Rising upside risks to inflation

INFLATION in Malaysia may not be as high as in the US, which hit 8.6% in May, but many are watching for upside inflation risks.

Is the upward trend in prices a short-term phenomenon to the economic reopening, or does it indicate something more serious and global in nature?

With most companies holding onto stocks, inflation risks may not yet have made their way into the economy.

Nevertheless, rising commodity prices are among the main upside risks to inflation.

Supply chain disruptions, rising business costs, labor shortages and demand-side pressures in terms of demand recovery also pose upside risks, while the weak ringgit adds to costs and inflationary pressure.

Concerns over the removal of subsidies such as the heavy fuel subsidy pose another level of risk.

This could force the country to adopt a new cost base, with a complete rewrite of the cost structure.

Malaysia must now recognize that it cannot expect to retain the old cost paradigm.

The post-Covid 19 ecosystem is real, lest we choose to remain oblivious; the whole world is resetting, post-pandemic, and this will lead to a structural paradigm shift from the simplest activities to complex manufacturing processes.

Product input costs have permanently changed and increased, due to defining events such as the Russian-Ukrainian war; these changes will lead to adjustments along the value chain related to input costs.

Take the example of roti canai, where the prices may have stayed the same but the person may have to order two instead of one because the size of the loaf has decreased.

The economics of the supply chain, from the wheat fields to the seller of roti canai to its consumer, will trigger consequent chain adjustments until a market equilibrium is found.

“Upside risks of higher and longer-term inflation remain,” said Socio-Economic Research Center executive director Lee Heng Guie.

The price of oil remains high; Despite news of production increases from the Organization of the Petroleum Exporting Countries, the easing of Covid-19 measures in China added another boost to oil prices.

If oil prices reach new highs, even testing US$150 (RM660) a barrel, we will see another round of inflationary upside, said Wellian Wiranto, an economist at OCBC Bank (M) Bhd.

Food is another key area to watch, with global markets still digesting the aftermath of the war with Russia.

With high fertilizer prices due to concerns about potash shortages, there are fears that crop yields will be reduced globally as farmers are forced to reduce their use of fertilizers.

This could lead to new risks of food shortages, thus aggravating the food inflation we face.

Inflation risks are certainly high, said Bank Islam Malaysia Bhd chief economist Afzanizam Mohamed Rashid.

Among the risks, the government decides to reduce fuel subsidies, as it has done in the past, as well as the country’s heavy dependence on import sources on which the weakening of the ringgit will have an impact. direct impact.

Maybank Investment Bank’s full-year inflation forecast of 2.7% implies the monthly inflation rate will climb to over 3% from January’s average of 2.2% to April 2022.

One of the main upside risks is the fuel price subsidy, said Maybank Investment Bank chief economist Suhaimi Illias.

A removal of every 10 sen per liter of fuel subsidy will increase annual inflation by 0.3 percentage point.

The rising trend of food protectionism is another concern, exacerbating food supply and price risks.

With food and commodity prices soaring, governments are tightening exports to protect domestic supplies, resorting to food protectionism.

Given the high cost of block grants, the government could consider a more targeted approach; Talks of a fuel subsidy mechanism have recently surfaced, with the fuel subsidy expected to jump 155% from RM11bil to RM28bil this year, CGS-CIMB Research said in a recent economic update.

Currently, retail prices for diesel and RON95 are only half of economic prices, according to calculations by CGS-CIMB Research.

This poses upside risks to the CGS-CIMB Research inflation forecast of 2.5%, should the government decide to let fuel prices float.

There will be an impact, in the coming months, with rising prices for some food items, but currently, with the fuel subsidy in place, it might not be too bad, said Chris Eng, chief strategist of the market at Etiqa Insurance and Takaful Bhd.

For now, there is a possibility of higher dividends from Petroliam Nasional Bhd to help manage the huge fuel subsidy bill.

There are fears that once the inventories companies currently hold are depleted, the inflationary effects will be felt on the consumer side, with the effects magnified by a rapidly strengthening dollar.

Tough trading conditions will cause a deep global recession where a stagflationary spiral is all but assured, said former Inter-Pacific Securities research chief Pong Teng Siew.

Many companies affected by Covid-19 are already facing tight working capital and unable to maintain old inventory levels, even if commodity prices had not increased. We will see a shortage of supply occur; as a recession causes a drop in demand, this supply crisis will make it difficult to even destroy demand to restore price equilibrium in the normal way.

Stagflation occurs when the inflation rate is high and the economy slows down.

Some believe that the growing concerns about these upside risks simply reflect the short-term effects of the reopening of the economy.

Considering that spare capacity remains abundant in most industries, the risk of sustained inflation appears low, said Thomas Yong, managing director of Fortress Capital Asset Management Sdn Bhd.

The next few months will be crucial in assessing how these inflation risks play out, as most are confident of their upside potential to do even more damage.

Yap Leng Kuen is a former editor of StarBiz. The opinions expressed here are those of the author.