The Kingdom of Bahrain can be referred to as one of the few countries in the world that has maintained acceptable inflation rates, hovering around 3%, thanks to a number of factors. Foremost among these factors is the pegging of the Bahraini Dinar to the strong US Dollar, which has shielded it from significant devaluation experienced by many currencies in emerging markets. Additionally, high interest rates and a controlled injection of liquidity into the market have contributed to this stability.
While many a book can be written on Fed’s balancing act on inflation in a post Covid world, which has been made more complicated with the ongoing war and related energy crisis, fear mongering has only made things worse as recent bank runs across the globe evidently show.
This leads us to the natural question, what comes next for global inflation? And where does this leave the MENA market?
Industry experts told the International Monetary Fund (‘IMF’) recently that regional diversity made the implementation of monetary policy in the MENA region a challenge. Since 2020, the Middle East region has been grappling with inflation due to higher food prices and currency depreciations, though We expect this to slow down in the short term, in line with the IMF expectation. Global inflation is expected to hover at 6.6 percent in 2023, from 8.8 per cent last year and further decline to 4.3 per cent next year .
The MENA region’s performance has been buoyed by two of its biggest economies, the UAE and Saudi Arabia. Both have shown resilience amid global doom and gloom, due to oil windfalls and consistent economic reforms. The Saudi government expects the economy to grow by 3.1% in 2023 , while the Central Bank of the UAE expects the economy to grow by 4.3 per cent in 2024. The cushioned impact of the recent global bank failures has only helped their case.
Regional inflation will also have an impact of the continuous modest run of the US Dollar. In our view, the Dollar remains one important driver of capital flows to the MENA market. Modest USD weakness should, therefore, be supportive of further capital flows into the region.
In the immediate future, global inflation also looks most likely to recede. Supporting this are easing supply bottlenecks and lower commodity prices. Arguably more important for global investors, however, is the longer-term outlook for inflation and if we will return to the ‘old normal’ of ‘lowflation’? Or will fighting inflation be the Fed’s predominant concern? We believe that a return to the old ‘lowflation’ environment is the least likely outcome. There are three key factors driving this view.
One of the main drivers of ‘lowflation’ was the acceleration of globalisation following the initiation of diplomatic ties between the US and China in the 1970s, the collapse of the Berlin Wall in 1989 and China’s accession to the World Trade Organisation in 2001. These three events unleashed a huge wave of disinflationary pressures as companies focused on redirecting investment aimed at increasing cost efficiency. This trend is best evidence by the rise in the trade intensity of global economic activity (see chart below).
However, there are signs that this ‘peace dividend’ is starting to unwind as the trade intensity of GDP has started to decline. Meanwhile, there is increasing anecdotal evidence that even the trade that is taking place is factoring in geopolitical risks. This is leading to ‘friendshoring’ or ‘nearshoring’. While this is presumably a better economic outcome than onshoring, the benefits are likely to be significantly lower than a more globalised world.
The trade intensity of global economic activity appears to have peaked
The second factor that is likely to drive inflation higher is the drive to become carbon neutral. While the increased cost for greener sources of energy will diminish over time, they are unlikely to disappear. Meanwhile, the scale of infrastructure investment required to achieve the net zero targets is incredible, and this is likely to put upward pressure on the prices of all sorts of raw materials and inputs.
The final potential driver of higher inflation is the world’s aging demographics. Urbanisation, the prevalence of the internet and more access to education are driving fertility rates lower around the globe. This will reduce the size of the global workforce and likely give workers increased bargaining power, as opposed to the declining trend over the past 30 years. If this scenario plays out, higher wages will likely put upward pressure on inflation.
Working population likely to decline putting upward pressure on wages Therefore, while the trend for 2023, and maybe into early 2024, is likely to be for inflation to fall back towards central bank targets, we believe the next decade and beyond is likely to be characterised by upside risks to inflation. The vast majority of my career has been in an environment when central banks have been focused on avoiding a debt-deflation spiral. Going forward, it is likely to revert to an environment where it is more alert to the upside risks to inflation and less willing to come to the market’s rescue every time there is a risk-off environment.
By Steve Brice, Chief Investment Officer at Standard Chartered Bank’s Wealth Management unit
