Monetary and fiscal policy Surging prices have forced governments to raise interest rates to curb inflation and safeguard financial stability. These changes are happening against the backdrop of historically high private and public debt. Will central banks continue to tighten monetary conditions aggressively, possibly tipping economies into a recession? Or will they ease up, perhaps risking further price increases now and harsher restrictions in the future? If countries take fiscal measures designed to shield firms and households from higher costs – for example, subsidizing electricity and food – will those measures work at cross purposes with actions that tighten monetary policy? Or, due to mounting shortages and rising prices, will fiscal policy tighten further, possibly leading to slower growth and political backlash?
For Asia, moves by the US Federal Reserve are particularly important. Continuing aggressive interest rate increases in the face of persistent inflation raise concerns of capital outflows from the region’s emerging economies, which may be accompanied by currency depreciations. This could lead to financial volatility and increases in the debt burden of governments and enterprises to the extent that their borrowing is denominated in US dollars, the dominant global currency.
Financial markets Rising interest rates mark the end of low-cost debt and an increase in the cost of borrowing for firms and households. Regional bonds have experienced escalating yields due to changing risk premiums and uncertain future cash flows of financial assets. These factors have led to financial volatility reflected in widening credit default swap spreads, declining and unstable equity markets, fluctuating currencies, and growing uncertainty with respect to the soundness of banking systems, particularly in the US and Europe (considering the recent failures of Silicon Valley Bank, Credit Suisse and others). How should enterprises plan, structure and finance their investments in this uncertain climate? How will the heads of households adjust their borrowing and spending? Will emerging threats to banking systems in the US and Europe spill over into Asia, reminiscent of the contagion during the Asian financial crisis?
Asian managers might feel like they are dealing with a cluster of interconnected earthquakes that are continually transforming the context for strategy and operations. As governments get involved in a widening range of product markets, today’s world is characterized more and more by the weaponization of both global finance and global supply chains. What does all this mean for a rules-based global economic order and the place of Asian economies and enterprises in it?
Few CEOs and policy makers have the experience or possess a playbook for navigating such a chaotic environment. The usual methods of risk management – for example, assessing political risk in a particular country or geographic region – are no longer sufficient. These approaches do not allow managers and policy makers to identify, let alone manage, uncertainties and risks that are interconnected, cross-border and global in nature.
Expanding the toolkit for navigating a turbulent world
Tools supporting strategic decision making in times of turbulence must combine analytics with creativity. The challenge is to identify sources of uncertainty and their potential implications for enterprises. Constructing composite scenarios allows the testing of the resilience of alternative strategies. Typically, this has involved postulating baseline, optimistic and pessimistic scenarios.
Events can be interpreted very differently, depending on assumptions made. Consider the following: How effectively and how quickly will businesses resolve observed bottlenecks in key supply chains such as semiconductors? How will this be shaped by geoeconomics – for example, the US-China rivalry? How will observed increases in the price of energy and food affect the response of central banks, and inflation expectations? What will be the adjustment in exchange rates, capital flows, financial asset prices, and public and private debt in response to higher interest rates? How will the war in Ukraine and related sanctions affect the flows of goods, services and finance in global markets? In Europe? In Asia?
A scenario combines expectations about such a disparate range of factors into an integrated picture of alternative futures. An optimistic scenario would be based on assumptions that such factors, taken together, evolve in a favorable way toward a strengthening global economy. In a pessimistic scenario, assumptions about the set of such factors would lead to expectations of further disruptions and constraints, intensifying pressures on enterprises.
In a turbulent world, it is essential to go beyond composite scenarios and make explicit the specific underlying assumptions about particular events and issues, as well as potential strategic options. An example would be to specify clearly the expectations with respect to the response of central banks to actual increases in inflation. This way critical assumptions can be assessed, monitored over time and adjusted as needed, based on new information.