Inflation? What inflation?

 

From Paolo Casadio and Geoffrey Williams

The latest data on the consumer price index (CPI) from the statistics department confirms what we have been saying for some time, that despite the noise and chatter about rising prices, Malaysia does not face an imminent inflation problem.

On the contrary, the data shows that annual inflation moderated in December 2021 to 3.2% compared with 3.3% in November.

For the year as a whole, inflation in the final month had fallen from the peak of 4.7% seen in April 2021 and is clearly on a downward trend.

On a monthly basis, prices rose by only 0.4% in December compared with November, of which 0.3% came from higher prices for food and non-alcoholic beverages, which increased by 1.0% in one month, the highest increase since 2015.

Food accounts for almost 30% of the CPI basket and is the highest weight in the index.

It is also likely that the food shortage pushed up, at least partially, the restaurant and hotels component of the CPI, which rose 0.4% in one month, the highest since September 2018.

The causes of price increases in other components of the CPI are also well understood. The first is the increase in the global oil price, over which Malaysia has no control.

The effect can be seen in the difference between headline inflation and inflation excluding fuel. The second is the effect of the removal of utilities subsidies to reduce electricity bills, introduced during 2021 to cushion the effect of the lockdown policies.

The third is supply-side constraints due to the impact of the lockdowns on production and transportation of food and higher costs, including feed for livestock.

This was also made worse by labour shortages due to restrictions on foreign workers and, most recently, the impact of devastating floods in parts of the country which also hit production and transportation very severely.

Against these known real, mostly policy-induced effects, the claims that an increase in the money supply or the Covid-19 stimulus packages have caused or will cause inflation are simply incorrect in our view.

The rise in the price of chicken is not a monetary phenomenon!

The good news is that, based on the data, there are no new factors pushing up prices as a whole and following a period of deflation in 2020, prices across the board are normalising towards levels consistent with longer term-price stability.

Malaysia: Inflation, actual and forecast (annual % change).

According to our forecasts, core inflation will be around 1.6% on average in 2022, rising slowly but remaining below 2% by the end of the year.

We forecast headline inflation to stay around 2% on average in 2022 but there will be a bumpy path, as you can see from the graph.

We see three main factors that will keep inflation relatively low.

First, the cap on petrol prices, especially RON95, will help control any further oil price effects.

Second, wages and salaries are still low and stagnant and have yet to see any real recovery, so wage-push inflation will not be a factor.

Third, price controls across key components of the CPI, particularly some categories of food, will mitigate the supply-side pressures which have caused prices to rise.

These factors will help to prevent possible increases in international oil prices from spreading to prices as a whole, the so-called pass-through effect.

While price controls are useful in the short term, they are not sustainable or advisable in the long term and an immediate removal of all remaining Covid-19 restrictions is necessary to free up supply-side constraints.

To ensure that headline inflation remains decisively under control, we recommend that the temporary subsidy on utilities to reduce domestic and commercial electricity bills should be reintroduced immediately.

This subsidy was very effective during 2021 and reduced the housing cost component of the CPI by 2.5% month-on-month in July last year, contributing a 0.6% monthly reduction in the overall index in the same month.

This reduced headline inflation, in a temporary but significant way, would help to eradicate inflation expectations and ward off dangerous calls for increases in interest rates or cuts in government spending.

If this was introduced immediately, we estimate that the annual headline inflation figure for January would drop to between 1.6% and 1.7%, and remain below 1.5% each month until June.

Tapering out the subsidy in two steps during October and November would see headline inflation rise again, stabilising around 2% at the end of the year. This is shown by the red line in the graph.

This initiative should encourage price stability, with the three measures of headline inflation, core inflation and inflation, excluding fuel, converging to the long-term trend around 1.9% towards the end of the year.

It has other advantages in that the costs are not paid by the government but carried by energy providers that enjoy high profits anyway.

They should welcome this idea as an extension of their corporate social responsibility programmes which have significant social benefits.

While reintroducing the utilities subsidy is a temporary risk management measure, which provides some insurance to protect the economy from bad surprises coming from international oil costs, the price stability that will be achieved will give an important advantage to Malaysia in recovering its growth path and catching up with respect to the other Asean countries.

It will also keep inflation expectations under control and avoid the siren voices of misguided calls for higher interest rates or reduced government spending, which could be disastrous at this stage of Malaysia’s fragile recovery. - FMT

Professor Paolo Casadio is an economist at HELP University and Professor Geoffrey Williams is an economist at Malaysia University of Science and Technology.

The views expressed are those of the writers and do not necessarily reflect those of MMKtT.