Inflation: Friend or Foe

DAVID SPRING PT COLUMNIST Sydney, Australia

NO-ONE wants inflation. Central banks around the world have been battling inflation since mid-2022, as COVID-era stimulus ended and Russia’s war in Ukraine affected the world economy. The effects of this have been uneven across the Pacific, as mixed postpandemic economic growth has confronted inflation in various ways. Let’s look at the impacts and how firms can weather the economic storm.

The most obvious impact of global inflation is that the cost of imports started increasing significantly from early 2022. Oil prices made the headlines when they spiked – a 28% increase in February-March 2022. Oil gets all the attention because of the flow through of high oil prices to materials and goods, as the cost of transport and manufacturing rise. Oil is now back below pre-Ukraine war levels, so this inflationary stimulus is abating.

Inflation to one side, it is actually the pandemic that has driven the variability of economic growth across the Pacific. Most Pacific nations have a narrow economic base, so depending on the resilience of the reliant economic sectors, the overall economy rises and falls.

From 2015 to 2019, the Solomon Islands’ average annual economic growth rate was 3.0%, driven by export of natural resources, namely round logs. The economy rebounded well from the pandemic-related border closures with infrastructure expenditure, primarily for the Pacific Games , but in April 2023, the economy is still contracting at -3.4% . Headline inflation is at 9.2% (core inflation is steady at 5.9%) and the current central bank interest rate is set at 9.6% to fight inflation. The bank may want to drop interest rates to stimulate economic growth but cannot do so responsibly until inflation is under control.

Fiji has a less resource dependent economy, and relies also on tourism. The Asian Development Bank (ADB) is forecasting the Fijian economy to grow by 14.5% in 2023. This is a bounce, coming off some lean pandemic years. The “services” sector (aka tourism) is contributing 3-4 times as much as the next sector. Inflation is at 2.0% in March 2023. The economy is roaring and inflation is under control – this cannot last! Samoa is another different case but is an exacerbated version of Solomon Islands: very high inflation (11.7%) and negative economic growth (-6.0%).

What can contractors and consultants actually do about inflation? Firstly, there’s nothing that they can do on monetary policy – energies are better spent on mitigations than worrying about what the central banks may do.

Secondly, ensure the escalation clauses in the contract are activated and claimed against. The FIDIC Red book includes these, as do most other engineering contracts. Thirdly, be aware of how other competitors will be affected. Consider work-in-hand, exposure to the high inflation markets, exchange rates, depth of local knowledge and networks. Their ability to withstand the effects of high inflation may give you ideas on how to handle it. Knowing how vulnerable they are also gives you a sense of how likely they are to prepare a low bid for the next tender.

Oil prices made the headlines when they spiked – a 28% increase in FebruaryMarch 2022. Oil gets all the attention because of the flow through of high oil prices to materials and goods, as the cost of transport and manufacturing rise.

Lastly, consider whether inflation can be used to one’s advantage. Is there an upside, or is it all downside?

Gaming the system by putting hedges or bets on which commodities will increase in price and buying large quantities of them is a mug’s game. The best course of action is to be informed and apply it to your situation. Consider the following wisdom from The Economist:

1. Supply shocks (the difficulty of getting supplies) can take a long time to subside, during which they drive up inflation across many sectors - core inflation in the eurozone remains stubborn at more than 5%, and Australia’s has also been over 5% for more than a year.

2. The world is running out of workers, which may keep inflation elevated, especially in ageing countries. Not a problem in the Pacific, but may present an opportunity.

3. If fiscal policy (government spending) is pushing the other way to stimulate demand and boost investment, monetary policy (interest rates) must do an awful lot of work, i.e., they will go very high or remain elevated for a long time.

It is an unusual set of circumstances that the world economy is facing. Low interest rates settings and high government spending during the pandemic left central banks ill-prepared to stave off the flow-on inflation, which was supercharged by Russia’s war. Pacific firms can weather this economic storm by being informed, understanding how these risks affect firms differently (including their own) depending on sector and exposure, and having some cash set aside for a rainy day – that day may well have arrived.

About the Author

David is an experienced engineer, with over 20 years experience in construction, design and international development. David has been working in Solomon Islands and Vanuatu as a team leader for the past six years, specifically on road and bridgeworks. He worked on intraMinistry roles at the Ministry of infrastructure Development (MID, Solomon Islands) and led the Cyclone Pam road reconstruction project in Vanuatu, understanding donor requirements and how development projects are procured and delivered. Continuing as a Team leader for MID and with some corporate responsibilities for Cardno, David seeks to deliver equitable access for communities, which generate social and economic benefits.