Tuesday, April 15, 2008

Economics 101 : Inflation rate

Economic downturn: pray for soft landing
Dr Wong Ang Peng


What? Inflation at 2%? Indeed it is, as reported in Bank Negara Malaysia (BNM) – Annual Report 2007, published on March 26. Not only it is at an unbelievable low, it also declined from 3.6% in 2006.

When most countries of the world including Singapore, Thailand, Philippines, China, and the Arab countries have either reported or estimated inflation for 2007 at ranging from 4 to 8%, Malaysia’s at 2% must be among the best managed economies of the world. Deutsche Bank has estimated in November 2007 that the real inflation rate for Klang Valley is 8%.
Is our government flattering itself, or is it typically ‘government speak’?

Inflation rate is deduced from the CPI (Consumer Price Index). Taking a hypothetical case, assuming a cup of coffee is RM1. Giving it a base point of 100, if the price of coffee the following year has increased to RM1.20, which translates to 120 points, by calculation, 20 divided by 100, and then multiplied by 100 to get the percentage. Hence the cup of coffee has contributed to 20% of inflation for the year. Taking into consideration all the consumer prices (food, transport, utilities, housing, entertainment, restaurants, education, health, equipment, etc), and the disparity in prices at different geographical regions, the price index for all consumer items is tabulated for the inflation rate.

Considering that about 30% of consumer items are under price subsidy, the official reported 2% inflation rate may not raise much of an eyebrow. However, upon closer scrutiny of the BNM – Annual Report 2007, the CPI base year has been brought forward from 2000 to 2005. Hence the 2007 inflation rate of 2% was measured compared to 2005 price index. There is certainly a price difference for the cup of coffee based in 2000, 2005, and 2007. When computing the CPI of year 2007 to 2000, and the year 2007 to 2005, two different sets of figures will show.
The above may be theoretical in argument. But the more practical side, based on the following statistics, should sound the alarm bell :
Food and non-alcoholic beverages – 47.1%
Transport – 18.3%
Housing, water, electricity, gas, and other fuels – 13.9%
Alcoholic beverages and tobacco – 7.4%
Restaurants and hotels – 5.6%
Recreation services and culture – 3.2%
Miscellaneous goods and services – 3.0%
Furnishings, household equipment and routine – 2.4%
Education – 1.7%
Health – 1.1%
Clothing and footwear – minus 2.2%
Communication – minus 3.1%
(The abovementioned items and their percentage contribution to inflation for 2007. Source : Department of Statistics, Malaysia)

The poor and the lower middle income group do not care if the price of golf clubs has declined from 2005 to 2007. It also means nothing to them if the price of a branded T-shirt or a flat-screen TV has declined. They care most when the prices of food items increase. And for 2007, inflation of food items has increased to 47.1%, up from 29.7% in 2006.

The majority of the population who make up the poor and the lower middle income group cannot escape rising price in food items, basic transportation costs and housing and utility bills. These top three components contributed the most towards the inflation rate in 2007. Inflation steals value and is considered a form of invisible tax. In proportion of their take home income to expenditure, it is the poor who have to pay more for this invisible tax.

Our government’s contention is that inflation due to external factors may not be effectively controlled by monetary policy, thus has decided to maintain interest rate at 3.5%, ever since April 2006. This is a flawed argument. External factors alone cannot raise inflation unless money supply also goes up. At a 3.5% interest rate, one of the lowest in the region, it enhances credit expansion. The well-to-do and the business class, be they local or foreign, will be favoured. Credit cards usage are encouraged, and most often people spend beyond their limit. Credit expansion and growth in money supply will bring further inflation.

If it is true that the inflation numbers have been massaged, as widely believed, and that the real inflation rate is to be 6 to 8%, then the artificial low interest rate at 3.5% will cause distortion to the economy by sending inaccurate price signals to producers. Easy credit to property developers can lead to an oversupply situation in many parts of the country. There are already signs as such.

We have now arrived at an economic crossroad. We need to have foresight and act decisively. Interest rates can still rise 50 basis points to 4.0% and will still not hurt capital investment. Credit expansion should be geared towards infrastructural development and not for businesses of a speculative nature. Easy money through credit cards usage should be curtailed immediately.
The path to take at this crossroads is the one to favour consumer protection and the socio- economic well-being of the masses who are obviously to be impacted most during the economic turbulence ahead.

And when the downturn comes, we pray for a soft landing. The other path will lead to distortion, mis-allocation of financial resources, more inflation, and possible socio-economic ruin.


Source : http://www.malaysiakini.com/letters/81238

No comments: