This article first appeared in The Edge Malaysia Weekly on December 21, 2020 - December 27, 2020

INFLATION is likely to make a comeback in 2021 after a deflationary trend this year as the Covid-19 pandemic supressed demand for goods and services.

Economists surveyed by Bloomberg are projecting a decline of 1.5% in November in the consumer price index (CPI), which measures the inflation rate, tracking last month’s reduction by a similar rate. For the period from January to October, the CPI decreased by 1%. The Department of Statistics Malaysia is set to release the inflation data for November next Wednesday.

A more subdued inflation pattern is expected in 2021, likely around the 1.5% to 2.7% range, which would be milder than the levels seen three years ago of around 3.7%.

Prof Datuk Dr Rajah Rasiah, distinguished professor of economics at the Asia-Europe Institute of the University of Malaya, believes the projected rate to be reasonable.

“I think Malaysia should not be overly concerned with inflation as the worst inflation rate we have ever faced is less than 10%, which was reached in the mid-1970s following the first oil crisis when oil prices soared by four times.

“We should hope for an inflation rate of between 1% and 3%, for otherwise, it may have a dampening effect on economic growth,” he tells The Edge.

Brian Tan, regional economist at Barclays Asia Pacific, has pencilled in a rate of 2.7%. “The decline in CPI this year has largely been due to lower retail fuel prices and electricity tariff discounts that were provided as part of the government’s response to the Covid-19 outbreak.

“These factors will likely fade in the next year, resulting in the return of CPI inflation. We forecast 2.7% CPI inflation in 2021,” he says.

Malaysia’s CPI for 2020 is expected to decline by 1.1%, says Sunway economics professor Dr Yeah Kim Leng, who projects a 1.8% “benign growth” in inflation in 2021.

“The below trend CPI forecast for 2021 takes into consideration the slack in the labour market as well as in the overall economy in the first half of the year. A stronger surge in consumer spending, triggered by an early roll-out of a safe and effective Covid-19 vaccine and unleashing of pent-up demand in conjunction with supply shortages, could result in an inflation comeback,” says Yeah, a senior fellow at the Jeffrey Cheah Institute in Southeast Asia.

“However, given the global deflationary environment even before the pandemic, the likelihood of Malaysia encountering runaway inflation, even at a moderate pace of 3% to 4%, is considered to be low. Supply shocks, especially to food and energy commodity markets that could result from natural disasters, supply chain disruptions or geopolitical conflicts, are potential sources of inflation shocks to watch out for.

“Given the deep recession in 2020 in the global and national economies, growth and recovery followed by inflation will be next year’s order of priorities for the government, firms and households,” says Yeah.

Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid is hesitant to call the CPI pattern in 2020 deflationary.

“This is simply because the primary mover for the seemingly deflationary pattern is transport and housing, water, electricity, gas and other fuels. Both categories accounted for 14.6% and 23.8% in the CPI basket and both sub-indices have fallen by 10% and 1.4% during the first 10 months of 2020.

“On the contrary, the food and non-alcoholic beverages, which constitute 29.5% of total CPI, increased by 1.2% between January and October this year. Therefore, if you remove the volatile items, namely the fuel and other administered prices, the core CPI has gained 1.2% in the first 10 months of 2020 from 1.1% in the same period last year.

“This seemingly deflationary trend, which was brought chiefly by fuel and electricity, may not be carried forward in 2021. As such, we should see the return of inflation next year,” he says.

Bank Negara Malaysia governor Datuk Nor Shamsiah Mohd Yunus has also said that the risk of deflation is low in Malaysia, even though headline inflation is expected to turn negative this year.

The governor said back in May that for Malaysia to fall into deflation, a “prolonged, broad-based decline in prices, coupled with a collapse in demand” was needed.

However, economists warn that a prolonged period of deflation could occur should there be weak economic recovery.

“A persistent recession or weak economic recovery, together with sticky high unemployment, will lead to prolonged deflation. Other contributory factors include low commodity prices and excess capacity in the economy.

“Low consumer and investor confidence contribute to weak or lack of spending that in turn leads to price declines and a more enduring deflation,” says Yeah.

