Inflation? What inflation?

THE Statistics Department’s latest data on consumer price index (CPI) confirms what we have been saying for some time: despite the chatter about rising prices, the country is not facing an imminent inflation issue.

Data shows that annual inflation moderated to 3.2% in December last year, compared with 3.3% in November. This is after it reached 4.7% in April. Clearly, inflation is on a downward trend.

Prices rose by 0.4% in December compared with November – of which 0.3% comprise cost of food and non-alcoholic beverages, which saw a 1.0% increase in one month, the highest since 2015.

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

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

The causes of the price increase in other components of 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 last year to cushion the effects of lockdown policies.

The third is supply-side constraints due to the impact of lockdowns on production and transportation of food and higher costs, including livestock fodder. This is made worse by labour shortages due to restrictions on foreign workers and most recently, the impact of devastating floods.

Against these known real, mostly policy-induced effects, the claims that an increase in the money supply or the coronavirus 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 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 toward levels consistent with longer term-price stability.

According to our forecast, core inflation will be around 1.6% on average this year, rising but remaining below 2.0% by the end of the year. We forecast headline inflation to stay at about 2.0% on average this year, 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 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. An immediate removal of all remaining Covid-19 restrictions is necessary to free up supply-side constraints.

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

This subsidy was effective last year 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 will help eradicate inflation expectations and ward off dangerous calls for increases in interest rates or cuts in government spending.

If this is immediately introduced, we estimate the annual headline inflation figure for January to 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 will see headline inflation raise again, stabilising at about 2.0% 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% toward 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 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. – January 22, 2022.

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

* This is the opinion of the writer or publication and does not necessarily represent the views of The Malaysian Insight. Article may be edited for brevity and clarity.

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