India and China have been hit by a surge in consumer prices that, together with a slowdown in growth, has sparked fears of “stagflation” in the world’s two most populous countries.
If the Asian powerhouses were to be overtaken by the phenomenon — rising prices in a stagnant economy — their slowing economies would pose a grave threat to global growth.
The prospect of stagflation has haunted Beijing for the past six months. China’s economic growth is at a 29-year low and consumer price inflation remains above 4 per cent. The coronavirus which has engulfed the country in recent weeks is set to damp economic activity further.
In India, meanwhile, growth has tumbled to a six-year low of just 4.5 per cent, while inflation spiked to 7.4 per cent over the previous year in December.
But economists question whether the two countries are truly suffering stagflation, or just a series of shocks to food prices, masking what is not inflationary but deflationary pressure. That uncertainty leaves central banks with a dilemma over how to respond.
“To speak of stagflation here is really a bit misleading,” said Frederic Neumann, co-head of Asian economics research at HSBC in Hong Kong. Given the hit to demand caused by high food prices, he said, “one could argue that in the medium-term this is actually more disinflationary”.
Going purely on the numbers, China and India are experiencing stagflation. But the term also describes a mechanism that hit western economies after the oil shocks of the 1970s, when workers demanded higher wages to compensate for the rising cost of living, pushing prices up further, and forcing central banks to raise interest rates, which choked off growth.
It is not obvious such a mechanism is now in play. In China, swine fever caused a surge in pork prices, spilling over to alternative foodstuffs. While overall inflation is rising, core inflation — which strips out volatile components such as fresh food — has been moving down.
In India, food prices jumped 12 per cent year on year in December, with a particular surge in vegetable prices, which were up by 60 per cent.
“The current spike we have seen in food inflation is largely an outcome of unseasonal rains,” said Sunil Kumar Sinha, principal economist of Indian Ratings and Research, the local arm of Fitch. “I don’t see inflation keeping at an elevated level for very long.”
Ila Patnaik, an economist at the National Institute of Public Policy and Finance, said she also believed the current spike in inflation was “transient” and would ease once the next onion crop came in. “It’s basically vegetable prices . . . it’s not persistent inflation,” she said. “As of now, I wouldn’t start calling it stagflation.”
The People’s Bank of China and the Reserve Bank of India have to make a difficult choice. If food prices do feed through to broader inflation, they will need to raise interest rates to bring it under control. But if the inflation effect is temporary, the central banks should worry instead about weak demand, or risk inflation falling below target further down the line.
So far, the PBoC has been less aggressive on easing than in past years, risking lower growth to prevent rising inflation and the accumulation of bad debt. Total social financing, the government’s broadest measure for credit expansion, grew 10.7 per cent year on year in December, marking what Barclay’s economist Zhou Yingke called a stabilisation in credit growth for the year.
The RBI is expected to pause a monetary easing cycle that has cut its benchmark interest rate cut by 135 basis points to 5.15 per cent over the past year. If food price inflation does not subside, said Saurabh Mukherjea, founder and chief investment officer of Marcellus Investment, it will be difficult for the RBI to lower rates further.
The central bank could even feel it had to raise rates to maintain the credibility of its inflation target, a major blow to an already weak economy. “If the RBI now hikes interest rates to deal with this surge in inflation, it will be extremely damaging,” he said. “The Indian economy needs higher rates now like it needs a hole in its head.”
Perhaps the greatest risk is for Asia to become tied up in fighting temporary food inflation while prices for other goods and services suffer the same kind of slide seen in Japan and the eurozone.
Mr Neumann said: “We would argue that the disinflationary pressures we’ve seen building up in the world economy over the last few decades are actually taking hold in Asia.” If that comes to pass, the threat to Asia’s economies is not stagflation, but simple stagnation.