In early June, I spoke about the political risks of inflation, the impact of the Russian invasion and more while on a trip to Turkey. The following were my opening remarks, looking at how these different risks – conflict, isolation, sanctions and developing of new supply chains have added to inflationary risks and complicated resilience.
War is exacerbating the ongoing inflationary trends that stem from uneven recovery from pandemic. These in turn risk domestic stability and regional cohesion and incentivize countries to find alternate supplies. .
Recurrent lockdowns in China have delayed shipments, increased costs for items that did materialize and building redundancy in supply chains will add costs. These measures may help redistribution between labor and capital. Comfort with more localization and state-driven economic choices also comes with costs.
The conflict itself and interpretation of sanctions are remaking supply chains – whole segments of exports to Russia are impaired and more importantly Russian exports and Ukrainian exports are affected – the link to global economy is greatest for food and fuel prices. These hikes add to concerns about social stability as well as growth and financing crisis.
There are few outright winners but there are some countries that are better placed – these are mostly energy and or food producers such as GCC countries where stronger liquidity is helping growth and more petrodollars are being absorbed at home – and more investment is going abroad. Others – deficit countries with food and fuel import needs are doubly hit, especially those where monetary policy was already easy.
Inflation is global, but country specifics matter – countries with more monetary and credit growth and stronger domestic demand like Turkey but also the US . Other countries with later reopening have less domestic demand but tend to have more vulnerability to fuel and especially food imports. Similarly some EM like Brazil and even Russia quickly began hiking rates and had little fiscal space – less inflation but also less growth.
In Europe and many EM, energy is a bigger driver of inflation than in US as labor market is less tight, the earlier shock in 2021 (natural gas). Weaker currencies amplify this.
Combo of weaker growth and higher inflation is triggering a more aggressive policy normalization, which in turn is likely to weaken growth and add to financing costs for many emerging economies. There are few risks of default from major EM countries, but smaller countries on the verge like Sri Lanka, Lebanon, Zambia El Salvador. And we know the difficulties of coordinating on addressing debt issues
Both food and fuel price spikes are politically damaging – but the food dynamics are most challenging to solve given limited options and impact of climate change. Also they link more to domestic political stability in EM, whereas energy issues even more linked to political fatigue in developed economies.
Impact of sanctions going forward.
non-Russian fuel is likely to be more expensive as countries seek to lock in supplies. The US and its allies face important questions about how much to crowd in emerging market buyers such as Turkey, India, China, among others. The US focus on domestic gas prices and real political risk as it makes midterm prospects worse suggests more likely to focus on cutting Russian revenues via driving price down rather than just cutting production. There is a divide between those most focused on constraining Russia and those focused on broader issues and economic/political issues.\
On food there are short-term and long-term issues. Short-term including planned exports, longer due to restrictions on fertiliser etc. Most food benefits from strong exemptions to sanctions, but these exemptions are offset by shipping bans and broader risks. Humanitarian exemptions are often hard to implement and Russia is a unique example of exemption to get food out vs previous sanctions programs that tried to facilitate funds going out. Plus a rare example of conflict obstructing flows that is globally relevant.
US political pressure points are more around energy, emerging markets are also and in some cases more concerned about food prices. In fact there was a lot of wargaming This reflects role that Ukraine and Russia play, as well as the indirect cost of tighter fertiliser. Food prices tend to make up a much smaller share of DM consumption baskets, but play a major role in many EM. Note that breaking point/contributor to Arab Spring was an increase in food and fuel prices.
What to do about it? Any policies need to balance between short and long-term goals and between local and global. This balance won’t be easy. Some measures may include.
- Support for farmers
- Affirmative measures to address sanctions overcompliance.
- Redistribution
- Policies to allow for discounted Russian oil
- Clearer signals about how to manage range of energy security goals -climate and access volumes provisions.
- Capital transfers to pay for additional costs – more realistic debt sustainability.
Subsidies and tax cuts are politically attractive but may not help much as it keeps demand somewhat more elevated and weakens balance sheets somewhere. If it takes it off balance sheet of consumer it usually goes on to government and thus population.
Tariff adjustment? Possible help for the US, but wouldn’t reverse some of the other trends. Plus US is still very committed to boosting production at home and encouraging other countries to do so. That underpins recent TTC (EU) and Asia economic policies. The USG seems yet to have decided what would be a good outcome from its policies with China. Overall, tariffs aren’t helping.
Ziemba Insights 