Coping with Inflation
CIMB Private Banking economist Song Seng Wun shares his views on what is causing inflation, its impact on the economy and how businesses can navigate these challenges.
Inflation is a loss of purchasing power over time: It means for every dollar you spend, it does not buy as much as it did previously. Inflation is typically expressed as the annual change in prices for a basket of goods and services which gives us the Consumer Price Index or CPI.
The current spike in inflation is partly due to the increase in consumer demand. As countries emerge from pandemic lockdowns, more shops begin to re-open and people are increasing their consumption and spending with money saved during the last two years. Economists refer to this phenomenon as ‘revenge spending’ or ‘revenge buying’ which is used to characterise the increase in consumer spending after an unprecedented adverse economic event.
Effects on businesses
The most immediate effect will be an increase in expenses as prices of commodities and raw materials rise, as well as transport costs. There will also be higher fees for bank loans. As seen in the recent increases in interest rates by the Federal Reserve of the United States, monetary authorities and Central Banks of other countries will usually raise interest rates to cool consumer demand. Businesses, including SMEs, will find it more expensive to borrow money for expansion or to pay for improvements in operations. For the time being, most businesses have two choices, to pass these higher costs to their customers or let these eat into their profit margins.
Of course, there will still be businesses that may prosper. These could include companies that deal with oil, gas and other forms of energy as well as logistics businesses.
Inflation and the stock market
Generally, higher interest rates will increase the cost of borrowing and lead to a drop in investments by listed companies. With elevated inflation and interest rates, many firms will face higher debt repayments. This will reduce economic growth and therefore lower share dividends – reducing demand for their shares.
Inflation may also sow greater uncertainty and discourage firms from making risky investment decisions. This uncertainty can lower profitability for firms, making shares relatively less attractive. In periods of uncertainty, investors may pull out of shares and put a higher percentage of their portfolio in safer options, such as index-linked government bonds or physical assets that hold their value, such as real estate and gold.
Furthermore, if interest rates continue to rise, bonds become more attractive compared to shares. Low interest rates make shares much more attractive, as with shares, there is the possibility of getting better dividends. If interest rates rise sharply over the next few years, then investors will be encouraged to switch back from shares to bonds because investing in bonds will offer higher returns.
What’s next?
For the second half of this year, I think inflation will ease. Many of the areas where prices were being pushed up last year by extraordinary demand are now seeing inflation rates come down and this will happen to more goods through 2022.
Inflation will subside once revenge spending is satisfied. At the moment, consumers complain about high prices but still continue to engage in expensive activities such as purchasing luxury items or going on holidays. Once this pent-up demand is satisfied, prices may stabilise. Also, if prices continue to stay high, consumers will prefer to save money instead of spending it which will lead to a drop in demand for certain goods.
There are plenty of reasons to believe that the price burst will fade. Much of the price increase this year is due to shortages of goods which will improve as companies figure out how to produce and transport what people want to buy in a pandemic-altered economy.
Cost of labour
In addition to higher input costs, labour costs are also set to rise with economies opening and more in-person activities. Already, we are seeing a labour crunch in the travel and hospitality sectors. Singapore has also tightened its foreign labour policies so wages could still increase in the coming years.
In addition to higher input costs, labour costs are also set to rise with economies opening and more in-person activities. Already, we are seeing a labour crunch in the travel and hospitality sectors. Singapore has also tightened its foreign labour policies so wages could still increase in the coming years.
Mr Song Seng Wun was director and regional economist of CIMB Research for more than 17 years before assuming the post of economist at CIMB Private Banking
