By Dr Ray Choy, Head of Economics & Research
Globally, inflation is now a dominant narrative partly due its high levels that developed countries such as the US and Europe now experience. With inflation levels at more than 8% in the US and over 6% in the Eurozone, Malaysia’s latest CPI (consumer price index) reading of 2.8% year-on- year (yoy) in May-2022 appears relatively benign. However, ask any Malaysian consumer, and most of them would exclaim that their experienced CPI is significantly higher than what official data suggests. There needs to be an explanation of this phenomenon.
Perceived inflation tends to be higher than official CPI data, which measures broad price changes for a basket of goods and services. For an ordinary consumer, inflation is usually perceived on price changes of goods and services which are frequently purchased. Furthermore, consumer items of daily use have lower values and therefore, a price increase would have a larger percentage change as compared to a price change on expensive items such as capital goods. Additionally, consumers have a tendency to remember price increases rather than decreases since paying more is obviously more painful (and therefore, more memorable) than receiving discounts.
There is also the concept of “your inflation and my inflation”. Inflation differs across neighborhoods and regions. In Malaysia, the highest headline inflation was seen in Selangor & Wilayah Persekutuan Putrajaya at +3.7% yoy in May-2022. The lowest inflation was experienced in Melaka at +2.1% yoy.
Since official CPI data measures price changes according to a basket of goods and services, it uses fixed weights for each grouping of items. Therefore, someone with lower income may spend a greater proportion of income on daily essentials as compared to someone with higher income. As such, high inflation can be particularly detrimental to the poor.
Key drivers of inflation
Food inflation is accelerating, mainly caused by the Russia-Ukraine war. Russia is the world’s biggest exporter of natural gas, a key ingredient for fertilizer. War-related sanctions against Russia have led to higher fertilizer costs, resulting in higher vegetable prices and feeds for livestock. Russia is also the largest producer of wheat. Apart from the war, climate change has affected crops’ yields. Rising income levels, urbanization and accompanying socio-cultural change has also led to higher demand for animal-based protein. This causes an adverse environmental impact due to more land and water usage, exacerbating the negative feedback loop with deteriorating climate change and poorer agricultural yields (i.e. shrinking supply capacity).
Food costs are the largest driver of inflation in Malaysia by weight, comprising 29.5% of the CPI basket. In May-2022, the price of food and non-alcoholic beverages increased 5.2% yoy, and has been accelerating throughout the year. Given the continuing Russia-Ukraine war alongside supply chain disruptions caused by China’s COVID-related lockdowns, food inflation in Malaysia will likely remain elevated. For example, within food inflation, sub-indices for Malaysia’s meat, vegetables and dairy product prices increased the most, at 8.0% to 9.5% yoy in May-2022. That said, channel checks suggest that food sellers have not held back on price increases over the last couple of months, implying that food price inflation is unlikely to abruptly spike up beyond what has already been experienced.
Apart from external factors, food inflation in Malaysia is also dependent on government policy, due to subsidies on core food products. For example, there was a recent consideration of cutting subsidies on chicken, and while it was not implemented, this may be a concern in the future. For now, the government has stated supportive intentions and expects Malaysia to spend 51 billion Ringgit on subsidies for fuel, electricity, and food, assuming that commodity prices remain at current levels. While the increase in government revenue from rising commodity prices may be insufficient to offset higher subsidies this year, there may be room to manage this through a reduction in government expenditure. Against this policy backdrop, Malaysian inflation will likely remain well-anchored. At this juncture, governments in Asia remain wary of social dissent should subsidies be abruptly removed, particularly during a period when economies are on a fragile road to recovery. Additionally, in Malaysia’s case, subsidies will likely be encouraged by a highly anticipated election which is due before September-2023.
Furthermore, the recent rise in Malaysia’s interest rate by 25 basis points (0.25%) with an ongoing likelihood of higher interest rates will further dampen incomes, heightening the importance of subsidies in buffering the higher costs of living.
Subsequent and second round inflation effects related to food is to be expected. Compared to the abovementioned perishable foodstuffs, inflation at dining establishments has yet to increase as rapidly, rising by 5.1% yoy in May-2022. With the rise in minimum wages since May- 2022 alongside labour shortages, it is likely that prices at restaurants may climb further in the months ahead.
The other major components of inflation are housing and utilities, with a 23.8% weight in the CPI, and transportation, with a 14.6% weight. Fortunately, housing and utilities prices rose 1.2% yoy in May-2022, a very mild increase. A large supply of incoming residential real estate supply coupled with a continuing trend of lower loan approval rates will likely suppress housing prices. Meanwhile, transport CPI rose 3.9% in May-2022, driven by the continued increase in RON97 petrol price. Despite calls by economists and much hype on the potential of an evolved pricing mechanism, the Malaysian government has recently announced its intention to maintain fuel subsidies, another important factor anchoring low inflation in Malaysia.
Forecast inflation to remain contained, supportive of bond market
Subsidies in Malaysia are likely here to stay, and will help keep inflation near current levels. According to Bank Negara Malaysia (BNM), 2022 headline inflation is projected at 2.2% to 3.2%, while core inflation is also projected at 2.0% to 3.0%. The International Monetary Fund (IMF) forecasts Malaysia’s 2022 CPI at 3.0%. Based on a median survey of economists by Bloomberg, the inflation outlook is sanguine, where 2022 and 2023 inflation in Malaysia is expected to increase to 2.6% and 2.2% respectively, with the highest forecast being a mere 3.3% in 2022 and 3.1% in 2023. While inflation forecast uncertainties remain, headlined by external events, the potential range of outcomes at the domestic level is likely to be more narrow than perceived. As such, unlike developed countries which need to hike rates aggressively to tame high inflation, we do not see BNM needing to do the same. BNM can afford to gradually normalize our interest rates while our growth numbers are still showing an upward trend. We maintain our view of 1 – 2 rate hikes in 2H2022, bringing our OPR to 2.25% – 2.5% by end of 2022.
In Malaysia’s case, tensions remain between the goal of inflation containment and fiscal consolidation due to the presence of subsidies. Nonetheless, subsidies are not unique to Malaysia’s history of macroeconomic policy management. Furthermore, the recent revision of Malaysia’s sovereign rating outlook from negative to stable by Standard & Poor’s will provide greater flexibility and time for Malaysia to manage its government finances.
Anchored inflation will be supportive to Malaysia’s bond market. With the benchmark 10-year government bond yield exceeding 4% in Malaysia, the inflation-adjusted real yield of Malaysia continues to remain positive and relatively attractive compared to developed markets, such as in US and Europe, where 10-year real yields are in negative territory. High bond yields which fully price in interest rate normalisation and elevated inflation will remain a lynchpin to constructive positioning in Malaysia’s bond market.
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