Inflation rates continue to remain high in many countries. However, some are beginning to see a slowdown in the growth of consumer prices.
Global pressures are causing rising prices
Russia’s invasion of Ukraine has had a direct impact on global price levels. The cost of food and fuel have notably risen as Russia is a leading exporter of oil and gas and both Ukraine and Russia account for large quantities in the trade of certain foods, particularly grains, as well as iron. The reduction in production and trade of these goods drives price levels upwards. This has happened as it has been physically impossible to produce the same volume of products in a war zone. Also, Western sanctions on Russia have effectively reduced supply to those countries.
These price rises also have knock-on effects in other industries. For example, rising fuel costs impact the logistics industry as companies have higher transportation costs. Food companies that use grains in their ingredients must either absorb the price hike in the grain or pass it on to consumers. These could be restaurateurs, supermarkets or individuals themselves.
Covid-19-related lockdowns in China, the world’s largest goods exporter, also impacted prices. Lockdowns have caused production levels to fall, driving up prices. Although these lockdowns have had an impact on a global scale, the countries that rely heavily on Chinese importers have been most affected. Sri Lanka, which is on the verge of economic collapse, gets almost one-quarter of its total goods imports from China, and it is not alone in recording such figures. It should be noted, however, that in Sri Lanka’s case, high inflation is only one component of the country’s downfall, with economic mismanagement the primary perpetrator.
Additionally, supply chain issues – the ability to get goods from production to consumption – still linger. Not only do these directly impact inflation, but they are also directly impacted by inflation. A vicious cycle.
Inflation in the US and China
Inflation in the US is on a downward trajectory. US inflation peaked in June 2022 (9.1%). Since then, it has slowed in each subsequent month. We now see signs of the US on the downward path of its shoehorn inflation curve. The drop comes after the Federal Reserve (Fed) increased interest rates from 4.25%-4.5% to 4.5%-4.75% in February 2023. This is its eighth hike since the Fed began raising rates in March 2022, when its rate was 0%-0.25%. The Fed wants to return inflation to its 2% target. Inflation in the US is being driven by the increased cost of housing, food and medical care.
Meanwhile, China’s inflation rate has remained relatively low. Its CPI rose to 2.1% in January 2023. This represents a gain of 0.3 percentage points compared with December 2022. China has a self-imposed 3% inflation ceiling. Food prices, in particular pork and vegetables, were key drivers of price increases. The government’s cancelling of its zero-Covid policy could well see inflation creep up further in the coming months. Consumer demand may outstrip supply in food, travel and entertainment and housing sectors, driving up prices.
The highest inflation rates in the world
Of the 183 countries analysed by Investment Monitor, 70 had inflation rates in excess of 10%. Three of the ten highest rates are found in Africa, with Zimbabwe having the highest inflation rate in the world at 230%. Argentina and Turkey, detailed above, are the only G20 countries in the top ten globally. Russia, the country with the third-highest inflation in the G20, ranks 59th globally. Countries that are relatively poor, import reliant and politically weak are at more risk of higher inflation levels.
Inflation impact on FDI
According to the International Monetary Fund (IMF), world inflation reached 8.8% in 2022 (compared with 2021 prices). The IMF expects this will fall to 6.5% in 2023. It also anticipates that advanced economies will return to normal much quicker than emerging markets and developing economies.
The expectation is that inflation will negatively impact foreign direct investment (FDI) levels in the first half of 2023. However, given that most countries in the world are experiencing inflation, investors may also want to undertake FDI to reduce exposure in certain markets. The inflationary pressures may also promote FDI in the form of regionalisation – bringing operations closer to consumer markets. On the contrary, operations farther afield may be deemed too costly, and nearshoring or closures may occur. Foreign investment will depend on inflation levels in the company’s home country and proposed destination country.
Inflation becoming a more prominent FDI driver
Given the high levels of inflation, it would be unsurprising to see investment promotion agencies further promote stable inflation levels in the short to medium term. Although currently not at the forefront of any investment promotion marketing material, an economy with relatively low inflation could promote economic stability to investors. Stable price levels are almost a given in the site-selection process, especially in developed markets. This (now) global issue may change that mindset.
Investors must also judge the expected longevity of rising prices. This may cause overseas expansion to pause in the short term. However, in the medium to long term, inflation will not be as big an issue for cross-border investment. Investors will be closely monitoring government policies to curb inflation. The UK’s Chancellor of the Exchequer Kwasi Kwarteng, lost his job after the markets reacted badly to his September 2022 mini-budget.
The risk of economies falling into a recession will also weigh heavy on investors' minds, at least into the first half of 2023.
Finally, companies may struggle to find the right talent if wages rise in line with, or even get close to, inflation rates.
How to stop soaring inflation
Interest rates are a key tool in controlling inflation. An increase in interest rates makes it more attractive for people to save money. If people are saving money, they are not spending money, which in turn will start to bring down price levels. Increasing interest rates also makes it less attractive for people to borrow money as they will have larger interest repayments. Imagine the difference in taking out a mortgage with a 1% interest repayment rate compared with a 10% rate. This affects consumers' disposable income.
The key balancing act that governments and central banks must consider is the impact on economic growth. Generally, higher interest rates can tame economic growth as the investors question the investment potential of the country.
If geopolitical factors diminish, there could be a positive supply side impact. The rising price of commodities such as foods and fuel may begin to fall if, for example, the Russia-Ukraine conflict stopped and production levels returned to normal. Eroding supply chain issues would also impact prices from the supply side. For example, falling fuel prices and more easily accessible routes to market could reduce transport costs. In turn, this could result in companies passing on savings to consumers in the form of lower-priced goods. That said, the Russian invasion of Ukraine does not appear to be coming to an end any time soon and the global inflation rate issue is unlikely to have an easy solution.
(This article was first published by Investment Monitor yesterday [21])