What today’s rising inflation means for shipowners

Rising inflation has been the focus of global policymakers in recent weeks as the rapid economic recovery has caused a mismatch between supply and demand while businesses try to rebuild their inventories and overcome supply chain hurdles that were caused by the pandemic. Most countries, including the US and the UK, have seen inflation rise faster than expected, giving rise to debate on how swiftly they should ween their economies off massive monetary stimulus. Both the Federal Reserve and the Bank of England said they will tolerate higher inflation and won’t raise interest rates for the moment, but hinted that a modest increase in interest rates next year might be needed to keep rising prices in check. While most economists agree with the Fed’s view that current inflation pressures are transitory, central banks in developing countries are raising rates to fend off a rise in inflation and some banks, including Germany's Deutsche Bank have issued warnings that focusing on stimulus while dismissing inflation fears will prove to be a mistake if not in the near term then in 2023 and beyond. A little inflation might not be a bad thing as it historically helps asset prices Cause for concern? If interest rates go up in the future, where does this leave shipowners who are already facing challenges of raising capital as banks continue to push the implementation of shipping’s green agenda? Dr Martin Stopford, a leading shipping economist and non-executive director of Clarksons Research, advises to relax and forget about inflation as it takes pretty extreme conditions to generate heavy inflation such as what the world experienced during the First and Second World Wars and the 1970s oil crisis, during which interest rates hiked and eventually settled down. "So far the economic impact of the pandemic is not in the same league as the 1970s oil crisis and why pick on inflation? OK, so US inflation has increased to 5.4%, but that’s against a background of disruptions and shortages that will probably sort themselves out over the next year," Stopford says. Last month, the International Monetary Fund said in its latest World Economic Outlook that inflation is expected to return to pre-pandemic ranges in most countries in 2022. However, it warned that persistently high inflation readings could lead to a reassessment of the monetary policy outlook and increased rates. Meanwhile, a global survey of nearly 500 economists taken this month by Reuters concluded that recent rising inflation in key economies around the world would be transitory. Over 70% of economists said the current uptrend in global inflation will pass and not lead to any major jumps in interest rates. Lock in LIBOR Dagfinn Lunde, a regular Splash columnist and founder of eshipfinance.com, also does not see any central bankers or politicians these days being courageous enough to fight inflation with extremely high interest rates. "I really do not believe it is a big thing for shipowners to worry about. I only advise them to lock in the LIBOR just to be sure and avoid surprises in their projects,” Lunde advises. Lock in the LIBOR just to be sure and avoid surprises in ongoing projects From the shipowners perspective, Khalid Hashim, managing director of Precious Shipping, wants the underlying world economic growth rate to always be in positive territory, even if it means the company will end up with higher interest rates on its borrowing. "Time charter rates for ships go up very sharply very quickly during periods of world economic GDP growth rates. Whilst higher interest rates would mean additional financial costs, they would pale in comparison to the bonanza in earnings that such underlying world economic GDP growth rates bring to shipowners,” Hashim says. Hashim believes higher interest rates are not something to be feared but can become deadly when they arrive during periods of healthy world economic GDP rates when shipping is in a recession due to the overordering of ships, which was the case in the past upturn. He now hopes for a multi-year upcycle for the dry bulk markets as the supply of new ships is not following the boom patterns of the past. Helping asset prices In the container sector, Tim Huxley, chairman of Hong Kong-based Mandarin Shipping, feels that it is unlikely that inflation will lead to rises in interest rates, but a little inflation might not be a bad thing as it historically helps asset prices. For Huxley, higher interest rates might ease the flight to find investments that provide a yield and so perhaps stop the inevitable next round of private equity cash coming in which will probably find its way to unwanted newbuildings. "Excess newbuildings are always the curse of markets,” Huxley cautions. "Any returns you are going to get on cash deposits through higher interest rates are not going to match the returns container and bulk carrier owners are currently generating-if they do, we're really in trouble," he says. There is a growing divide between those worried that prices may be increasing too quickly and those arguing that economies need much more time to grow. Big corporations