This article first appeared in Forum, The Edge Malaysia Weekly on April 27, 2020 - May 3, 2020

The Malaysian economy entered deflationary territory in March with the inflation barometer, the Consumer Price Index, contracting 0.2% year on year. February’s CPI was 1.3%.

Moving forward, projections are for this deflationary trend to persist for the next few months, at least until the third quarter of this year. For the whole of 2020, expectations are for the inflation rate to be at between zero and negative 0.5%. (Rule of thumb for a healthy economy is an inflation of about 2%).

In the past, when deflation occurred as it did in 2009 and again in 2019, it proved to be short-lived and, hence, did not pose a problem for our policymakers. Will it be the case this time around?

Based on March CPI data, deflation is not likely to be a cause for concern in the immediate term as core inflation remained unchanged at 1.3%, indicating stable demand pressure.

However, given that the current Covid-19 induced economic crisis is unprecedented, deflation may warrant more attention than what has been given to it during the last two crises. This is because of the lack of visibility on when the Covid-19 pandemic will finally run its course and the magnitude of the economic carnage that it will leave behind.

In March, the deflationary pressure came mostly from lower oil prices, reflected by the contraction in the transport component of the CPI. Transport accounts for 14.6% of the CPI basket. In the coming months, the reduction in electricity tariffs will also put downward pressure on the CPI. Additionally, it will be driven by reduced consumption spending due to job losses and salary cuts.

When does deflation become a cause for concern? The March deflation can be attributed to several converging factors — crashing equity prices,  a sell-off in the bond market, tanking oil prices and negative economic growth.

This time around, we should not brush deflationary pressures aside; the coming months bear watching. While many see that the March deflation is caused by transitionary factors such as the plunge in oil prices, the possibility of it snowballing into danger zone and starting a vicious economic down cycle can be very real.

In the past, the periods of deflation were short-lived — fiscal and monetary expansions were effective in pulling the economy out of the recession. But this time around, projections are for deflation to stay around longer — at least over the next six months; visibility beyond that is still lacking.

History has shown that for policymakers, deflation is even harder to put a stop to than inflation. The signs that we should be watching out for in the coming months include unemployment numbers, downward pressure on wages, prices of food and, last but not least, retail spending and private investments.

Already, the pandemic and lockdowns have led to a significant global decline in consumer spending in almost every category with the exception of food and consumer staples. Even if the lockdowns end, we may not see a return to normalcy for some time to come; some economists reckon that recovery could only come in 2021.

The latest warning of a recession of unprecedented depth came from Fitch Ratings last week — it made further large cuts to its global gross domestic product forecast. World GDP is now forecast to contract 3.9%, twice as severe as the 2009 recession. It will likely turn out to be the worst recession in the post-war period, it warns. “No country or region will be spared from the pandemic,” it says.

The current thinking is that the global growth, even when it recovers, will remain below pre-pandemic levels through the whole of 2021.

Much will depend, of course, on how effective the government’s pump-priming measures will be and the ability of businesses, especially the small and medium enterprises (SMEs), to survive the still unfolding economic crisis. By the way, SMEs provide more than 50% of the country’s total employment and contribute some 37% to the GDP of the domestic economy.

For now, the prognosis on the economic outlook is not good. Many SMEs are floundering; by nature, SMEs are mostly not cash rich and many of them cannot survive when their operations come to a standstill. Of course, the six-month loan deferment will help, but many of them will still have to cut back the jobs and impose pay cuts to keep costs low, at least until the outlook improves.

So, we will see a rise in unemployment (most see this peaking at 4% on the assumption that businesses start hiring again by the last quarter of 2020) and a downward pressure on wages, which are converging to stifle consumer spending.

Private investments have also taken a beating — many businesses that have financial resources have taken a wait-and-see stance in the current environment. If the deflationary trend persists, companies will not want to expand as they will either incur more losses or make less profit. The ripple effect is slower hiring and lower salaries.

While fiscal and monetary expansion programmes will cushion the near-term economic shock, it will take the economy a much longer time to return to normalcy. It will not be business as usual — the pandemic will certainly trigger a sea change in the global economy, and businesses will have to adapt to, perhaps, a new world order. In the meantime, consumer demand will remain weak as wages and employment will continue to be undermined in this volatile environment.

And that’s where the danger lies. The worry is when we see a demand-decline spiral. If businesses do not invest and consumers cut spending, consumption spending will take a beating across the board over time. The government will find it harder to reflate the economy, more so when it is already facing fiscal constraints. A huge setback is the sharp drop in oil prices; this is not helped by the fact that as corporate profitability falls and people’s income shrinks, tax revenue will fall.

The negative inflation rate has given the central bank more room for monetary policy easing — we will likely see more rate cuts in the coming months. This will help in the short term, but in the longer term, policymakers will face some tough challenges in their efforts to shelter the economy from the storm.

Anna Taing is managing editor at The Edge

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