Stresses over food and energy

The new worries about food and energy are leading to more interventionist policies as governments try to find ways to bolster domestic output and source imports from friendly and reliable countries.

| 7 min read

In Sri Lanka there have been riots over the high price of food and the shortages hitting the country. There have been power cuts and difficulties in getting oil as the country runs out of foreign exchange to buy the imports at inflated prices. The country cannot meet its upcoming debt payments and is asking the International Monetary Fund (IMF) for support.

A new Governor of the central bank has raised Sri Lanka’s interest rates by 700 basis points to start to control the runaway inflation at the cost of a further squeeze on incomes. There have been riots against food prices in Peru. The IMF is handling requests from Chad, Ethiopia and Zambia for debt relief. There are dangers of other emerging market countries finding it too difficult to meet debt interest and repayments as their foreign exchange reserves are needed for the escalating price of imported energy and food.

Ukraine so badly savaged by the Russian invasion is in receipt of $723m of special assistance from the IMF, Japan, the UK and other donors. The world is adjusting to Ukraine, one of its great suppliers of wheat and sunflower oil, becoming instead a recipient of food aid. Egypt is trying to ensure replacements for its heavy dependence on Russian and Ukrainian grains. Turkey, Bangladesh and Yemen also import substantial quantities from Russia and Ukraine.

The IMF and World Bank have warned that the strains on low-income countries from Covid-19 have just been worsened by the surge in commodity and food prices and by likely disruptions to harvests from war. As the dollar strengthens and US interest rates rise, so low-income countries come under more financial pressure.

Chart 1: Government debt as % of GDP (2020)

The IMF points out that some of these tensions hit the advanced world as well as the emerging world. Total indebtedness worldwide has surged to over 250% of GDP, with state debt now over 100% on average. They recognise that governments needed to expand spending and accept lower tax revenues during periods of lockdown, and now have the problem of how to offer enough support to low-income countries and people at a time of a big cost of living squeeze.

The advanced countries need to remember those on low incomes in their own jurisdictions. The last official Eurostat figures said that 96.5 million people, or 21.9% of the European Union (EU) population is at risk of poverty or social exclusion. In the US, the census figures reckon 11.4% of the population is poor, and in Japan some 16% earn less than half median pay – which leaves them very short when energy and food goes up in price.

Whilst this has been true for many years, it matters more and is highlighted more today owing to the resurgence of inflation and physical shortages. If governments do not respond well to the need to boost benefits, minimum wages and state pensions, people fall behind rapidly as prices of the basics of food and energy soar. This March, US inflation reached 8.5%. In the EU, Polish inflation is going above 10%, Spain has reached 9.8%, the Netherlands 9.7%, Greece 8.9% – and even Germany is at 7.3%. Keeping warm, driving to work and putting food on the table has got particularly expensive, cutting deep into the budgets of anyone on a low income.

Chart 2: Inflation rates worldwide

All this has a bearing on the stagflation which some now think will stalk economies and markets. We can see the inflation part of this unfriendly mix already. Many of the main economies are now slowing. The US is entering a period of tough monetary tightening which is designed to reduce growth and slacken demand. The German economy saw falling GDP in the fourth quarter of 2021 and is seeing downward revisions to growth for this year.

Whilst the richer, better paid in advanced countries have some savings to draw on to sustain their discretionary purchases as their food and heating bills rise, many on lower pay have no such cushion. For them, paying so much more for heating means cutting out items that they would like but can no longer afford from family budgets. By these means inflation in the costs of the basics reduces demand for the discretionary. For a time, you can experience high inflation and poor demand growth.

There are three possible outcomes

If all goes well, the monetary tightening and government actions starts to bring inflation down, and the central bank can then allow a policy which permits some better growth again. Markets will respond favourably after the adjustment to higher interest rates. If the central banks fail to regain control of inflation, employees may succeed in demanding higher wage settlements and a fast inflation sets in, which requires tougher action by the authorities. As wage rises try to keep up with price rises, companies need to continue to put up prices to cover more of their increased cost. If the central banks and governments overdo the austerity, then they will collapse inflation – but at the price of creating a recession.

The new worries about food and energy are leading to more interventionist policies.

Meanwhile, the pressure on family budgets has a direct impact on public opinion and voting patterns. Marine Le Pen in France is playing up the cost-of-living squeeze to maximise her vote against Emmanuel Macron. She is promising tax cuts to alleviate the budget pressures. In Sri Lanka, people protest to replace the President based on the difficult economic circumstances. In the US, President Biden makes getting inflation down a prime issue as he seeks to reclaim the votes rising prices are taking away from his party in the polls.

The new worries about food and energy are leading to more interventionist policies as governments try to find ways to bolster domestic output and as they seek imports from friendly and reliable sources. We will watch these food markets carefully and monitor the success of the main central banks in judging how far to go in curbing inflation. This will be the major influence on asset markets as investors respond to the way central banks seek to get inflation down without bringing on recession.

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Stresses over food and energy

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