4 Policy makers will need to guard against 'nominal illusion' hiding stagflation risks

The latest inflation numbers, when read with the tepid 1.9% growth in the Index of Industrial Production (IIP) for the month of March, do not bode well for the state of the economy, which seems to be caught in a low-growth high-inflation or stagflation like situation.

Given the fact that monetary policy will increasingly turn hawkish going forward, this calls for a more proactive fiscal policy approach to protect, even promote demand. Whether fiscal policy takes up this challenge or not will also depend on its ability to stay clear of what economists call a “nominal illusion” which has given an artificial boost to some high frequency economic indicators such as tax collections or export earnings. Sajjid Chinoy, the chief India economist of JP Morgan had warned against this in an article for BQ Prime.

In fact, the latest IIP numbers underline the precarity of consumer demand in the Indian economy. The consumer goods sub-category of the IIP in March was actually lower than its March 2021 value, which was primarily a result of a contraction in the consumer durable category. With inflation expected to put a squeeze on purchasing power and additional headwinds from an increase in debt servicing costs due to rising interest rates, aggregate demand will only face a big challenge going forward. When RBI releases its forward-looking surveys in the first week of June, we will have greater clarity on the damage inflation has done to consumer sentiment and the extent of hardening of inflation expectations.