Stagflation by stealth: Why India’s economic risks are more homegrown than global

The global economy is once again confronting the spectre of stagflation. In textbook terms, stagflation refers to the uneasy coexistence of stagnant or slowing economic growth, high unemployment, and rising inflation – a combination that conventional macroeconomic policy struggles to address effectively.

Once considered a relic of the 1970s, when oil shocks triggered prolonged periods of high inflation and weak growth across advanced economies, stagflation has re-entered policy discussions as geopolitical tensions in West Asia disrupt energy markets, trade routes and supply chains.

A growing number of global analysts have begun warning of stagflationary risks across both advanced and emerging economies, particularly as oil price volatility and currency pressures intensify.

India, too, is being drawn into this conversation. But to attribute the risk of stagflation in India solely to war would be analytically convenient – and misleading. The more uncomfortable truth is that the building blocks of a stagflationary environment may already exist within the Indian economy, with external shocks merely accelerating their effects.

Robust growth

On paper, India appears resilient. GDP growth is estimated at around 7.4% for 2025-’26, while inflation has remained within the Reserve Bank of India’s tolerance band at roughly 4%-5%. Yet, these headline indicators conceal deeper structural weaknesses.

Unemployment continues to hover at around 6%-6.5%, with youth unemployment significantly higher. Labour force participation remains uneven, real wage growth has been sluggish and private consumption – which accounts for nearly 60% of GDP – has shown signs of fatigue, particularly in rural areas.

The result is an economy that grows, but not in a way that generates broad-based demand or income. In such a context, even moderate inflation begins to feel more burdensome, especially for lower-income households. Stagflation, then, need not arrive dramatically – it can emerge gradually through the coexistence of weak demand, fragile employment, and rising costs.

External shocks, internal weaknesses

The conflict in West Asia has intensified these vulnerabilities. For a country that imports over 85% of its crude oil, volatility in global energy prices has immediate consequences. Fuel costs feed into transport, logistics, and food prices, making them a key transmission channel of inflation in India.

Even when retail fuel prices are politically managed, the underlying cost pressures eventually surface elsewhere in the economy, particularly in sectors such as agriculture and small-scale manufacturing.

At the same time, the rupee has weakened to above 90 per US dollar, continuing a trend that predates the current conflict. This contributes to imported inflation, especially in energy and intermediate goods. The war, therefore, is not the origin of India’s stagflationary risk – it is the trigger that exposes and amplifies existing imbalances.

Evidence from the Fast Moving Consumer Goods sector – often treated as a proxy for mass consumption – reinforces this concern. Recent data suggests that rural demand, while occasionally outpacing urban consumption, has been uneven and slowing, with growth moderating sharply to nearly 3%-4% in 2025.

Urban demand, meanwhile, has remained subdued, with volume growth in some quarters as low as 2%-3%. More importantly, a significant part of FMCG growth has been driven by price increases rather than real consumption gains. This points to a deeper issue: what appears as resilience in aggregate consumption may, in fact, reflect inflation-led value growth rather than robust demand.

This creates a difficult policy environment. The Reserve Bank of India must balance inflation control with growth concerns, but its room for policy space is limited. If global shocks push inflation upward, interest rates may have to rise. Yet, tighter monetary policy risks further dampening demand. The consequences are particularly severe for Micro, Small, and Medium Enterprises, which contribute nearly 30% to GDP and employ around 40%-45% of India’s workforce.

Higher borrowing costs, combined with rising input prices, could squeeze their viability, with ripple effects on employment and local demand. Monetary policy, in this context, is operating within narrow margins, trying to contain inflation without tipping the economy into a sharper slowdown.

Opportunity for correction?

There is also a growing divergence between macroeconomic narratives and everyday economic experience. India may be the fastest-growing large economy, but that growth is unevenly distributed. Urban consumption shows pockets of strength, but rural demand remains fragile as data suggests slower volume growth in rural markets, pointing to underlying demand constraints.

At the same time, inflation – particularly in food and fuel – hits lower-income households disproportionately, making the cost of living feel significantly higher than headline numbers suggest. In such a setting, stagflation does not arise from a dramatic spike in prices, but from a persistent mismatch between modest growth and lived economic reality.

Paradoxically, this moment also presents an opportunity. External shocks provide political cover for policy correction. The government can address structural weaknesses – whether in employment generation, energy dependence, or MSME support – while attributing the urgency to global developments.

If managed well, such interventions could not only mitigate stagflationary risks but also strengthen long-term resilience. In effect, this is a rare moment where course correction and political credit can coexist.

It would be premature to declare that India is in stagflation. But it would be equally complacent to dismiss the possibility. The real risk is not of a sudden crisis, but of a slow-burning imbalance – where growth underperforms in terms of jobs and demand, and inflation edges upward under external pressure.

The war may have triggered the conversation, but the underlying story is domestic. And unless addressed, stagflation in India may not arrive with a shock – it may simply creep in, quietly, beneath reassuring headline numbers. The real danger is not that stagflation will arrive. It is that we may recognise it only after it has already settled in.

Freddy Thomas teaches economic analysis of law at the School of Law, Christ University, Bengaluru.