Moody?s has stirred a hornet?s nest by saying the Indian economy is facing stagflation, where growth is slow and inflation high. Can 6% growth at a time when developed economies would be lucky to get any growth at all be called stagflation?

India is now at a stage where we will see slow growth and high inflation for some time?GDP growth has slowed to a 9-year low of 5.3% in January-March 2012, with WPI inflation staying sticky near 7.5% in May and CPI inflation in double digits. Ideally, it should have been the reverse: GDP growth should have been 7.5% plus and inflation near 5%. Clearly, the growth-inflation dynamics have reversed.

As it stands now, we are in a low growth and high inflation trap. Getting out of this will require coordinated fiscal and monetary policy action to bring inflation within the comfort zone. Pushing up growth will require steps to overcome policy-related bottlenecks, to improve the investment climate. Since much of the inflationary pressure is structural?food inflation is back to double-digits mainly due to supply-side constraints, and fuel inflation stayed near 14% even though energy prices have not been fully passed on to consumers?monetary policy alone cannot be fully effective. It has to be supported by actions to reduce fiscal pressures and supply-side bottlenecks. Not surprising, RBI has left policy rates unchanged at its mid-quarter policy review on June 18 and flagged concerns over the lack of fiscal and administrative initiatives to curb inflation.

Coming back to the economic outlook for 2012-13, Crisil expects GDP growth to stay flat at 6.5%, same as last year. The average WPI inflation is expected to stay at about 7%. The current economic expansion certainly appears to be well below the country?s potential growth. Potential growth is defined as one which is tolerable and does not stoke inflationary pressures. RBI regards India?s potential GDP growth as about 7.0-7.5%. We may not grow at the potential rate all the time, but as long as it is accompanied by benign inflation, that will be acceptable. The worry today is the provenance of higher-than-acceptable inflation when growth has materially slowed below its potential.

In the past few quarters, aggregate demand has been growing at a slower pace, output in some sectors like mining has declined and investment rates have fallen. But it may be too early to say that we are technically in stagflation, understood as a combination of stagnant growth and high inflation in the context of advanced countries. In fact, it is difficult to define stagflation in the Indian context. A slower GDP growth of 5% generates the same alarm as zero-growth does in the West. This is because India needs to grow much faster to solve its problems of poverty and catch up with developed countries.

The present economic situation in India is all the more worrisome as the extent of the slowdown is comparable with that of the eurozone. While the growth rate of the eurozone has fallen from a little over 3% just before the Lehman crisis to zero by the first quarter of 2012, India?s growth has come off from 9% plus to 5.3% during the same period. We still maintain about the same differential in the slowdown in GDP growth. Mind you, this is despite the fact that recovery was glacial in the developed world after the Lehman crisis while India was one of the quickest to rebound with a growth rate of 8.4% in both 2009-10 and 2010-11.

While fast recovery has been accompanied by high inflation in 2010 and 2011, the present slowdown has not moderated the price rise to that extent. Then, is India heading for stagflation? The answer is, we are still not there but appear to be moving in that direction.

The author is chief economist, Crisil (As told to Raj Kumar Ray)

Saugata Bhattacharya

Is India in a stagflationary environment? Probably. Whoa! 6% growth is stagnation? When global growth is forecast to be less than 4% and developed economies would be lucky to get any growth at all? With the eurozone debt crisis, faltering global trade and a high interest regime?

Well, technically, stagflation is incorrect, but India is showing all the signs of a major slowdown, the severest in almost a decade, with inflation yet remaining high. And judgement of growth and inflation conditions will always be with reference to some period, trend or peer group. More importantly, it will be based on perception.

The most important hallmark of a stagflationary environment is persistence. The term stagflation was not heard in 2008-09, despite a slowdown which was sharper but which turned out to be transient. After 2 quarters of sub-6.5% levels, growth bounced back again at 7.5%. More importantly, inflation came down from 11% in August 2008 to -0.4% in June 2009, although it climbed just as sharply back to close to 11% by April 2010. Unlike those wild gyrations, today?s inflation is likely to be headlining at close to 8% for the year, and growth, with luck and patience, will go above 7% only in the last quarter of FY13.

And growth is not just about hard numbers; sentiment is as important. With the global and Indian monetary and fiscal stimulus fresh in memory, investment conditions upbeat, interest rates low, the spectrum auctions having closed like a dream, things could not have looked better. The situation is significantly different now. The change in the ratings outlook from stable to negative by two global rating agencies has added to the perception of weakening.

Today?s perception of stagflation is mainly arising from an asymmetric situation where headline inflation persists at high levels, fuelled by structural imbalances, while consumption demand, and growth, is faltering because of a collapse in investment. But as things stand today, space for a fiscal and monetary policy boost is extremely limited.

However, the scenario can change, if not quickly, if capex activity picks up, fiscal deficit is contained and the rupee strengthens in the second half of 2012-13. The priority now is to improve the investment climate (and sentiment) which has deteriorated significantly, and which has led to the most important difference between the current period and 2008-09: the rupee?s slide. This has exacerbated all the underlying macroeconomic imbalances via the fiscal and current account deficits and made RBI?s inflation management much harder.

How do we lift investor sentiment? First, some of the stalled or idling power projects need to be restarted or optimised by ensuring coal and natural gas linkages and mitigating other frictions including land and environmental clearances. The revival of a few large stalled projects will have significant backward linkage impacts on SMEs which sub-contract projects. A hike in the prices of subsidised fuels, despite a short-term impact on inflation, will have a contractionary impact on demand and hopefully neutralise the impact of fuel prices.

Monetary easing alone can?t resolve all the problems. We need a concerted effort from central and state governments and RBI, via monetary, fiscal, tax, industrial, export, land and labour policies. If we start now, there is a fair chance that the current situation could be reversed by this fiscal year?s end.

The author is Senior Vice President, Business and Economic Research, Axis Bank. Views are personal