It must not be news to us anymore that we stand at a precipice. Most reasonable commentators and experts are forecasting a wave of recession to sweep across the globe in a few months from now. There is little to suggest that this wave will leave the UAE or the wider GCC region unscathed. It behooves us to understand the factors that have led to this situation, only so we may be best equipped to navigate through the incoming rough waters.
It does not need much retelling that costs have gone up. Everything from grocery items to fuel costs, and from housing to your weekend family restaurant meal has gone up, and one would have had to be comatose through this entire stretch to not sense it.
Purchasing managers across the board have noticed the wave of price rises of raw materials and input costs. Those who source their inputs from China have been hit especially hard, and the rapidity of the supply shock has caught many of them by surprise. Increases in raw materials and input costs may be transferred wholesale to the customer, but there may be resistance to this from the customers concerned, which while they may perhaps be unable to react to immediately, they will definitely move away from in a few months’ time. The way value chain economics works implies that pervasive increases in costs will automatically lead to a pervasive decline in demand for the goods produced.
For business managers, this is a time of especial concern as they figure out ways to continue to maintain their profitability and efficiency while causing as less worry as possible to their customers and their own staff. It is natural at this stage for HR costs to be on top of everyone’s minds. Pay rises may meet a glass ceiling or a temporary moratorium despite significant pressure from below. After two years of remote working and the concomitant haircuts in salary, it may be a time when these temporary haircuts assume more permanent forms. From an employee’s perspective, salary incomes not keeping up with rising consumption expenditure would naturally put pressure on said expenditure as well as savings. Runaway inflation will also have a deleterious impact on existing cash savings, forcing people to reconsider their savings and investments choices.
The choices to be made by business managers may not entirely depend on the position of their own business and their own previous performance leading up to this time. Even the most efficient businesses in a sector, such as the HVACR sector, may be forced to raise prices simply because everyone else is doing so.
Unlike several other countries, the UAE has managed to weather through the continuous barrage of adversities over the last couple of years with elan, and has come out the other end with a lot to be justifiably proud of. The chief reason for this is the endless reserves of pragmatism shown by the leadership of the UAE, which has managed to cultivate friendships with one and all international partners, not bending unduly to pressure from certain parties to disavow partnerships with certain others, even as the country continues to discontinue problematic relationships with dignity and self-assuredness. The UAE realises, more than most others, that pragmatism is what got the country from 1971 to 2021; and it knows that it will have to dig even further deep into its wells of pragmatism to take the country from 2021 to 2071.
But for a few tepid surprises, it is a foregone conclusion that the wave of inflation affecting the world will eventually affect the real estate sector in the UAE, as well; as will it affect allied sectors, such as HVACR and Facilities Management.
Clever businesses usually utilise these situations to reconsider their business models and adopt various strategies to tide over the crisis with as little damage as possible. From tactical changes in payroll expenses to headcount management and to office space transfers, at the strategic level, businesses may carefully consider their portfolio of offerings, and rank each segment or activity on an acceptable basis, such as profitability, growth potential and historical performance. Following this, the activities or segments that score the lowest will be marked for winding down.
In parallel, clever businesses will also look for ways to diversify their offerings into new, more promising activities, service offerings as well as markets to offset the losses sustained when getting rid of the old and underperforming entities. It should be noted that the ongoing supply shocks in commodities, such as oil, where you had Brent Crude trading at multi-year highs of over USD 150 per barrel at times during this year, has led to significant economic rents being gained by oil producers such as Saudi Arabia and the UAE, which has meant that the projects market underway in these countries will continue to chug along for the foreseeable future. However, the longevity of this windfall is suspect. Business planners would be cautioned to proceed with utmost care and maximum flexibility in terms of contract arrangements.
One difference with the current wave of troubles is that borrowing rates will finally go up after a period of almost 15 years of continuously depressed rates, making the financing of projects much more expensive. Much of this is being driven by decisions of the US Federal Reserve in the face of runaway inflation in that country. Since the UAE Dirham is pegged to the US Dollar, the Central Bank of the UAE has little option but to mimic the interest rate policy of the US Federal Reserve. And the US Federal Reserve is planning up to eight separate increases of the borrowing rate by 50 basis points (100 basis points is one per cent) each time through 2022 and 2023. The “Finance Cost” section of your company’s income statement will begin to balloon this year, unsurprisingly. Since the base rate charged by the UAE Central Bank is a given, it behooves finance managers to manage their companies’ funding requirements with deftness and flexibility so that these costs are minimised.
If times get too hard, just remember that you are not alone in this. Everyone is going through a similar time.
Krishnan Unni Madathil, Auditor, Bin Khadim, Radha & Co Chartered Accountants, writes a bi-monthly macro-analysis on geopolitics, incumbent political structures, global business and finance exclusively for Climate Control Middle East. He may be contacted at email@example.com.