India better placed to avoid stagflation risk, says RBI report

Paints an encouraging picture of economic activity gaining strength, with most GDP constituents exceeding their pre-pandemic levels

Even as stagflation risks loom over some of the major global economies, including the US, India is better placed to avoid such a risk, the Reserve Bank of India (RBI) says in its monthly ‘State of the Economy’ report, released on Thursday.

“In the midst of this increasingly hostile external environment, India is better placed than many other countries in terms of avoiding the risks of a potential stagflation,” the report says.

At least 83 per cent of fund managers surveyed by Bank of America Research this month see the global economy facing the risk of stagflation – the phenomenon of rising inflation and slowing economic growth.

But the RBI report paints an encouraging picture of economic activity gaining strength, with most gross domestic product (GDP) constituents exceeding their pre-pandemic levels. “The recovery remained broadly on track. This demonstrates the resilience of the economy in the face of multiple shocks and the innate strength of macro fundamentals as India strives to regain a sustainable high-growth trajectory,” the report says.

“With a growth rate of 8.7 per cent in 2021-22, India’s GDP surpassed its pre-pandemic (2019-20) level by 1.5 per cent and the recovery remains robust in 2022-23 so far,” it adds.

While growth recovery is encouraging, the inflation situation in the country remains grim. Headline Consumer Price Index (CPI) -based inflation has remained above the RBI’s upper tolerance band of 6 per cent for all five months of 2022. Prompted by this sharp increase in inflation, the central bank has increased the policy repo rate by 90 basis points to 4.9 per cent in a little over a month.

“The recent actions by the RBI, which demonstrated its commitment to price stability while supporting growth, augurs well in this milieu,” the report says.

On 7.04 per cent inflation in May, the report says: “The inflation print for May has brought some relief as it has recorded a decline after seven months of continuous rise.”

The report observes that the current rise in inflation, mainly due to a war in Europe, lies outside the realm and remit of the RBI. At the same time, the central bank needs to act to contain the second-order effect of price rise.

“Inaction by the RBI will be seen as accommodating the inflation shock, and such a perception may lead to the belief that inflation is getting out of control,” the report says, adding that an increase in interest rates by the RBI and tightening of monetary and liquidity conditions will help bring down inflation.