Prospects of ’stagflation’ are rising, with added supply-chain risk, China’s lockdowns, and tighter labour market conditions 

The prospects of prolonged inflation and slower economic growth are rising, with added supply-chain risk from sanctions on Russia, China’s pandemic lockdowns, and tighter labour market conditions in general, according to Fitch Ratings.

It sees 34 of 81 publicly rated APAC corporates facing ‘Elevated’ downgrade risk under a stagflation scenario. This includes 23 of the 49 APAC corporates rated ‘BBB-’, which would fall out of the investment-grade range and become ‘fallen angels’ if downgraded.

The severity of labour shortages and associated wage pressures varies across APAC economies, with, for example, Australia being more exposed than China and Indonesia.

Fitch’s analysis considered two key factors: each corporate’s existing rating headroom (how close they are to breaching negative rating sensitivities) and the impact of a scenario in which oil and other commodity prices were significantly higher than in its baseline over 2022-2023, resulting in higher input-cost inflation, dampened demand and higher interest rates, affecting corporate cash generation. 

The rating agency also considered the impact of foreign-exchange risk and continued supply-chain disruption.

Within the overall group, 33 corporates were assessed with ’Low’ rating headroom, 22 of which were rated at ‘BBB-’. They include 13 India-based entities whose ratings would be vulnerable to shifts in India’s ‘BBB-/Negative’ sovereign Foreign Currency IDR rating or its ‘BBB-’ Country Ceiling. All 33 corporates were assigned ‘Elevated’ stagflation downgrade risk.

The effects of stagflation were assessed as posing a ‘High’ risk for only 5% over the portfolio, but ‘Moderate’ for 60%, and ‘Low’ for 35%. Cost pass-through ability, a lower inflation impact on demand, and manageable forex risks can reduce overall inflation pressures on profitability and cash flow.