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Arrest inflation at 5%  
Malaysia Perspective | 28 July 2011

By Yang Ming Wan

Inflation, as earlier expected, has taken off and is on its way up. Since the last quarter of last year, Malaysia’s consumer price index has bottomed out and has been rising for six consecutive months.

Over the past six months, inflation has since lifted off from a low of 2% in October and November to reach 2.4% in January this year. It continued to ride on the gathering momentum to hit 3% in March, a critical point with which to gauge its future trend. The latest reading in May showed that it has breached this psychological barrier to register 3.3%, indicating that inflation is well and truly on the rise.

Government policies that sparked inflation
The rate at which inflation has risen in just six months has set a new 26-months high record since March 2009. Based on the trend that the March inflation figure is a full 50% higher than Q4 of last year while the latest figure is 65% higher, the record level of 3.5% set 26 months ago looks set to be broken very soon.

In addition to the accelerating rate of increase over the past six months, a more important factor that has ‘fuelled’ the ballooning inflation is a series of government policies announced in June. From June 1, the Government is abolishing the super-grade diesel subsidy of 32 sen per litre for nine categories of vehicles.

With that, the price of diesel for these transport vehicles has risen from RM1.48 per litre to RM1.80, an increase of 21.6%. Lorry operators promptly announced that they are revising their transportation fees by 30% higher.

In addition to higher transportation costs, the government also announced that electricity tariff will go up by more than 7%. Industries and businesses are the first to bear the brunt of the higher electricity bills, which translate to higher operating costs. These costs will almost certainly be passed on to the consumers eventually. This is especially so for manufactured goods, because the whole supply chain from production to sales involves electricity usage, of which a portion may also involve transportation. For this reason, inflation in June and July will surely be forced upwards further.

Official inflation target of 4-5%

The double whammy of rising transport and electricity bills will certainly trigger a chain of price inflations. Once the 3.5% level is breached, the next resistance level will be at 4%, which is not too likely to hold either.

Minister in the Prime Minister’s Office, Datuk Seri Idris, has hinted strongly that the government’s goal is to keep inflation at 4% to 5%, and is likely to keep it at this level over the next three years.

Idris knows very well that the low inflation in Malaysia has largely been due to the subsidies handed out by the government. The gradual abolition of subsidies that he has proposed must be carried out in tandem with the level of inflation that our economy is able to withstand. Past experiences show that our inflation has never exceeded 5%, for otherwise the economy will contract; if inflation breaches and remains above 5%, the economy will go into recession.

In both the past two financial crises that we experienced, namely the currency crisis in 1997-1998 and the sub-prime crisis in 2008, our economy started contracting and went into recession when inflation breaches the 5% defence level. Therefore, we cannot afford to understate the importance of this magic number.

Difficult to control inflation by abolishing subsidies

If the external economic environment does not throw up any unexpected crises, the Malaysian Government could indeed stabilise inflation at a specific level by controlling the subsidies, which was why former Prime Minister Tun Dr Mahathir Mohamad had set up the subsidy mechanism in the first place. At that time, Tun Dr Mahathir Mohamad was pursuing many mega infrastructure developments, and he was worried that over-development would lead to a high inflation. In order to avoid the pitfall of this economic factor, he set up this subsidy pricing mechanism so that he could continue with his mega developments without needing to worry about any side effects.

However, it is always easier to tie the proverbial bell on the tiger than to untie it. Idris insists on abolishing the subsidies system, and has also set out the action plan. In order to avoid causing inflation that will hit the country’s economic growth with this move, he even consulted Bank Negara, who gave the assessment that “our economy is able to withstand an inflation rate of 5% for up to 3 years.”

It seems that Idris will likely go ahead with phasing out all subsidies while keeping inflation close to 5% over the next three years. However, Idris must realise that it is possible to control inflation only when the subsidy mechanism is still in place.

Once subsidies are abolished, it will no longer be as easy as before to control inflation at 4-5%.

chenzhaojun

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