The State of the Nation: Falling oil prices set to take the sting out of new tax

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THE fall in global oil prices may have hamstrung the nation’s economic growth, undermined the government’s fiscal position and weakened the ringgit, but Malaysians can breathe a sigh of relief because cheaper prices at the pump eased inflationary pressures to a five-year low of just 1% in January.

In comparison, the Consumer Price Index (CPI) had risen 2.7% year on year in December.

Economists slashed their inflation forecasts in view of the latest CPI figure. CIMB Research cut its prediction to 2.7% from 4%, Maybank Investment Bank Research trimmed its estimate to between 3% and 4% while AllianceDBS Research revised its projection to 3.5% from 4%.

With the implementation of the Goods and Services Tax (GST) on April 1, the timing could not have been better. The moderating CPI will offset the inflationary impact of the 6% value-added tax, giving the central bank more room to manoeuvre on its monetary policy.

“In the lead-up to GST’s implementation, which will inevitably result in a temporary spike in the CPI for 12 months, slumping world oil prices have acted to lower Malaysian inflationary pressures.

“This means the CPI will not show much of an uptick in 2015 despite the new tax, helping reduce the risk of significant monetary policy tightening by Bank Negara Malaysia,” says Rajiv Biswas, Asia-Pacific chief economist for IHS Global Insight.

In a nutshell, moderating inflation mitigates the need for Bank Negara to raise the overnight policy rate from 3.25% now. In fact, if economic growth continues to moderate, the central bank may even have the leeway to cut interest rates to help stimulate the economy.

It also helps that the country is once again experiencing positive real interest rates after a brief spell of negative real interest rates when inflation exceeded the rates.

In line with a reduction in RON95 to RM1.91 in January, transport costs declined sharply during the month, falling 6% y-o-y. A high base effect helped as well. Transport has 14.9% weightage in the CPI overall while petrol and diesel make up 8.5% of the index.

Since petrol prices dropped further in February to RM1.70 a litre, lower transport costs are expected to further pull down the CPI for the month.

Looking ahead, there may not be much more room to reduce petrol prices as global oil prices have rebounded to US$60 per barrel from a low of around US$48 per barrel earlier this year. However, oil prices are expected to stabilise at this level at least until the second half of the year since members of the Organisation of the Petroleum Exporting Countries have indicated that they have no intention of cutting production.

The recent announcement that electricity tariff will be cut by 5.8% or 2.25 sen/kWh to 36.28 sen/kWh from March 1 to June 30 will also ease inflationary pressures.

That said, other than some savings on petrol, the man in the street might not feel that the cost of living has come down, and rightly so. The effects of cheaper fuel have yet to spill over into daily consumables like food due to price stickiness — prices of goods go up quickly but come down slowly.

According to statistics, as a basket that has 30.3% weightage in the CPI, “food and non-alcoholic beverage” prices rose 2.8% from the previous January. Almost every component in the basket saw an increase, except for meat, which fell by a marginal 0.4%.

In fact, the “food away from home” category (which falls under the food and non-alcoholic beverage group) saw a y-o-y increase of 3.5% in prices in January. Since this group makes up a substantial 10% of the CPI and tends to be the most visible, it is not surprising to find a strong perception among consumers that costs are rising.

In the metropolitan areas, the “food away from home” category, which makes up 10.5% of the urban CPI, saw a sharper y-o-y rise of 3.8% in January.

While the price of food is unlikely to come down as sharply as that of petrol, the government’s price reduction campaign in selected hypermarkets from March 15 should allay some of the concerns about the rising cost of living.

At the same time, falling oil prices, which have reduced cost-push pressures, are not the only reason inflation has eased. Economists point out that moderating demand-pull pressure from weaker consumer sentiment is also a cause.

Excluding food and non-alcoholic beverages, core inflation, which is a proxy for demand-pull inflation, actually eased with prices rising only 0.2% y-o-y in January — well below consensus estimate of 1.9% for the month. In contrast, core inflation rose 2.8% y-o-y in December.

Core inflation is one way of gauging consumer spending. Perhaps telling of weakening consumer sentiment is the fact that the “clothing and footwear” group, which has 3.4% weightage in the CPI, saw prices ease 0.6% y-o-y.

Softening consumer demand is a concern, given that private consumption is the engine of the country’s economic growth. The World Bank has slashed its 2015 GDP growth forecast for Malaysia to 4.7% but the official GDP forecast is still between 5% and 6%.

If lower inflation persists, it could lead to disinflation and create a liquidity trap — where monetary policy cannot be eased further to stimulate the economy. This is what Japan has been battling for over a decade and now the eurozone is facing the same problem.

However, Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz has indicated that she is not concerned that Malaysia’s inflation could dip into “negative territory”.

Says IHS Global Insight’s Rajiv, “With the implementation of GST in April, there will be a temporary spike in headline inflation in Malaysia for 12 months. After that, the tax will not affect inflation. However, in the first 12 months, CPI inflation will likely remain positive.”

He expects the CPI to average 3.3% in 2015 and moderate to 2.7% in 2016 and points out that producer input prices in Malaysia have already turned negative. Last December, producer price inflation in the domestic economy dropped 4.4% y-o-y.

Weaker inflation at this juncture is positive for the country, especially in mitigating the impact of GST. However, compared with neighbouring countries like Indonesia, Malaysia is not benefitting as much from it because of its heavy dependence on oil money.

“Both Indonesia and Malaysia have benefited from lower CPI inflation due to the fall in world oil prices. They have been able to significantly reform their fiscal position by slashing fuel subsidies as oil prices fell,” explains Rajiv.

“The key difference between Indonesia and Malaysia is that the former is a net oil importer, so lower world oil prices will not dent its overall GDP growth. Indonesia is a net oil importer but still an LNG exporting nation.”

In contrast, the slump in oil prices is expected to trim Malaysia’s GDP growth by 0.7 percentage point to an estimated 4.8% in 2015, he adds.

However, because Malaysia’s economy is well diversified, it is more resilient to oil price shocks compared with other petroleum-exporting countries, he notes.

The public is spooked by the sharp fall in crude oil prices because it means reducing oil money and a possible widening of the budget deficit.

Nonetheless, it is not all doom and gloom — lower inflation could be a boon to consumers with a heavy mortgage burden. They can probably sleep better as there is little likelihood of an interest rate hike any time soon.

This article first appeared in The Edge Malaysia Weekly, on March 2 - 8, 2015.