Our Notes on Crisis : Supply Disruption, Commodity Boom & Inflation
What’s on Inflation
Inflation is starting to pick up anywhere from developed economies to emerging markets. The pressure on price stability is seen to hit a multi-year highs above central banks target. We believe that the rise of inflation worldwide is driven by supply and demand imbalance as the consequence of Covid-19 pandemic that disrupted global supply chain, despite remained anchored inflation expectation.
In response to a higher inflationary pressure, central bankers started to discuss the future monetary policy response. Reducing liquidity injection is likely followed by earlier interest rates hike should the inflation persist.
From Covid-19 to Commodity Boom & Higher Inflation
Input shortage and supply disruption due to lockdown policy have propelled commodity prices to surge. We all witnessed that from energy prices to food and industrial metals have reached a multi-year high.
According to World Bank report, rising commodity prices is expected to last until the end of 2021 before slowing next year. However, based on their forecast, commodity prices to remain above pre-pandemic level meaning that higher inflationary pressure to continue in 2022.
Note that this scenario would differ if input shortage and supply disruption can not be handled properly. The increase in geopolitical tension among commodity producing countries as well as the failure of central banks to communicate their stance would have an impact of rising inflation volatility.
Macro Impact of Commodity Boom on Indonesia’s Economy
As commodity exporting countries, Indonesia would be benefitted from higher commodity prices. We expect commodity boom to increase government revenue. , An increase of oil price by USD1/bbl would add government revenue by IDR4.39tn. Should the average price of crude oil to reach USD74/bbl in 2022, we expect government revenue to increase by IDR22-30tn.
However, rising oil price also could burden government budget as the subsidy for fuel price rising. Increase in oil price would also have an inflationary impact. Our model showed that for an increase of USD1/bbl in oil price would be translated into 0.12 percentage point higher in CPI. We expect domestic inflation to gradually increase in 2022, yet the degree to remain manageable.
Impact of Inflation on Investment
High inflation would erode purchasing power and financial asset returns. Some worried that the risk of stagflation may materialize soon with persistence of high inflation. During 1970’s U.S. stagflation, investment in gold outperformed equities, government bond significantly, indicating that gold is a good hedged against USD devaluation. Note that it was 5 decades ago when USD was no longer pegged to gold as a backdrop. However should inflation persist we expect gold to become a good safe haven.
In Indonesia, the period of high inflation occurred post 1977 Asian Financial Crisis to 2010. At that time, we observed domestic financial market was not quite sensitive. Stock market tumbled and government bond yield rose significantly due to 2008 GFC primarily caused by massive foreign outflows. We see that capital flows remained one of the most significant risk to domestic financial markets given foreign investors holdings on domestic asset is still considered high.
Again we also observed risk on outflows partly due to monetary normalization by the Fed, yet we hope that the impact would not become as severe as in 2013. The combination of financial market development, domestic investor basis and appropriate policy response would be the effective buffer for although short term shock may happen and volatility risk is still haunting.
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