Is Malaysia Entering a High Inflation Cycle?

KUALA LUMPUR (March 25): Global inflationary pressures have risen in the eye of a perfect storm underpinned by supply disruptions, surging energy and commodity prices, and increased demand amid economic reopening.

Back in Malaysia, most economists expect inflation to trend higher this year to reflect the rise in commodity prices and wages, but do not expect inflation to accelerate rapidly like in the US as domestic fuel subsidies limit the upside.

The Consumer Price Index (CPI) expanded 2.3% year-on-year in January 2022. The Department of Statistics Malaysia is expected to release the February figure on Friday (March 25).

When contacted, Socio-Economic Research Centre (SERC) executive director Lee Heng Guie expects this year's inflation to trend higher in the range of 3% to 3.5%, compared with 2.5% recorded last year to reflect the effect of imported inflation on food inflation coupled with wage-push inflation as businesses seek to protect their margins.

He explained that wage growth is the key driver for inflation. The proposed rising minimum wage rates will ultimately create a labour cost "snowball effect" for employers, pushing labour costs higher across all positions.

UOB Malaysia senior economist Julia Goh and economist Loke Siew Ting agreed that risks to inflation are still tilted to the upside.

Among the key upside risks are global supply chain disruptions, escalating commodity prices, higher wages due to post-pandemic labour shortages and revised national minimum wage, expiry of government's price control schemes, and potential subsidy rationalisation programmes.

"Escalating oil prices are also adding pressure to Malaysia's government fuel subsidy bill and raising the flag for the government to refocus on the fuel subsidy rationalisation plan in order to manage the burgeoning subsidy bill and rebuild fiscal space to respond to future challenges. This potential subsidy rationalisation programme, alongside expiry of government's price control schemes and post- pandemic labour shortages, are expected to drive inflation higher towards year-end. "Minimum wage hike, coupled with the existing labour shortage issues, will then further accelerate the uptrend in private sector wage growth, affirming the second- round effects on inflation in the later part of the year. With all these prevailing risks, we keep our above-consensus inflation forecast of average 3% for this year," both Goh

and Loke said in a Feb 24 note.

Meanwhile, MIDF Research economist Abdul Mui'zz Morhalim foresees that the overall consumer price index (CPI) inflation will be in a range of 2% to 3%, capped by domestic fuel subsidy.

"With the inflation outlook remaining manageable, we don't foresee hyperinflation risk in Malaysia. While high inflation is a risk to the growth outlook, we expect inflation will not accelerate strongly in the coming months.

"In addition, the high oil prices will not result in high inflation in energy prices, limited by the cap imposed on domestic fuel prices and diminishing low-base effect," Abdul Mui'zz told The Edge.

According to him, the source of inflation for this year is expected to come from strengthening demand and supply constraints, including rising production costs.

"By components, we opine that rising food prices will be among the key contributors to upward price pressures. Following the broad rise in commodity prices, food prices could increase further. As a net importer of foods, Malaysia will also incur higher imported inflation, and rising prices of animal feed and fertilisers will also contribute to higher food prices. In addition, increase in wages and prolonged supply disruptions will add to rising production costs, and suppliers may pass on more cost increases to consumers by raising selling prices," he added.

Last month, Bank Negara Malaysia (BNM) governor Tan Sri Nor Shamsiah Mohd Yunus said the nation is "nowhere near" the risk of very-high inflation because upward consumer price pressure had mainly been due to Covid-19-pandemic-driven supply- chain disruptions even as demand recovers in tandem with improving economic conditions due to Covid-19 vaccination progress.

Businesses to embrace rising costs and downside risk to economic growth

SERC's Lee said businesses need to prepare for rising inflation and interest rates. Against this backdrop, he sees the downrisk of the outlook for Malaysia's economy.

"When inflation goes higher, it will curb consumers' spending and corporations have to bear higher business costs. If they cannot fully pass down the costs, hence earnings will be affected.

"Globally, people are seeing a risk of high inflation and long periods of inflation and there will be lower (economic) growth, especially in the US. They also worry if they make a wrong policy could push their economy into recession. In China, its "zero- Covid" policy has prompted more stringent lockdowns and it may cause the economy to slow down...all this (consequences) will hit Malaysia's export demand," Lee added.

With all the prevailing risk, Lee said his risk assessment to Malaysia's economy tilted to the downside. Currently, SERC has projected a gross domestic product (GDP) growth of 5.2% for 2022.

SERC's forecast is lower than the government's projection of 5.5% to 6.5% underpinned by continued expansion in global demand and higher private-sector expenditure, according to BNM.

Considering the latest developments, including the indirect impact brought from Russia's invasion of Ukraine and US's move towards tighter monetary policy increasing domestic business cost, Lee sees there is a need for the government to relook at the GDP outlook for this year.

Malaysia's economic performance in 2021 showed a recovery momentum with growth of 3.1% compared to a contraction of 5.6% in 2020.

Economist expects BNM to raise OPR up to 50 bps in 2022

On the monetary policy outlook, the build-up of domestic inflation pressures together with sustaining growth momentum and more aggressive US Federal Reserve (Fed) monetary policy tightening would justify an interest rate hike by Bank Negara Malaysia (BNM) as early as in the second quarter (2Q) this year, said UOB Malaysia's Goh and Loke.

"A sooner-than-expected rate increase will also help to preserve some room between Malaysia's overnight policy rate (OPR) and the US Fed Funds rate, and maintain exchange rate stability. Thus, we expect the OPR to be raised twice this year. "Thereafter, a successful transition into an endemic phase and a possible easing of geopolitical risks could provide ammunition for further monetary policy

normalisation in 3Q22, bringing the OPR to 2.25% by end-2022," they added.

They stated that the Central Bank kept a wait-and-see approach to assess the impact of Russia-Ukraine conflict and other prevailing risk events on the domestic growth and inflation outlook before adjusting its monetary policy stance.

MIDF's Abdul Mui'zz, who is expecting 6% GDP growth this year, foresees BNM raising the OPR by 25bps to 2% in the second half this year (2H2022), bringing the monetary policy to a more normal level on the back of sustained economic growth and manageable inflation outlook.

The OPR which has been maintained at 1.75% since July 7, 2020 is the lowest on record.

In 2020, the Central Bank slashed the OPR four times for a cumulative 125bps

as the economy was marred by a pandemic with a 5.6% contraction in GDP compared to 4.4% growth in 2019.

(Source: https://www.theedgemarkets.com/article/malaysia-entering-high-inflation- cycle)

QUESTION 1

Explain the inflation driven by the global supply chain disruptions. How this phenomenon will affect the Malaysian economy as a whole?

QUESTION 2

In your point of view, why do you think the expert worries about the tendency of rising inflation and interest?

QUESTION 3

Discuss why economists reject the hyperinflation risks in Malaysia?

QUESTION 4

Explain the monetary policy that can be used to curb the expected inflation hike in Malaysia

QUESTION 5

Assume that you are one of the manufacturing players, and suggest how to mitigate the risk from the inflation driven by the global supply chain disruptions with your company.