Will ESG be yet another cause of inflation?

Portfolio manager explains how sustainability focus among businesses could ripple out to consumers

Will ESG be yet another cause of inflation?

With questions swirling around snarled supply chains, the unleashing of pent-up demand, and the lingering effects of unprecedented monetary stimulus, to name just a few factors, getting an accurate read on inflation this year will be tough for central banks and market participants alike.

And according to Charlene Malik, portfolio manager at TwentyFour Asset Management, the increasing momentum in ESG may complicate the issue even further this cycle.

“As companies and individuals adopt sustainable practices, we believe the potential exists for inflationary consequences in the short and medium term,” Malik said in a recent blog post.

From an environmental perspective, she said the ESG drive is pushing many corporates to significantly reduce their environmental footprints, and net-zero pledges are on the rise. The drive to make processes more efficient and explore new technologies to curtail emissions, Malik said, will push companies to incur higher costs through research and development spending.

Similarly, upgrades to more energy-efficient forms of transport and office space will surely drive increased capital expenditure. Efforts to shift toward sustainable packaging in manufacturing industries, Malik added, will translate to higher costs that “could easily be passed on to the end consumer.”

On the social front, she pointed to likely increases in costs associated with recruitment and retention amid a greater effort toward workforce equality and diversity. Achieving gender equality, notably, will necessitate a harder look at measures to retain women, particularly post-maternity leave.

“One could speculate that the sheer costs and complications of childcare were a factor in many working mothers choosing to leave their job [during the pandemic],” she said, noting that companies hoping to retain that demographic will have to offer assistance in some form.

Similar reasoning applies to the recruitment and promotion of workers from ethnic minorities, poorer socio-economic backgrounds, and employees with disabilities. Recruitment drives, skills training, and retention initiatives focused on such employees will be an ongoing expense for businesses, Malik said.

“Furthermore, those companies with supply chains in the developing world could face increased pressure to mollify social conditions … by implementing fair pay initiatives for all workers in their supply chain and ensuring no child labour is used, even in the businesses of their suppliers,” she added.

In terms of governance, she argued that companies will need larger teams, new hires, and bolstered corporate social responsibility committees. Adhering to global initiatives such as the UN Sustainable Development Goals or the Climate Pledge, Malik noted, will entail added costs associated with monitoring and reporting on top of implementation.

“[C]ompanies that fall behind the crowd or those in ‘dirty’ sectors could see their access to capital markets turned off,” she added. “As a result, their cost of capital would be higher; a cost likely passed on to end consumers.”

While she acknowledged there’s little hard data at the moment to support her argument, she noted that various companies in Q1 earnings calls signalled their intentions to pass on supply chain price increases to their end consumers.

But while ESG costs could create near- and medium-term inflation risks for consumers, they could very well fade and vanish in the long run.

“Lower running costs of electric vehicles, increased productivity from having a diverse workforce and stable energy prices bestowed by renewable energy sources are all plausible beneficial effects created by companies adopting a more sustainable posture,” Malik said.


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