Ernest Hemingway once said, “The first panacea for a mismanaged nation is inflation of the currency; the second is war.” There are few quotes that capture the brutality of inflation like this does.
The uneven post-pandemic recovery, the continued Russia-Ukraine conflict, and an overall complex geopolitical climate offer limited optimism. If a recent Continental Group survey is anything to go by, the inflation impact is seemingly not lost on the public in the Middle East.
A resounding 41 per cent of respondents said inflation is the biggest threat to the economy this year, with many beginning to witness the impact on the cost of living. The governments have been proactive in their response, by earmarking sizable monetary support for low-income citizens and stockpiling key commodities. There is a consensus on Middle Eastern economies’ strengths to weather the storm.
The impact of inflation is expected to be par for the course in the region: Higher domestic fuel prices and a rise in input costs leading to food and other commodities becoming costlier. This is to say the impact is across the board.
Oil production has led to a cash surplus, enabling governments to offset commodity-price shocks. However, because these are importing economies — particularly food imports — inflation is inescapable. And being pegged to the US dollar and with the annual inflation rate in the US at 9.1 per cent for the 12 months ending June 2022 — many regional nations are essentially importing inflation.
Despite noticeable risks, central banks continue to remain hawkish, caught between whether to combat excessive inflation or induce recession. Apprehensions over aggressive interest rate hikes by are now abating due to their potential impact on inducing a recession.
Setting up for another rally? For stock and bond markets, this means that a greater part of the decline has already taken place and that a new rally phase could commence before long. A far greater decline would also be risky from the perspective of central banks as many assets serve as collaterals for the loan.
At this juncture, it is advisable for investors to review their portfolios, as exposures to particular sectors may have changed dramatically given recent market movements. However, one must proceed with caution before exploring portfolio changes for short-term gains from commodities such as energy.
From what can be deduced thus far, prices can rise rapidly but reversals can happen just as quickly. This is especially true when the cause of the sharp increase is a geopolitical event.
The solution hinges on strategic allocation, preferably in consumer staples, healthcare, tech, and financials, thereby maintaining a balance between growth and value investing. Though it may sound counterintuitive, rebalancing your portfolio by selling recent winners — such as energy companies — and buying sectors that have declined may allow you to lock in some gains while ensuring you’re not over-exposed to the risk of a commodity price reversal.
Though inflationary pressures are being felt across the globalized world, the recovery will boil down to structural tailwinds in individual economies. In the Middle East, the consumer pulse is generally upbeat, with a whopping 68 per cent of respondents affirming their continued confidence in equity markets in the same survey.
Don’t go with past responses The non-oil sectors in two of the biggest economies in the Arab world, the UAE and Saudi A, continue to be resilient, with new orders rising and employment levels remaining buoyant. This is evident in the UAE with both business and service sectors thriving through the period of unexpected disruptions.
That said, soaring inflation will continue to pose risks of a recession. And past experiences cannot be trusted entirely to formulate solutions to a modern-day situation, which, due to the complex causal factors such as geopolitical conflicts and the pandemic effect, can be safely deemed unprecedented. But much of the onus is on central banks to devise policies that are attuned to a ‘stagflation’ situation while ensuring transnational congruence in financial markets.