GDP CONTRACTION: ARE WE ON OUR WAY TO STAGFLATION?

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By Shashank Kumar from Surendranath Law College, Kolkata

“Our vision is not just of economic growth, but also of a growth which would improve the life of the common man.” -Dr. Manmohan Singh

INTRODUCTION

These were the exact words of our former Prime Minister, which now seem so far off from fulfillment. As we are heading towards the  recession period, our social and economic life is on stake. Recently, the Indian GDP shrank by 23.9% in the second quarter of 2020, and also broke the highest contraction record. The continuation of the Coronavirus caused lockdown from March may be one of the biggest reason for the contraction.  But the Government of India cannot hide their failures in the name of “ACT OF GOD”. 

There may be a lot of reasons for contraction, but every taxpayer has to know that we cannot develop on the debris of a fallen economy and social life. Government announced the series of schemes during Coronavirus lockdown which gives many opportunities to every sector. Yet, the migrant labors and especially the middle class people have to suffer a lot. Now to understand the current scenario, there are some economic terms which every taxpayer has to know.

Gross Domestic Product, also abbreviated as GDP, is the total value of goods and services produced in a country. In simple words, it is an economic indicator used worldwide to show the economic health of a country.

The present situation where the economic health is deteriorating, where many people keep losing their jobs and business activity is grasping the economic straws to hold cash flow is often termed as Depression, by many economists.

Stagflation is that type of situation, where there is no positive growth and along with that, there is high rates of unemployment and poor consumer demands.

 STAGFLATION IN INDIA

Former Prime Minister, Dr. Manmohan Singh, had warned in the month of November in 2019  that the Indian economy was entering a stage of stagflation with high inflation and stagnant demand.

India is the world’s fifth largest economy by nominal GDP and the third largest by purchasing parity, the growth chances of  India is always remain positive because we has a large number of youth population , low dependency ratio and having positive integration in world economy. India also had the world’s second largest labor force in 2019.

Now, the Covid -19 pandemic increases the risk of stagflation. The economic trend of stagflation is marked by rising inflation and falling GDP growth. According to RBI, governor Mr. Das does not think that there will be stagflation and that the consumer inflation should be moderate. No doubt that stagflation is a double edged sword. However, Nomura India consider this scenario as a supple chain disruptions during a pandemic.

After July 20, economic indicators started showing signs of improvement as the lockdown was uplifted and the cash flow started.

 REASONS

According to modern economics, stagflation occurs when a price rises all across the board.  But herein India, the running situation is a little different. At the moment, prices have risen due to two reasons;

  1. The supply is shaken, mainly from oil, food and gold , where there is no sign of demand-pull inflation 

  2. The Covid-19 pandemic may be one of the biggest reason. It has shaken the world economy. Every nation is fighting against this virus. This pandemic has cast its shadows across different business lines, creating huge disparities in global production and supply chains.

There are some other reasons for this scenario as the Government cannot blame this pandemic wholly to hide their failures . Some of them are;

  1. The effect of Demonetization – As this change holds an important mark in the Indian economy. When the NDA led Modi Government banned 500 and 1000 rupees notes overnight, the industrial and corporate investment were frozen. Not only private consumption, small enterprises  were out of money, too. This situation dried the cash which caused a slowdown in the economy.
  2.  Roll out of GST or goods and services tax has led  – To the nationwide slowdown, which cannot be denied to have hampered the small business more than Demonetization did. GST holds numerous rules and regulation which are really out of scope for the small business class people.
  3. Global Slowdown – India is a net commodity exporter, there has been a slump in the volume of exports. Government’s steps may be for the betterment, but the series of unusual things along with Coronavirus resulted in the slowdown of the global economy. Foreign Development Investment or FDI, is reserved for speculative financing, rather than to improve the real economy.

The cause of the problem consists of Supply –Side being shaken up. Along with that, the other three contributors to this problem are: Demonetization, stressed banking sector, GST implementation and problems in agricultural sector.

