Why Asia’s CEOs fear inflation as biggest hurdle to coronavirus recovery

Supply-side constraints, loose monetary policy, geopolitical tensions and weakening consumer sentiment are just some of the issues weighing on business leaders’ minds
Asia’s economic vitality means it will remain a leading source of growth in the future, but expect more bumps on the road to recovery

Colleen K. Howe

Published: 5:00pm, 19 Oct 2021

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The International Monetary Fund last week called on central banks to watch out for persistent inflationary pressures but said it was too early to talk about stagflation. From the perspective of business, though, worries about stagflation are already here.

In a recent survey of Asia-based CEOs conducted by the Asia Business Council, nearly 40 per cent of respondents believed that inflation – driven by supply-side constraints and loose monetary policy – would be the biggest economic challenge over the next year. That is up from just 7 per cent of respondents in last year’s survey.

Even in mid-2009, when 67 per cent of respondents surveyed thought economic conditions would improve in the next 12 months, only 18 per cent saw inflation as their primary concern. That was the second-most optimistic year on record since the survey began in 2006.

The increased concern this year suggests recent price rises are not just the side effects of an overheating economy, which would be expected as the world recovers from a crisis of the magnitude of the Covid-19 pandemic.

There is evidence that the inflation expectations of businesses are good predictors of actual future inflation. As the IMF warned, there is cause for concern if companies and workers expect inflation to linger, which could feed into a cycle of wage increases and higher prices.

That this inflation is driven at least in part by supply-side constraints makes it more challenging to address. The typical response to inflation – tighter monetary policy – cannot solve these structural issues.

A second factor supporting expectations of continued higher prices is the changing nature of supply chains. The pandemic and the resulting supply constraints for goods ranging from medical supplies to semiconductors have exposed the weaknesses of supply chains and made firms determined to build more resilience into their business models.

But more resilient supply chains can also be more expensive; companies had gravitated towards the just-in-time model to cut costs and increase efficiency. Maintaining higher inventory buffers – one of the key ways to bake more resilience into a supply chain system – increases costs.

If production was organised on a lowest-cost strategy, nearshoring could mean higher expenses. Adopting standardised processes across plants and sites is associated with an initial upfront cost. The shift towards greater resilience is likely to also mean higher costs, at least for some time.

How far can reshoring and decoupling go given interconnected supply chains?

Combine that with the unpredictable nature of geopolitical tensions for another potential drag on global growth. Around 12 per cent of participants in the annual survey expected geopolitical tensions and US-China economic friction to be the biggest economic problem in the coming year.

Tit-for-tat tariff increases might be a thing of the past, but there is always the risk that a sudden policy shift could force businesses to rejuggle their supply chains. That is yet another reason for businesses to build more redundancies into their systems or implement onshoring, further increasing costs.

A third issue is that rising prices dampen consumer sentiment. Consumption in developing Asia has already been hit hard by the pandemic and repeated lockdowns in some economies.

A winter 2020 World Bank survey of businesses ranging from micro to large, for example, found that business sales were around 50 per cent lower than before the pandemic in the Philippines and Indonesia. Small and micro enterprises were more affected than large enterprises.

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China’s economy rose 7.9 per cent year on year in the second quarter of 2021

That could have long-term effects on economic growth through the breakdown of supplier and customer relationships and the loss of job knowledge. Food and energy price spikes could make the situation even more dire, further cutting into households’ pocketbooks just as demand is starting to recover.

Finally, Asian economies are vulnerable to the effects of global monetary policy. A decision by the US Federal Reserve to scale back bond purchases could trigger concerns over capital outflows from Asia.

That would come at an inopportune time for China. Financial market regulators are already on edge in the wake of the Evergrande crisis and amid an ongoing campaign to address risks in the financial sector.

On the other hand, while most executives polled in the survey attributed rising prices to supply-side factors and monetary policy, a few credited a recent surge of pent-up demand. Some 60 per cent of respondents, representing some of the largest businesses in Asia, said demand in their industry or sector had already surpassed pre-pandemic levels.

More needs to be done to ensure smaller enterprises benefit, too, but the fact the recovery has been impressive overall despite waves of continued pandemic-related restrictions on commercial activity speaks to the economic vitality of the region.

Asia remains likely to be one of the fastest-growing regions in the years to come, but expect some bumps in the road as the recovery continues.

Colleen K. Howe is a programme associate at the Asia Business Council

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