are increasingly sounding the alarm in their quarterly numbers as they struggle to cope with supply chain disruptions that are pushing up prices. Whether rates go up or not in the future, we still can't forget the energy transition agenda as the industry needs new and cleaner ships on the water. From the brokers' point of view, Affinity's Richard Fulford-Smith reports the orderbook has been at very low levels so the future is bright for those in the container and dry bulk markets who have been through fleet replacement programmes already. However, he thinks the political will to hold interest rates will wane with inflation and that higher funding costs and general inflation should worry owners committing to long term fixed price employment contracts. Fulford-Smith suggests asset inflation, including higher fleet replacement costs, will enhance the values of new ships as older, less efficient ships can face much higher costs and earlier obsolescence. "Shipping faces unprecedented change at a time when legislation will eventually increase significantly the cost of running all but the most ESG compliant ships. That should worry certain shipowners who ignore the advice to look forward,” the veteran broker warns. The IMF’s take The global economy is projected to grow 6% in 2021 and 4.9% in 2022, according to IMF, which stresses vaccine access as a key question for the outlook on how inflation expectations will evolve. It sees two blocks: those that can look forward to further normalisation of activity later this year and those that will still face resurgent infections and rising Covid death tolls. IMF chief economist Gita Gopinath warned that "inflation is expected to remain elevated into 2022 in some emerging markets and developing economies." Many factors are at work in this uncharted recovery and it remains to be seen what a socially acceptable level of inflation is. Even as delta risks loom, early signs from the third quarter show growth accelerating and inflation peaking after its recent jump, at least in the US. China and Europe on the other hand are expected to see greater tolerance for inflation by freeing up more funds for banks to lend, while Russia and Brazil have already started hiking rates. For the world’s biggest central banks, recovery is on track and inflation risks are passing meaning they will be in no hurry to make major moves. The Bank of England, for instance, projected that inflation will hit 4% this year while maintaining rates at 0.1%. “CPI inflation has risen markedly, to above the monetary policy committee’s target of 2%, and is projected to rise temporarily to 4% in the near term. The rise largely reflects the impact of the pandemic as the economy recovers,” the bank said in its latest monetary policy report. High freight costs have been one of the main obstacles in the US economic recovery this year, adding to inventory shortages and higher prices. Nevertheless, they are not seen as a long-term driver of inflation and could even, if they come down a bit, prolong moderate inflation and offset any tightening of monetary policy by the Federal Reserve. Many shipowners rely on debt providers for their business growth, but according to Affinity's Fulford-Smith classically banks go missing at the best moments to invest in down cycles. "Right now they’re largely sidelined but with the good excuse that balance sheet requirements associated with shipping being deemed high risk have hurt them too much," he says. For the time being, shipowners are in the driving seat, enjoying the best times for the container and dry bulk shipping market in more than a decade, and they don't seem to mind increased interest rates as long as the growth continues. Still, there are no major signs of interest rates going up significantly and shipowners have learned their lesson and are keeping the discipline of not ordering much in these times, especially in the bulker segment, which should in addition to phasing out of older vessels keep rates high. Controlling Covid outbreaks and managing recovery while trying to find a viable solution for energy transition still drives most decision making for governments and a rise in interest rates from central banks would inevitably slow down economic growth. If macroeconomic conditions remain strong in 2023, policymakers will be forced to act, but not just yet. Another big name in maritime economics, Dr Roar Adland, professor of shipping at the Norwegian School of Economics, says that debt levels are so high, both in the private and public sector, that the global economies simply cannot handle higher interest rates. "For that reason, and due to the political will to keep kicking the can down the road forever through central bank intervention, I do not believe interest rates will rise meaningfully in the foreseeable future, and so shipowners have one less thing to worry about,” Adland asserts.

What today’s rising inflation means for shipowners

Should shipping be worried by the direction of many central banks? Splash Extra interviews economists, brokers, financiers and owners on the risks of rising interest rates

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