 "Cause and effect: Are corporate profits fueling inflation globally")
The story so far: The global economy encountered unprecedented challenges due to widespread inflation last year. The Federal Reserve has regularly raised interest rates at its last 10 meetings since March 2022. In its last meeting this month, the Fed raised its benchmark rate to over 5 per cent. It is debatable whether these attempts to bring inflation under control in the US have been actually fanning and feeding corporate profits. The graph of corporate profit margins in the United States has seen a steep rise every quarter from $2001.5 bn in Q2 of 2020.
The highest-ever mark of $3001.3 billion was achieved in Q2 of 2022 due to skyrocketing prices of services and commodities. Inflation rose to 9.1 per cent in June last year, and persists at 4.9 per cent despite the hiking cycle of the Fed. Interestingly, inflation in the US was at 0.3 per cent in April 2020 and remained under 2 per cent until February 2021, when things were increasingly moving towards normalcy after lockdowns.
Despite interest rate hikes by central banks globally to tame inflation and the post-pandemic normalisation, consumers in many parts of the world continue to deal with steady rise in the cost of living, especially in the United Kingdom, where the rate of rise has been the fastest in 45 years. UK policymakers are calling for wage restraint to curb inflation. However, the question remains: do higher wages drive up prices and demand?
It has been widely reported that the wage growth continues to lag behind high inflation in several parts of the world. According to a European Central Bank blog post published in March: “On average, from 1999 to 2022 unit profits contributed around one-third to the GDP deflator, over 2022 they contributed an average of two-thirds.” This means, in the euro area, for almost quarter of a century, profits were fueling one-third of the inflation rate on average. The figure rose to an average of two-third in 2022.
After pandemic, the war in Europe—now in its fifteenth month—brought its own challenges for countries that relied on imports from Russia and Ukraine. Last year in April two months after the invasion, the International Monetary Fund (IMF) pointed out that since both Russia and Ukraine are major commodity producers (accounting for up to 30 per cent of the global exports for wheat), supply disruptions due to the conflict have resulted in soaring global food and energy prices.
The IMF also warned that the conflict would affect the global economy, resulting in weak growth and uncontrollable inflation. In response to Western sanctions last year, Russia cut gas supplies to several European countries, including Germany and France, compelling these nations to explore business with Qatar for steady supply of gas. The war only added to the woes of markets wilted by the post-pandemic slowdown.
The negative impact of the war and Covid-induced restrictions proved more challenging for the developing world, particularly in South Asia, where countries like Pakistan are still spectacularly struggling. The nation’s debt-strapped economy is seemingly on the brink of collapsing like Sri Lanka’s due to political turmoil, fall in demand because of loss of income, higher import prices hamper steady inflow of goods due to increasing value of dollar, and dwindling forex reserves.
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India is dealing with its own domestic problems related to the surging prices. A pack of brown bread priced Rs 30 before March 2020 has so far witnessed a price increase of 50% in the country. During its three-day Monetary Policy Committee (MPC) meeting last month, the Reserve Bank of India (RBI) made no change to the repo rate of 6.50 per cent. In FY 2022-23, the repo rate rose by 250 basis points.
Recent developments: The World Health Organization (WHO) has declared the end of the pandemic and the war is still going on. The ill-effects of turmoil in Eastern Europe are now not as adverse on the global economy as forecasts suggested last year. According to the International Energy Agency, Russian oil exports reached a post-invasion high in April with revenues rising by $1.7 billion to $15 billion, with nearly 80 per cent of crude supply going to China and India, which are two of the world’s most populous nations.
The world economy is expected to gain momentum this year in the third quarter. Despite the clouds of uncertainty in the form of the looming recession, the tech sector in the US performed far better than any other sector in the first quarter of this year, with performances of firms such as Apple, Meta, Alphabet and Amazon exceeding expectations.
Price rise is rampant across the world since the pandemic plunged the global economy into a debacle. The recent data published by the statistical office of the European Union, Eurostat suggests that this year in April consumer prices in the euro zone were 7 per cent higher than the previous year. While inflation in the Euro zone stood at 7 per cent, an improvement from the rate of 9.9 per cent at the beginning of the year.
In February, a trade deficit of Euro 200 mn was reported in the eurozone. In March, after a gap of 17 months the Euro zone returned a trade surplus of Euro 17 bn—breaking a long run of deficits caused by the invasion of Ukraine and soaring energy prices as a result of unprecedented cuts in crude oil supply by Organization of the Petroleum Exporting Countries (OPEC) other oil-producing countries.
Last year, despite the highest inflation in four decades, companies in the United States reported huge profit margins. In the fourth quarter of 2022, S&P 500 reported fat profit margins, despite a decline of 2.2 per cent in earnings per share for members. Corporate profit margins that stood at 10 per cent in 2019 reached their highest level in 72 years, rising 6.6 per cent year-over-year to reach over 15 per cent.
While in the Euro zone, profit margins of public companies (measured by net income as a percentage of revenue) averaged 8.5 per cent in March this year, according to Refinitiv. At the end of 2019, the average margin was 7.2 per cent. In India, Adani Enterprises—that is also into agro, oils and foods business—despite finding itself on a sticky wicket due to the Hindenburg Research’s report, recorded a 139.6% rise year-on-year in its net profit.
What this means: Profit-gouging corporations are making it big from Silicon Valley to Ahmedabad, and consumers are at their behest due to their market power. As corporate profits continue to witness a steep rise despite the inflationary environment, the important question is are businesses in the Euro zone and elsewhere increasing prices for profits, which is also fanning and feeding inflation? There is no denying the fact that businesses in Europe, and other big corporations across the world, have market power to maintain demand despite hikes in prices without worrying about losing consumer base.
In a Reuters article published in March this year, Paul Donovan, chief economist at UBS Global Wealth Management, was quoted as saying: “It’s clear that profit expansion has played a larger role in the European inflation story in the last six months or so. The ECB has failed to justify what it’s doing in the context of a more profit-focused inflation story.” In February, the ECB’s Economic Bulletin Issue 2, 2023 had noted: “The environment of supply/demand imbalances in many sectors, high input price pressures and generally high inflation appears to have facilitated increases in profit margins that go beyond pure recuperation of input costs.”
Clearly, the profit-gouging mechanism of businesses is feeding inflation but that may not be true for all economies. The assumption that supply bottlenecks due to the 2020 disruptions and increasing energy prices are driving this surge no longer seems plausible. A substantial increase in profit margins can be linked to increased corporate power (not necessarily gained in the post-pandemic years) that has driven inflation in the past two years in several parts of the world.
(These are the personal opinions of the writer. They do not reflect the views of www.business-standard.com or the 'Business Standard' newspaper.)