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Rapid Pace Of Inflation Complicates Policy Outlooks In 2022

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Inflation is expected to pick up in 2022 as the effects of ongoing global supply chain disruptions are transmitted to Malaysia’s consumer prices. The nature of this cost-push inflation limits the effectiveness of conventional monetary policy while the government’s various price control efforts will impose an exorbitant fiscal cost.

The prices of raw commodities (e.g., food and fuel) and their derivative products (e.g., fertiliser and metals) have escalated significantly. The IMF’s aggregate global commodity price index jumped 52.7% YTD April 2022, markedly faster than the pre-pandemic trend of 1.9% annually between 2010 and 2019. These broad-based price increases come amid an extended period of unfavourable global supply conditions on the back of the Russia-Ukraine war and economic lockdowns in key Chinese cities. Export controls in major commodity exporting countries compound these effects. As a result, most firms globally will face higher production costs.

In Malaysia, the degree of cost pass-through from companies to households is somewhat mitigated by existing subsidies and price controls. However, as labour-intensive and commodity or import-dependent firms will be most affected by current conditions, the degree of cost pass-through would be significant for these firms. In particular, the general price of food is expected to climb faster than the 4% uptick registered in the first four months of 2022 (pre-pandemic average: 3.3%) if supply conditions remain unresolved.

We expect Bank Negara Malaysia (BNM) to mainly adjust interest rates on the basis of economic recovery while also responding to the risk of demand-pull induced second-order effects and inflation pervasiveness. While increasingly widespread, the extent of price increases is currently less severe than that seen in previous rapid inflationary episodes.

At the same time, second-round price effects or a wage-price spiral is not immediately evident as labour market conditions have yet to fully recover. Nevertheless, rising food prices is a policy concern as at least 20% of the expenditure of most Malaysian households goes towards food. Further, the impact of the rising cost of necessities is disproportionately felt by the more marginalised segments of the economy.

As secondary inflation risks remain limited at this juncture, we expect the Overnight Policy Rate to gradually normalise to end the year at 2.25% in line with the pace of economic recovery.

The fiscal cost of managing subsidies and mitigating price pressures is substantial. For example, an oil price assumption of USD100 per barrel coupled with current retail pump prices will lead to projected fuel subsidy expenditure of RM34 bil this year (14.6% of Budget 2022’s operating budget). Higher oil-and-gas-related revenues will be insufficient to fully offset this fiscal strain, thus necessitating the realignment or consolidation of various operating expenditure items. This may have implications for some federal government-led support programmes.

Given the nature of current price pressures, a near-term normalisation of inflation conditions is not expected. Domestic supply-side policies – such as improving domestic logistics and production capabilities, favourable trade agreements with suppliers of key commodities, and streamlining administrative bottlenecks – will be key in managing inflationary pressures this and next year.

About RAM Rating Services Berhad (RAM Ratings)

Established in 1990, RAM Ratings is a leading credit rating agency registered under the Securities Commission’s Guidelines on Registration of Credit Rating Agencies, 2011. In addition to the provision of credit ratings for corporate bonds and sukuk and their issuers, RAM Ratings also provides research and publications on Islamic finance, fixed income and macro-economic and industry analysis as well as data analytics relating to credit risk, counterparty assessments and other related domains.

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