We are constructing a new house. This week's steel vendor quote was shocking. The price of steel bars rose from Rs 50 a kilogram in February to Rs 60 today. That's a 20% rise in a couple of months. Then, at the tile shop, the owner said tiles won't be available until after May 1. Due to the LPG shortage, production has stopped, and prices may rise by at least 30% when it resumes.
This sudden rise in construction costs didn't just make us angry and frustrated, but also worried. In theory, I could have hedged this risk back in February through a forward contract. But in reality, that's not something you can do with a local supplier. We need something more to protect us. Having said that, businesses and countries have a few levers, and those are evolving in these uncertain times.
Common People Have Lesser Options
For most of us, inflation is the biggest risk, but we cannot do much about it. We have a handful of solutions to fall back on, such as holding gold, keeping cash buffers, diversifying across equity, debt, and real estate, and buying insurance. These don't eliminate risk, but they help soften the blow.
The problem is, all of this works only at a broad level. You can't hedge specific expenses. You can't lock in construction costs, school fees, or hospital bills in advance. So at the individual level, hedging is limited. You can protect your wealth, but not specific outcomes.
Where Financial Tools Fall Short
Companies operate with more sophisticated tools. They use derivatives — forwards, futures, swaps, options — to hedge against currency movements, interest rates, and commodity prices. But even here, they can go only so far.
Take Covid for example. No company could hedge that.
If risks are clearly defined, they can be hedged in the short term. But it becomes unclear in the longer horizons. We don't know what exactly needs to be hedged and at what cost. On top of that, derivatives require collateral, which ties up liquidity. Liquidity is exactly what you need most when things go wrong.
That's why financial hedging falls short when the problem shifts from risk to uncertainty. Risk is when you know the outcomes and their probabilities. Uncertainty is when you don't.
Revamping Supply Chains
But financial risks are only one part of the story. Businesses have become more vulnerable to supply shocks. Here, the problem shifts from prices to availability.
Modern production systems are so interconnected that missing even one input can halt the entire process. Think of a car manufacturer. It needs semiconductors, batteries, tyres, wiring systems, and dozens of other components. During the semiconductor shortage, companies like Toyota and Volkswagen had to cut production because one critical input — the chips — were unavailable.
This happens because firms rely on specialised inputs. Specialisation improves efficiency, productivity and quality in normal times, but it also reduces the number of alternative suppliers. Replacement becomes difficult during supply shocks. Recent experience has led companies to move towards building resilience.
Instead of trying to hedge everything financially, they are trying to keep the debt low, hold more cash, diversify suppliers, maintain inventory buffers, and spread operations across locations. It looks inefficient in good times. But in bad times, that helps companies survive.
Import Diversification, Economic Vulnerability
Now, let's move to countries. Countries need each other, whether it is oil, food, fertilisers, or critical inputs like semiconductor chips. The main concern is import concentration, not import value. If a country depends too much on any one country, it is vulnerable to supply shocks.
We've seen this recently. Europe scrambled to get gas post Russia-Ukraine war. India has been diversifying its oil imports across multiple countries during the recent disruptions in global oil markets. Even "China+1" came from the same idea.
Therefore, strategies that help them spread and reduce risks across suppliers, regions, and systems have become more important.
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Final Take
Individuals, firms, supply chains, and countries have all resorted to more diversification across different channels. That's the new normal.
Interestingly, this is something we've always known in personal finance. We are constantly told not to put all our eggs in one basket. But somewhere along the way, we forgot that principle in trade and geopolitics. In the pursuit of efficiency, lower costs, and short-term financial gains, systems became more concentrated. It worked well — until it didn't.
That's because uncertainty opens up a range of risks we cannot fully measure or prepare for. Consequently, financial hedging becomes insufficient and requires a wider approach.
Call it building redundancy, adaptability, operational flexibility, buffers, diversification, or even multilateralism at a country level. The names differ, but the idea remains the same. You may not be able to predict the shock, but you can decide how exposed you are when it arrives. Sadly, all I can do for my construction project is ensure I have enough money in the bank.
Disclaimer: The views expressed in this article are solely those of the author and do not necessarily reflect the opinion of NDTV Profit or its affiliates. Readers are advised to conduct their own research or consult a qualified professional before making any investment or business decisions. NDTV Profit does not guarantee the accuracy, completeness, or reliability of the information presented in this article.
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