Rajah concurs, saying that prolonged deflation is possible if consumer demand remains depressed, which could arise from rising unemployment and falling incomes.

“In fact, the sharp contraction in gross domestic product growth over the second and third quarters of 2020 is largely a consequence of the lockdown. The government perhaps has tried to avert that by easing the lockdown despite rising Covid-19 infections and deaths.

“Having said that, it is important to note that the pandemic is a special crisis, which is occurring again after the Spanish flu of 1918. Since people are central to development, governments should focus on containing and ending the pandemic first, with special efforts to assist the people more than being worried about recessions for the moment. The whole world is facing this situation,” he says.

On the global front, the rollout of vaccines on a large scale by Pfizer, Moderna and other companies, and the impact on global economic growth, will be closely assessed. For Malaysia, there is speculation of a general election taking place in the second half of the year, which could also impact growth.

Sunway’s Yeah says that an early rollout of the vaccine will enable consumer and business activities to normalise quicker, thereby enabling a concurrent firming of demand and prices.

He adds that the plunge in demand and weak recovery has made it difficult for businesses to pass through cost increases or raise prices to improve margins.

“With the expected increase in consumer confidence when a safe Covid-19 vaccine is available, the anticipated rise in consumer demand will result in positive price pressures as businesses reduce discounts and rebates offered during the Covid-19 downturn,” says Yeah.

University of Malaya’s Rajah says it may take some time before we can actually see the economic impact from the vaccines.

“Some organisations, such as the World Bank and the International Monetary Fund, have taken a positive position on the introduction of effective vaccines to contain Covid-19 and with that, a ‘V’ recovery approach, and therefore, have projected strong positive GDP growth rates for most countries in 2021, including Malaysia.

“Those projections, I believe, have also influenced our finance minister, Tengku Datuk Seri Zafrul Aziz, to forecast a growth rate for Malaysia of 6.5% to 7.5% for 2021.

“Given that Covid-19 vaccines are only now being tried on people, and even that in a sporadic manner, I do not think that its impact — whether positive or negative — will become obvious until August 2021. Hence, things are still unfolding, and it is too early to foresee this accurately,” he says.

On whether the elections could influence the inflation data, Yeah says that since elections tend to be accompanied by increased government spending and handouts, the economy will receive a shot in the arm.

“The demand boost will have an inflationary impact if there is inadequate supply or capacity to meet demand. However, the effect as seen in past elections is not expected to be significant, given the small size relative to the economy, short duration and one-off nature of the spending injection.

“On the flip side, if the election causes a rise in political uncertainties, consumer and business spending may weaken further and derail the economic recovery as well as exert further downward pressure on prices, thereby prolonging the deflationary environment,” he says.

There is always asymmetry in terms of the impact of fuel prices and the inflation rate, says Bank Islam’s Afzanizam.

“This simply means that general prices would tend to go higher if fuel prices were to go up. However, the same is not true when fuel prices go down. In the same vein, there is also an asymmetric effect on the exchange rate pass-through to inflation. What this means is that the depreciation of currencies tend to lead to higher domestic prices but the appreciation of currencies may not necessarily translate into cheaper prices,” he explains.

Thus, Afzanizam says that the government would need to be cognisant of such dynamics, especially when embarking on reforms in respect of subsidies and introducing new taxes, as it is not a straightforward affair when dealing with the effect of higher prices.

“It requires a clear strategy on how the government should communicate its intention, the execution, and the measurement of the outcome. There must be active engagement with the rakyat and the business community that will be affected by the policy changes,” he says.

In relation to vulnerable and low-income segments, Afzanizam says cash transfers could be the right tool to ensure that these groups will not be marginalised as a result of the policy reforms. “There must be a robust mechanism to monitor those who have been receiving cash transfers to ensure they would be able to elevate themselves up, in other words, upward social mobility.

“Apart from that, financial literacy is also crucial in order to ensure that personal finance among Malaysians will remain healthy and sturdy. We need to inculcate the savings behaviour and, at the same time, encourage our society to be savvy on investments,” he says.

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