Covid, disruptions and inflation

As the pandemic fear slowly subsides in regions where a significant portion of the population has been vaccinated, it is expected to worsen the global supply-demand gap. Demand is picking up in richer countries while supply from emerging economies is nowhere close to normalcy. This is bound to create an imbalance.

Global commodities’ prices – food, metals, hydrocarbons, etc. – are soaring. There are two types of economic problems – one is the stock and flow issue, and the other is negative real interest rates and economic stimuli. Countries like Pakistan are on the receiving end of inflation. There are inflationary spillovers, and the trend is likely to continue.

Recall that in the first half of 2020, the sudden drop in demand due to global lockdowns had plummeted commodities’ prices to multi-year lows. Lockdowns had adversely affected supplies too. Some countries (like China) were quick to realize that global stocks of commodities were falling. They started to build up their respective local reserves, and as a result, that demand triggered the reversal of commodities’ prices in the second half of 2020.

Since the supply issues continue to fester, the flow of commodities has remained low. This is especially in the case of food commodities, as their supply is mostly seasonal in nature. A few countries and investors foresee this supply-chain disruption to continue. And anticipating further price increases and supply gaps, they have sped up the purchase of commodities to ensure enough domestic stocks and to make capital gains on cheap money supply (due to low rates and monetary pumping), respectively.

The problems seem to get worse before getting better. About half of the US adult population has now received their first dose of the Covid-19 vaccine. There is immense pressure to open the economy and bring the demand back on track this summer. However, the situation in supplier countries (especially India) is chaotic. In China, manufacturers (global suppliers) are passing on the impact of higher commodity prices onto the processed goods. These trends are fuelling inflation.

Then, low interest rates and unemployment benefits seem to be making the situation worse in the US. Some economists are worried about the impact of lucrative unemployment benefits that may have discouraged people to get back to work at past compensation. Wages are increasing and that may trigger wage-price spiral. Investors are increasingly betting on commodity price hike by buying commodities on cheap borrowing.

Meanwhile, some governments are thinking about fiscal infrastructure spending to generate economic demand. With limited flow supply and falling stocks, this is also a recipe to fuel price increase in metals and minerals. The global investment in new projects (expansions) has remained stalled since 2020, thereby lowering the growth of future supply.

Moreover, the rise of the digital economy and increasing work-from-home incidence has boosted the demand of electronic goods. The semiconductor (microchips) shortage, which is well-established, has adversely affected the automotive industry. Many other industries may feel the heat soon. The cost-push factors have raised the costs of automobile, construction, and food processing. Soon, these factors are going to reflect in household inflation, if they aren’t already.

What complicates the situation is that the US Federal Reserve is not indicating any change in the monetary policy stance to counter cost-push, supply-side inflation. But that is creating asset bubbles – and it is already visible. The wage-price spiral can become a trigger, too. The longer lower interest rates continue, higher is the chance of asset bubbles to balloon even more. Seeing the level of global debts, it will not be an easy decision to increase interest rates, for debt-servicing by government and private sector will become difficult, if not impossible.

While there are talks of global economic reset, that is another debate. At this moment, Pakistan is feeling the heat of fresh rounds of food and commodity inflation. Not to mention (prior to Covid-19), economic stabilization tools – currency depreciation and high interest rates – had triggered inflation at home in 2019-20. The ongoing fiscal year, along with subsequent years, was previously envisaged to be of low inflation to spur growth. But that is not happening.

Food commodities’ prices in Pakistan have historically remained at premium with, or par to, international prices. That is happening in the cases of wheat and sugar. The global prices’ upward movement has been pushing prices northward here. Lately, corn and soybeans prices have also started moving up. That is making poultry dearer. Next in line is milk, which has the highest weight within food inflation.

Then, in non-food commodities, imported inflation in metals and minerals are set to hit prices, too. Construction, automobile and other industries may see upward price revisions. International oil prices are high, too. The government is yet to pass on the impact to consumers –but this has fiscal implications.

The government is focusing on growth and wants real negative interest rates to continue. That is creating asset-bubbles in the domestic markets, continuing to inflate commodities and other assets classes. The question is: for how long can this continue? One may say that until the US and other developed economies continue to keep real rates negative, the story may continue at home, too, as this would keep currency in global equilibrium.

However, the global equilibrium is being challenged. Based on conventional economic thinking, the expiry dates for these expansionary policies are approaching. Interesting times are ahead!

Copyright Business Recorder, 2021