The central bank has to keep a watchful eye on cost-push inflation for now, to anchor forward inflation expectations. THE Malaysian economy got an infusion of multiple packages of cash handout and financial relief, targeted loan repayment assistance, government spending and historic low interest rates to counteract against the ravaging impact of the Covid-19 global pandemic and movement restrictions. During a deep economic recession, keeping low interest rates, loan repayment assistance and easy credit facilities are intended to ease borrowers’ debt services burden (deferred or reduced amount of repayment); and making it easier for consumers and businesses to get cheaper financing. The lowering of interest rates (and fixed-deposit rates) would discourage savings and spur investors to put their cash and excess balances to increase their purchase of goods and services as well as riskier and higher-yielding assets like properties and stock market. Increased for these assets, all else equal, raises their prices. Lower interest rates to boost asset prices can have a double-edged sword. While higher asset prices increase the wealth of households to boost spending and lower cost of borrowing induces credit consumption and business capital spending, low interest rates can encourage excessive borrowing, more risk taking and higher debt levels. The question is that whether the government’s policy responses and Bank Negara’s monetary stimulus to the crisis will have unintended consequences, causing financial imbalances and a big jump in inflation down the road when the economic recovery is in full steam? Since the Covid-19 pandemic-induced economic downturn, Malaysia has suffered 11 successive months of deflation (falling prices) as measured by the Consumer Price Index (CPI) since March 2020, due to the shrinking consumer demand and collapsing crude oil prices (lower retail pump prices). The CPI has declined by between -0.2% year-on-year (y-o-y) and -2.9% between March and May before narrowing progressively from -1.9% in June to -1.4% in December, taking the full-year CPI to an average decline of 1.2% in 2020. In January 2021, the CPI declined by 0.2% y-o-y, attributed to transport (-5.1%), housing, water, electricity, gas and other fuels (-0.7%), clothing and footwear (-0.4%), and restaurant and hotels (-0.1%), which contributed 44.5% to overall weight of the CPI basket. Out of 552 items covered in the CPI, 340 items showed an increase in prices; 138 items declined, while 74 items prices were unchanged. The inflation outlook for 2021 and beyond against a backdrop of economic recovery will offer a contrasting picture. For 2021, headline inflation is projected to average higher between 1.5% and 2.5% or even higher, primarily due to technical low base effect last year in second-quarter 2020 as well as higher global oil prices and commodity price developments. Globally, prices for commodities like oil and base metals have rebounded strongly from the low in 2020 on the back of positive news about the Covid-19 vaccines trials and the embarking of mass vaccination programme. Brent crude oil prices have risen by 40.7% to average US$58.67 per barrel as of March 1,2021 (average US$56.87 in 2020) and Brent crude oil futures surged above US$70 a barrel on March 8 for the first time since the pandemic began. Crude palm oil also rebounded strongly by 43.2% to average RM3,846.82 per tonne as of March 9,2021 (2020 average: RM2,685.50). The World Bank reported that between April 2020 and February 2021, food prices have gone up by 33.4%, raw materials such as timber and rubber rose by 18.9%, while metals and minerals increased by 62.5%. The recent rise in the benchmark 10-year US Treasury yield above 1.50% for the first time since the onset of the pandemic was driven by the prospect of accelerating growth and inflation that could trigger the Fed to start unwinding the monetary stimulus sooner than expected, and cause a faster rise in interest rates. Malaysia’s bond yields also moved in tandem. Malaysia’s Producer Price Index (PPI), which measures the average change in the sale prices of raw materials (goods and services) paid by producers, serves as a leading indicator for the CPI. When producers face inputs’ inflation, increases in their production costs are passed on to the retailers and consumers. PPI for intermediate materials, supplies and components, which had declined since May 2020, has turned to +0.3% in December and +1.1% in January 2021. Are domestic inflation expectations well anchored now? We contend that higher fuel prices at the pump may cause public to begin behaving as though inflation is occurring given a sharp rise in the price of Brent crude since the last quarter of 2020. The base effect of rising energy costs will work on the transport prices. Pump price of RON95 had increased by 48.6% to RM2.05 per litre as of March 10,2021 from RM1.38, the lowest level on March 28-30 2020. The government has decided to cap the retail prices of RON95 petrol and diesel at RM2.05 and RM2.15 per litre, respectively, to protect consumer against the spike in oil price. Headline CPI will be getting normal from a depressed base in 2020. Much of short-term inflation pressure is a gradual normalisation of unusual disparities in supply and demand brought about by the Covid-19 pandemic, as domestic demand and economic activity recovers. Cost-push inflation will be calling the shots in 2021 amid still mending domestic demand. While headline inflation is projected to increase, albeit temporary spike but a sustained strong upward price pressures are unlikely given that wages, an important element in inflation remained weak during a time when the labour market still weak (unemployment rate of 4.9% at end-January 2021) and continued high number of employees lost employment (EIS: 15,669 employees were retrenched between January 1,2021 and March 3,2021 (2020:107,024 employees). Although economic activity has recovered gradually, the economy is likely to have spare capacity as a result of the Covid-19 as the economy’s output is expected to remain below its potential level for some time. A number of factors will influence how that spare capacity affects inflation, including the frequency of price changes across different sectors. Core inflation number and other price indicators bear close tracking. The central bank has to keep a watchful eye on cost-push inflation for now, to anchor forward inflation expectations. This is to safeguard against the occurrence of unrelenting wage demand inflation when the workers ask for wage rise to compensate for rising cost of living. During the 2008-09 Global Financial Crisis, Malaysia’s headline inflation moderated sharply from 5.4% in 2008 to 0.6% in 2009 before picking up to 1.7% in 2010 and 3.2% in 2011. Lee Heng Guie is Socio Economic Research Centre executive director. Views expressed here are his own.
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