MUMBAI : Just two years ago, Prime Minister Narendra Modi was helming an economy expanding 8%, 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.
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% 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% on Tuesday, the most since Dec. 5.
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.
Volatile Oil
Consumption makes up about 60% 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%, 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 in Mumbai, 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.