Will soaring oil prices cause ‘stagflation’ in India?

Contact Counsellor

Last Updated08/03/2022

Reports suggest that crude oil prices soared and touched almost $140 per barrel amid Russian invasion of Ukraine. This has posed a risk of causing Stagflation in India.

Stagflation is stagnant growth and persistently high inflation. It, thus, describes a rather rare and curious condition of an economy.
Typically, rising inflation happens when an economy is booming — people are earning lots of money, demanding lots of goods and services and as a result, prices keep going up.
When the demand is down and the economy is in the doldrums, by the reverse logic, prices tend to stagnate (or even fall).
But stagflation is a condition where an economy experiences the worst of both worlds — the growth rate is largely stagnant (along with rising unemployment) and inflation is not only high but persistently so.

The best-known case of stagflation is what happened in the early and mid-1970s.
The OPEC (Organisation of Petroleum Exporting Countries), which works like a cartel, decided to cut crude oil supply.
This sent oil prices soaring across the world; they were up by almost 70%.
This sudden oil price shock not only raised inflation everywhere, especially in the western economies but also constrained their ability to produce, thus hampering their economic growth.
High inflation and stalled growth (and the resulting unemployment) created stagflation.

In December 2019, it was also becoming difficult for the government to deny that India’s growth rate was witnessing a secular deceleration.
As revised estimates, released in January end, now show, India’s GDP growth rate decelerated from over 8% in 2016-17 to just 3.7% in 2019-20.
For one, in absolute terms, India’s GDP was still growing, albeit at a progressively slower rate.

Russia is the world’s second-largest oil producer and, as such, if its oil is kept out of the market because of sanctions, it will not only lead to prices spiking, but also mean they will stay that way for long.
While India is not directly involved in the conflict, it will be badly affected if oil prices move higher and stay that way.
India imports more than 84% of its total oil demand. At one level, that puts into perspective all the talk of being Atmanirbhar (or self-reliant).
Without these imports, India’s economy would come to a sudden halt — both metaphorically as well as actually.

Higher inflation would rob Indians of their purchasing power, thus bringing down their overall demand.
In other words, people are not demanding enough for the economy to grow fast.
Private consumer demand is the biggest driver of growth in India.
Such aggregate demand — the monetary sum of all the soaps, phones, cars, refrigerators, holidays etc. that we all spend on in our personal capacity — accounts for more than 55% of India’s total GDP.
Higher prices will reduce this demand, which is already struggling to come back up to the pre-Covid level.
Fewer goods and services being demanded will then disincentivise businesses from investing in new capacities, which, in turn, will exacerbate the unemployment crisis and lead to even lower incomes.