From Where We Sit

Making more out of inflation

Seb Serrano
By:
Seb Serrano
Contents

As the Philippine economy steps on nascent recovery from the COVID-19 pandemic, the headline inflation remains high at 4.6% in October 2021 from 4.8% in September 2021.  Except for June 2021, headline inflation rests well above the 2% to 4% target band of the Bangko Sentral ng Pilipinas (BSP). Could this high inflation just be transitory or the beginning of a longer-term problem? This is one the most important questions for the global economy now as central bankers and policymakers are divided. 

Inflation is generally defined as the rate of increase in prices of goods and services over a given period of time, which effectively erodes the value of money. Since the trust on money is within the domain of central banks (CBs), CBs are always on the lookout to keep inflation steady at a certain level so that consumers don’t notice changes in prices too much. Through their monetary policies, most CBs balance price increase by around 2% per year. A steady inflation rate is a good thing as it signifies a well-performing, productive, and developing economy. However, if inflation rates go a lot over than the target band most of the time, this indicates spiraling economic problems.

The BSP has recently reported that high inflation, i.e., above its target band, is only transitory and it is mainly because of weather-related disturbances affecting agricultural outputs, higher global crude oil prices, and the positive base effects. The positive base effects are attributed to abnormally low inflation in 2020 despite the cost-push factors and supply chain disruptions brought about by the pandemic. To illustrate the base effect, the crude oil price in September 2021 was P3,655 per barrel and if compared to September 2020, i.e., when prices were recovering from the pandemic crisis, it would show that the price has increased by 86% from P1,969 per barrel. On the other hand, if it is compared to September 2019, or the pre-pandemic level, it is only 17% from P3,128 per barrel. Based on these available data, the BSP maintains policy rates unchanged at a low of 2% to support economic recovery. However, other CBs such as those of Norway, Brazil, Mexico, South Korea, and New Zealand felt the need to clamp down inflation by raising policy rates.

Now, let us take a look at the already pandemic-battered businesses. How can they manage high inflation?

Forecast

The first move in managing high inflation is to forecast how long it will last. According to the BSP’s Q3 2021 Inflation Report, inflation is expected to settle at 4.4%, 3.3% and 3.2% in 2021, 2022 and 2023, respectively. This indicates that in 2022 and 2023, inflation is expected to be within the target band of the BSP. Although inaccurate forecasting bears risks, greater risks come from not forecasting at all. Without forecasting, businesses will always be chasing changing conditions and will face more challenging and unexpected problems. Therefore, companies should closely monitor and update such forecasts and make necessary adjustments that suit their respective businesses.

Manage price perception

The final chapter of an inflation story ends with how consumers felt the increase in prices. Managing price perception is difficult especially in uncertain times; hence, improving pricing power is critical. This starts with identification of market edge, and key products and services. By knowing this information, businesses can grow new offerings through enhancements and new customer experience, for example, resizing, new assortment, bundling and de-bundling products or services which, one way or another, change how consumers create price reference point of a “new” product or service. This calculated new customer experience is a result of crunching costs and margins of independent products and services, which gives businesses new approaches to sell both their key value items and other products that need a market push. 

Revisit supply chain

The pandemic has massively disrupted production shifts and, consequently, congested the global supply chain ecosystem. The imbalance of customer demand and supply pressed businesses to reexamine the savings and gains, such as low handling costs from implementing just-in-time inventory management, which is founded on predictable demand stable production. Businesses that do not have a stable supply chain might miss opportunities, or even suffer permanent damage to consumer perception if consumers cannot get what they want, when they want it. In this regard, businesses need to look at establishing alternate supply chains, appropriate stockpiling of critical supplies with low handling costs and updating safety stock levels based on pandemic and high inflation environment. 

Leverage and hedge

Inflation can help borrowers. With relatively low monetary policy rates and high inflation, taking a loan with fixed interest early on is advantageous because businesses will likely repay the loan with “cheaper” money than actually borrowed. This can even be more beneficial if the loan proceeds will be used for major expenditures such as bulk-discount inventories and planned expansion that will propel revenue streams and generate cash inflows. Why? Because businesses can effectively save a lot more compared to purchasing these items when inflation has normalized. Both assumptions are premised on having inflation as the only significant variable – the higher the interest rate, the lower the present value of debt.

Like leveraging, by having a reliable forecast of inflation, businesses can fix in operating costs with longer terms based on informed judgement. This can mitigate risks of unexpected changes in costs. 

Stress-test

Businesses can run a financial stress-test, i.e., by utilizing financial forecasts with the purpose of identifying the vulnerabilities that might come along the way. Knowing such vulnerabilities, businesses can be better equipped at strategically addressing them without the actual stress when the time comes or, better yet, businesses can proactively prepare and improve on said vulnerabilities. Examples of stresses or “what-ifs” are increase in cost of raw materials and business disruptions causing decline or delays in revenues. These stresses and related financial impact need to be responded to with a strategy or a corrective action. A stress-test is more meaningful if what-if scenarios, and strategy and corrective actions are quantified in currency.

At the end of the day, inflation is always on the deck since it is a function of the supply and demand of money, which is created through selling goods and services. Thus, if businesses play their cards right, they can make more out of it.

 

As published in The Manila Times, dated 17 November 2021