Possibilties of Stagflation

The budget has brought in mixed reactions from different quarters. The task for the FinMin was to balance the problem of economic reforms (read fiscal deficit) and the social reforms. While there is no doubt (as already argued here) that focus on social expenditure is necessary for the growth of the country in long term but seeing away from the problem of fiscal deficit has in built problems of possible Stagflation in the country.
The logic is simple. Increasing fiscal deficit (Govt Expenditure minus Govt Earnings which is around 6% of the GDP) means the government has to borrow more(around 400,000 crores) to meet its expenditures. Now when the government is borrowing a huge amount, the banks don’t have much more money to give out to other companies. As the demand for money increases to more than the supply of money, it results in increase in the cost of borrowing money i.e. interest rates. This results in 2 possible effects.
a. Less borrowing by the industries, which results in less expansion plans, hence less growth
b. As cost of borrowing increases, the cost of production increases and the company passes on these costs to the consumers resulting in increase in prices or inflation
Already we are facing a drought like situation in India due to lack of monsoons, resulting in increase in commodity prices. Though the inflation measured by the WPI index is less but the consumer price Index (CPI) which is a more relevant figure from the point of view of ‘aam aadmi’ still hovers around 10%.
Hence we can see a possible halt in growth and increase in inflation – in other words Staglflation.