In this blog post
Economic Context
An economic slowdown happens when the rate of economic growth declines which is measured by a country’s GDP (Gross Domestic Product) – the total value of goods and services produced in a year in a country. Many external and internal factors affect a country’s GDP which in turn has a ripple effect on its economy. Factors such as Government policies, labor markets, trade, foreign policies, financial markets, etc., would have a profound impact on the economy. The most important parameter that signals the economic slowdown is inflation. Inflation is the decrease in the purchasing value of money and the general increase in price.
While it is a known fact that most of the global IT companies have customers and revenue coming in from the US, the current increase in inflation is suggesting an economic slowdown in the near future. Therefore, IT companies globally are cognizant of this fact and are re-aligning their corporate, business, and marketing strategies to overcome this situation.
Current Situation
Amit Bajaj – President North America, TCS, in an interview with Business India quoted, “Yes there is a concern for the rising inflation and there is a concern for talent acquisition, but customers by and large are committed to the large technology adaption across industries”. This suggests that though rising inflation slows down the economy in the near term the greater commitment for large enterprises to significantly cut down their costs and to stay competitive in the market drives the IT services business globally.
The US economy has performed better in the past few months than most people realized. Inflation and related problems, such as tangled supply chains, may continue to challenge business leaders and policymakers, but the US economy is performing well by most measures.
- The unemployment level fell to 2%
- The labor productivity has increased
- Corporate profits are satisfactory which enabled further business investments
- Pandemic-driven technology adoption across industries
Challenges
However, rising geopolitical tensions have impacted the US economy through rising inflation. The political crisis affects the US in two main channels –
- Rising price of oil – As the US imposes sanctions on Russia, one of the major impacts would be the increased price of oil. Russia produces 12% of the global crude oil and the sanctions cause the price of oil to shoot up and the dollar value appreciates resulting in increased inflation.
- Exports to Europe – The dependence of Europe on Russia for Natural gas suggests that Europe could experience high rates of inflation or in the worst case, a possibility of recession. Moreover, 15% of the US exports go to Europe, and appreciating dollar values combined with direct decline in demand would make the US goods less competitive and may trigger a ripple effect on the US economy.
Both the above channels have a significant impact on US exports and thereby on the US economy. So, all in all, the following can impact inflation
- Geopolitical tensions
- Disruptions in the supply chain could be a concern but may be temporary
- Consumer spending on durable goods vs services thereby directly affecting the supply chain disruptions
- Wage negotiations and US monetary policies
Optimism
Deloitte attributes that there is a 55% probability that the US economy registers growth and inflation will fall back to 2% and a 30% probability that the US economy registers an inflation between 3-4% in 2022 despite heightened inflation predictions because of
- Ebbing of the Covid-19 pandemic
- Consumer spend patterns restoring to pre-pandemic trends where spend is more on services like entertainment and travel than durable goods (refer appendix 1)
- Smoother Fed policies
- Business investments continuing to rise to adapt to digital transformation for long-term benefits leading to faster productivity
- Absorption of the workforce due to increased productivity and thereby curbing unemployment levels (refer appendix 2)
Road Ahead
With the rising inflation in the US, concerns among the CFOs are on the rise. 75% out of 138 respondents identify inflation as a point of concern that obviously leaves a lot of planning and strategizing for CFOs to address and mitigate the situation. Following are some important scenarios that can happen and some vital parameters to consider to mitigate based on the context/scenario.
Based on the above chart the probable scenarios Deloitte predicted would be
- Blue skies – Inflation falls back to 2% over the course of 2022
- Sun Showers – Inflation rises over the course of 2022 to 3-4%
- Storm weather – Inflation rises over the course of 2022 to 8-9%
Some of the key parameters for CFOs to look at are (customize according to the scenario)
- Enterprise strategy
- Supply chain
- Pricing
- Capital structures
- M&A
- Human Capital
- Real estate
- Tax
To conclude, though the inflation is on the rise, it is a transitory phenomenon and not going to set in permanently. However, the inflation may peak at 3-4% during 2022 before returning to 2% because of the above-discussed factors. As a seasoned CFO one needs to have an impeccable financial execution strategy to keep the firm in the competition and sustain competitive advantage. Moreover, companies can also gain profit margins through a substantial reduction in costs that can impact business outcomes and ROI for the clients/customers, and hopefully, the inflation is another fading and falling tide.
References
Appendix 1 : Consumer Spending Growth
Appendix II: Labour Markets
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