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A worker assists a colleague with stems of bananas during a harvest in a field in Jalgaon, Maharashtra. Stagflation looms as the economy grinds toward its slowest expansion in more than a decade Image Credit: Bloomberg

Mumbai: Just two years ago, Prime Minister Narendra Modi was helming an economy expanding 8 per cent, spurring optimism India was on a path to become a major global growth driver.

Now, stagflation looms as the economy grinds toward its slowest expansion in more than a decade and inflation spikes above the central bank’s target, driven by higher food prices. Social unrest against a restrictive new citizenship law is yet another challenge.

7.3%

surge in inflation in December amid limited scope to deal with slowdown

And there’s few good options to deal with the slowdown. Dwindling government revenue and an already-stretched budget limit scope for fiscal support, while the shock 7.35 per cent surge in inflation in December and the threat of higher oil prices mean the door for further interest rate cuts is closing.

Sovereign bonds dropped after the inflation data. The yield on the benchmark 10-year bond rose as much as 10 basis points to 6.7 per cent on Tuesday, the most since December 5.

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Demonetisation hangover

So what went wrong? At the heart of India’s problems is a slump in consumption following a combination of policy missteps, from the unprecedented decision to ban high-value cash notes at the end of 2016, to the chaotic implementation of a unified goods and services tax the following year. That was followed shortly after by a credit crunch, which triggered a crisis among shadow lenders — a key provider of small loans to hundreds of millions of consumers and businesses.

Oil turns pricey

Consumption makes up about 60 per cent of gross domestic product, and spending has slumped as businesses shed jobs and put off investment plans. Consumer sentiment remains in the doldrums and the recent volatility in oil prices could be a further drag on spending. Economic growth in the fiscal year through March 31 is set to slow to an estimated 5 per cent, the weakest pace in more than a decade.

“The recovery is likely to be very gradual and a stagflation scenario is likely,” Teresa John, an economist at Nirmal Bang Equities Pvt said. (Stagflation refers to a condition of accelerating inflation and weakening growth.)

The central bank’s five interest-rate cuts last year and billions of dollars of liquidity pumped into financial markets have done little to spur lending. That’s because banks are already saddled with one of the worst stressed-asset ratios in the world and are neither lending much nor transmitting rate cuts to borrowers.

Rs20b

worth of tax cuts given by Sitharaman to companies in a bid to revive economy

The government has taken steps to revive the economy, but they aren’t bearing fruit yet. Finance Minister Nirmala Sitharaman gave companies $20 billion (Dh73.4 billion) worth of tax cuts, merged weak state-run banks with stronger ones and eased foreign investment rules. The government will also sell state assets in its biggest privatisation drive in more than a decade.

Some silver linings

There are some early signs that the economy may be bottoming out. The latest high-frequency indicators, such as the purchasing managers indexes for manufacturing and services, show activity is picking up. Industrial production and capital expenditure also improved late last year.

Economists are forecasting a rebound in growth to 6.2 per cent in the fiscal year through March 2021, although much will depend on how quickly global demand and domestic spending recovers.

And lots of concerns

“We are really extremely close to a point where we could be dipping into a major recession,” Abhijit Banerjee, winner of the Nobel Prize for economics last year, said this month in Mumbai. “The critical problem in the Indian economy is demand. You definitely want to stimulate demand.”

Nouriel Roubini, a New York University professor and well-known economic doomsayer, told delegates at a Mumbai conference last week that he doesn’t see evidence yet that the “slowdown is going to give way to a significant pickup in growth in this financial year.” He added that policymakers’ attention “should have been concentrated on the economy and is instead distracted by political things.”