STAGFLATION

Stagflation is a situation where growth of the economy in terms of output of goods and services slows down drastically and the levels of inflation, price level and unemployment shoots  up at the same time. In the early 1970s when OPEC  (Organisation of Petroleum Exporting Countries) a cartel  like organisation, cut oil production and increased it's prices several fold world faced an unprecedented crisis constraining the productive capacity of most economies that were heavily dependent on oil imports hampering their economic growth. On the other hand the oil price spike also led to inflation and push in costs and prices of commodities and services , leading to stagflation. 

In recent years combined effects of Covid19 and Russian  invasion of Ukraine has accelerated the slow down in global economy which is already suffering from the phase of protracted feeble growth and elevated inflation. According to World Bank this raises the risk of stagflation with potentially harmful consequences for middle and low income economies alike. The surge in energy and food prices over the past two years has been the largest and second largest respectively since the 1970s. It has been accompanied by steep slow down in global growth than 1975 recession.The global growth is expected to slump from 5.7% in 2021 to 2.9%in 2022-significantly lower than 4.1% that was anticipated in January. It is expected to hover around the same level over 2023-24, as the  war in Ukraine disrupts activities like investment,4 and trade in the near term,as pent up demand fades,and fiscal and monetary policy accommodation is  withdrawn.As a result of damage from pandemic and the war,the level of percapita income in developing economies this year will be nearly 5 percent below  its pre pandemic levels.According to World Bank the danger of stagflation is more than twice the deceleration witnessed between 1976 and 1979 because of weak investment in most of the world and persistent high inflation in many countries along with supply bottlenecks. External public debt in developing countries is at record levels characterized by large private creditors and variable interest rates. When global financing conditions tighten and currencies depreciate -debt distress previously confined to low income countries will gradually spread to middle income countries as well.

 The removal of the earlier monetary accommodation by USA and other advanced economies coupled with increase in global borrowing costs,wil impact adversely  the developing world. The US  Federal Reserves aggressive strategy against inflation is bound to cause severe disruption to global financial markets and impact growth across countries. Fed is determined to use all the tools to attain price stability and to make inflation target move towards long-term target of two percent. The US growth projection for 2022 has been sharply revised to 1.7% from earlier 2.8% projected in March.For South Asia growth  is projected to 6.8% and 5.8% in 2022 and 2023 respectively as against 7.5% for India for the financial year 2022-23. As a result of the impact of lockdowns in China growth is projected to slow down to 4.3 percent in 2022.Srilankan economy struggling with balance of payment and external debt crises is expected to contract by 7.8% in 2022and 3.7% in 2023.As a policy Fed is set to sacrifice some growth as it cools demand to push inflation lower. In addition over the next two years most of  the fiscal support provided by countries in 2020 to fight the pandemic will have to be withdrawn. Unlike the 1970s notably US dollar is comparatively very strong today in sharp contrast to it's severe weakness In 1970s.On the  contrary oil prices quadrupled in 1973-74 and doubled in 1979-80 .It may be noted here that today in  inflation adjusted terms oil prices are only two thirds of what they were in 1980.Similarly the  balance sheet  of major financial institutions are relatively strong  compared to their weak position in the 1970s. The markets are also in turmoil due to spike in US treasury yield leading to surge in sovereign bond yields of other countries as well.The dollar index has moved above 105 as money is expected to move back to dollar denominated treasury securities. This will accelerate foreign portfolio flows out of emerging market bonds. Obviously the Reserve Bank of India will have no other option except following Fed's measures of hike domestic policy rates in order to maintain the spread in sovereign bond yields and to support the currency. 

Oil price movements  driven by supply shocks in oil markets are often associated with important changes in global output and income shifts between oil exporters and importers. Recent studies using macroeconomic models indicated a supply driven increase in oil prices averaging about 40 percent over two years, which would lower global activity by about 0.2-0.6 percent over two years. With regard to food inflation higher input costs including for fertilizers, from rising energy prices etc are posing constraints in agricultural production globally whereas the war continues to disrupt planting and harvesting operations in Ukraine threatening wheat production and supply. Food insecurity prevalent in many emerging and developing economies is rising as the war in Ukraine pushed up global food prices. Food and Agricultural Organisation estimated that 2.3 billion lacked regular access to sufficient food. 

Policy tightening played a major role in the 1970s and 1980s to contain high inflation ,Monetary policy tightening were guided by prioritization of the objective of restoring price stability, reduced inflation in advanced economies to a median of 3% in 1986 from its peak of 15% in 1974.According to World Bank openness to trade and foreign direct investment is closely associated with positive technological spillovers  lower trade costs and stronger long-term growth. War has increased the risk of fragmentation in networks of trade, investments and digital connectivity. Financial policy need to rebuild foreign exchange reserves buffers and chalk out policies to counter financial stress.As far as foreign exchange reserves are concerned India is in a  comfortable position with reserves sufficient to meet more than 10 months imports requirements. Fiscal balances across countries deteriorated sharply during the pandemic. EMDEs fiscal deficit are still 1.1% higher of GDP than in 2019 and government debt is 10% higher than GDP. Withdrawal of fiscal support must be carefully calibrated and closely aligned with credible fiscal plans. 

In short stagflation trends are affecting across  countries with rising commodity prices and inflation ,heavily disrupted trade flows and tightening financial conditions and the risk of global economic fragmentation. A fragmented world is more volatile and vulnerable. Unlike the 1970s the inflation adjusted oil price increase has been lower now. Similarly the balance sheet of major financial institutions are relatively strong compared to their weak position in 1970s, and a  relatively stronger dollar.As far as India is concerned macroeconomic stability outweigh growth objective now primarily because as shocks come and impact we need to keep the order of economic priorities. However the government measures including lowering of taxes, continuation of privatisation and commitment to ensure the capital expenditure is expected to support growth momentum