FACTS AND THE BACKGROUND OF SLOWDOWN

India’s economic growth started degrading since the third quarter of the financial year 2016. Now, the growth is in a negative slope, and is a serious blow to the Government which had once promised to turn around the economic situation though decisive governance. The Ease of Doing Business Report has received great attention from this Central Government. India’s GDP has gone down from a high of 9.2% in the third quarter of 2016 to -23.9% in the current second year of 2020. However, Indian economy, as per global standards, now knocks the recessionary stage. 

All contributors to economic growth—domestic consumption, foreign consumption or export , private spending  and government spending are hit by the lockdown, which caused the slowdown in Indian economy. The UK and the European Union consider an economy to be in recession only when its real GDP growth actually turns negative over two consecutive quarters and by this criteria, Indian economy is really at a recession.. 

 IS STAGFLATION A PROBLEM?

 Many economists believe that the current slowdown is due to the lack of sufficient consumer demand. When there is no demand, supply has to be stopped due to the piling up of stocks and production units, leading to a reduction in labor force. It reduces the income which leads to less demand, which further reduces supply and stops production. 

Stagflation essentially ties the hands of the Government .The situation is dangerous mainly because of the normal low growth in the situation. It essentially prohibits the Government and the Central Bank from taking such countercyclical policy steps. Now, if the Central Bank decides to invest fresh money either by cutting interest rates or by other unconventional means, it may lead to a rise in price and retail inflation, rising further above the targeted range of RBI.

Higher inflation could cause a reduction in people ‘s standard of living as they  can afford lesser . The official data released by the National Statistics Office (NSO)  confirms that the weaker consumer demands and slowing down of private  investments are the key factors behind the slowdown of the Indian economy. Automobile industries that contributed 12% of GDP are suffering from huge loss as the sales have gone down. 

 IS IT TEMPORARY?

 Few economists think that the current scenario is just for the time being and soon it will be faded out. While others think that this is a serious issue, most likely caused by the supply side having been shaken up and the lockdown. 

However, to boost the economy, many schemes were introduced by Finance Minister, Nirmala Sitharaman. There is an addition of many new economic packages under Pradhan Mantra Garib Kalyan Yojna and Aatamnirbhar Bharat.Twenty lac crore packages were given to farmers, laborers and small scale industries.

UK reported a 21.7% contraction, France recorded 18.9% , Italy a 17.7% contraction in the second quarter of 2020. Not only in India, but the whole world is suffering from Recession. However, the slowdown of Indian economy is a deep structural issue that is not temporary. As everything now relies on the Government. Having supreme power, the Centre Government should realize the economic realities and avoid taking risks in policymaking.

CONCLUSION

 Many economists believe that severe drop in consumer demand simply to be a symptom instead of a primary cause behind the slowdown. Indian economy may not be in a stagflation phase, but slowing in the growth will be a problem which will later cause a risk to the Government’s $5 trillion goal. According to US, economic growth between 1973-75 saw five negative growth periods in consecutive quarters and tripling of inflation, is stagflation.

With an aim to acquire USD 5 trillion economy status, India has to achieve a  minimum of 9 % positive growth for five consecutive years. And to achieve that in 2025, Indian economy must be $3.3 trillion in 2021, $3.6 trillion by 2022, $4.1 trillion by 2023, $4.5 trillion by 2024–though the current scenario, trends and prospects do not favur this dream. 

The Government now needs to spend more on rural areas. Increasing rural people’s income may give positive effect on consumption demand. The current slowdown is due to the Covid -19 lockdown, Demonetization and the disruptions in economy due to the preparation for bringing GST. 

According to the World Bank President, Jim Yong Kim, “We think that the recent slowdown is an aberration which will be correct(ed) in coming month, the GDP growth will stabilize during the year. We’ve been watching carefully as PM Modi has really worked on improving the business environment, and so we think all these efforts will pay off as well.” 

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