• Dr. S A

3-I's : IR, Interest rates and Inflation

Integrated Reporting (IR)


Integrated reporting aims to provide a more holistic and balanced view of the company being reported on by combining material aspects such as strategy, governance, performance, and prospects in a way that reflects the commercial, social, and environmental context in which it operates.

The relationship between sustainability and IR

Sustainability reporting (as defined by the GRI Standards) is an essential component of integrated reporting. Sustainability reporting is a critical component of an organization's integrated thinking and reporting process, as it contributes to the identification of material issues, strategic objectives, and assessments of the organization's ability to achieve those objectives and create value over time. Integrated reporting is a growing trend in corporate reporting that aims to provide an integrated representation of key factors that are material to an organization's current and future value creation to its stakeholders and financial providers. In preparing their integrated report, integrated reporters build on sustainability reporting foundations and disclosures (e.g. GRI).

Integrated reporting is founded on three fundamental concepts:

Value creation for the company as well as others

The activities, interactions, and relationships of an organisation, as well as the outputs and outcomes for the various capitals it uses and affects, all have an impact on its ability to draw on these capitals in a continuous cycle.

The capital

The capitals are the resources and relationships that the organisation uses and affects, which are classified as financial, manufactured, intellectual, human, social and relationship, and natural capital in the <IR> Framework. These capital categories are not required to be used in the preparation of an entity's integrated report, and an integrated report may not cover all capitals; instead, the focus is on capitals that are relevant to the entity.

The process of generating value

The business model of an entity, which draws on various capitals and inputs and creates outputs (products, services, by-products, waste) and outcomes through the entity's business activities, is at the heart of the value creation process (internal and external consequences for the capitals).

Interest rates and inflation

Changes in interest rates have a variety of consequences

Interest rate changes have a variety of effects on the economy. The following are the most significant consequences of an increase in interest rates:

Spending decreases - both individual and business consumers will cut back on their spending. Higher interest rates increase the cost of credit, which discourages spending. Higher interest payments on credit cards/mortgages, etc., leave less income for spending on consumer goods and services if we assume incomes are fairly stable in the short term. As a result of the decrease in spending, the economy's aggregate demand falls, and unemployment rises.

Because of the inverse relationship (between bonds and the rate of interest) explained earlier, the market value of financial assets will fall. As a result, many people's wealth will be reduced. They are likely to react by saving in order to preserve the value of their total wealth, thereby further reducing economic expenditure. This phenomenon appears to be related to the UK recession of the early 1990s, when the housing market collapse exacerbated the economic downturn. Houses, rather than bonds, are the primary asset for many consumers today.

A rise in interest rates will encourage overseas financial speculators to deposit money in the country's banking institutions because the rate of return has increased relative to that of other countries, attracting foreign funds into the country. The banking sector in that country could make such funds available as loans to local businesses.

The exchange rate rises as a result of the influx of foreign funds, which increases demand for the domestic currency and thus raises the exchange rate. This has the advantage of lowering import prices and, as a result, domestic inflation. However, it raises the cost of exports and may make them more difficult to sell. Depending on the elasticity of demand and supply for traded goods, the longer-term effect on the balance of payments could be beneficial or harmful.

Inflation falls as a result of higher interest rates, which have three effects on the rate of inflation. First, if there is less demand in the economy, producers may be compelled to lower prices in order to sell. Profit margins and/or wage levels could be squeezed to achieve this. Second, high interest rates delay new borrowing, resulting in a drop in demand. Third, a higher exchange rate will raise export prices, putting a damper on sales, forcing producers to reduce costs, particularly wages. If workers are laid off, total demand will be reduced, and inflation will most likely fall.

Inflationary consequences

Inflation is simply defined as 'rising prices,' and it represents the cost of living in broad terms. The effects of inflation may be beneficial to an economy if the rate of inflation is low. The prospect of higher profits and relatively stable prices encourage businesspeople. However, there is some debate over whether the economic pain of lowering inflation below 3% to, say, zero is worth it (of, say, higher unemployment). However, everyone agrees that inflation above 5% is bad, and it's even worse if it's increasing. The main arguments for such inflation are as follows:

Consumer behaviour is distorted - People may postpone purchases because they anticipate higher prices in the future. This can lead to hoarding, destabilising markets and causing unnecessary shortages.

Income is redistributed - People on fixed incomes or without bargaining power will be disadvantaged as their purchasing power decreases. This is inequitable.

Affects wage negotiators - During times of high inflation, trades unionists on behalf of labour may submit higher claims, especially if they had previously underestimated the future rise in prices. If employers accept such claims, a wage-price spiral could develop, exacerbating the inflation problem.

Confidence in the business world is eroded - Wide fluctuations in the rate of inflation make it difficult for business owners to forecast the economy's future and calculate prices and investment returns accurately. Planning and production are hampered by this uncertainty.

Reduces the competitiveness of the country - If a country's inflation exceeds that of a competitor, exports become less attractive (assuming constant exchange rates) and imports become more competitive. This could result in fewer domestic and international sales of that country's goods, resulting in a larger trade deficit. For example, the decline of Britain's manufacturing industry can be attributed in part to the growth of low-cost imports during a period of high inflation, from 1978 to 1983.

Wealth is redistributed - If the interest rate is less than the rate of inflation, borrowers benefit at the expense of lenders. Savings are losing their real value. From savers to borrowers, and from payables to receivables, this wealth is being redistributed. The government benefits the most during inflationary times because it is the largest borrower (via the national debt).