dollar's appreciation post-pandemic raised concerns of stagflation.
Delays in monetary normalization post-pandemic also raised worries about potential costly stagflation.

Commodity Prices: Recent commodity price shocks are not as severe and persistent as in historical episodes.
Central Bank Focus: Global central banks' focus on maintaining price stability and healthier financial positions of institutions contribute to well-anchored long-term inflation expectations.
Macroeconomic Conditions: Favourable macroeconomic conditions, including eased financial conditions, moderate currency depreciation, and stable crude oil prices, have helped reduce the risk of stagflation.