Tuesday, May 15, 2012

India facing stagflation

India (as discussed back in December) is now struggling with one of the most difficult environments an economy could face - stagflation. Here are the latest four economic trends:

1. India's export growth is declining.

India: Merchandise Exports YoY

2. Industrial production is down sharply.

India: Industrial production YOY

3. Yet wholesale inflation is staying stubbornly high, driven by food inflation. Food inflation can be particularly devastating for developing economies where food costs are such a high proportion of household expenses.

India: Wholesale Inflation YOY

4. But the most worrying sign is the rupee weakness. INR hit new lows against the dollar - below the levels reached in December (the chart below shows how many rupees can be bought with one dollar).

USD-INR exchange rate

Rising import costs (particularly food inflation) are nearly impossible to control when the currency weakens this much.
Credit Suisse: With India looking rather stagflationary at present, the Reserve Bank of India faces somewhat of a dilemma. Does it ease policy further on the basis that economic growth is very weak and core inflation soft or keep rates unchanged as it worries about headline inflationary pressures?
The Reserve Bank of India (RBI) will likely cut rates again, simply because the core inflation remains relatively tame (core inflation as measured by RBI actually declined 0.1% due to a slowdown in manufacturing demand). But the outlook for growth is far from certain. With currency weakening, inflation could become difficult to control while growth is showing signs of slowing. These are the signs of stagflation.

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