Commentary: ‘Deflating’ Inflation – Reducing Prices In A Malaysia Which Had To Do Without

Bank Negara Malaysia (BNM) cited that despite moderating in the fourth quarter of 2022, headline inflation is expected to remain elevated in 2023.

The Central Bank’s Economic and Monetary Review 2022 released along with the Annual Report, 2022 today (March 29), said the continued strength in domestic demand and improvement in the labour market will similarly keep the core inflation elevated in the near term. The elevated core inflation will trend above headline inflation for a few months in 2023,” it said.

The central bank said on balance, both headline and core inflation are projected to average between 2.8 per cent and 3.8 per cent this year. After increasing for most of 2022, headline inflation has begun to moderate since the fourth quarter of 2022, mainly reflecting the moderation in global cost factors.

“In 2023, the more moderate global cost environment is expected to prevail given improvements in supply constraints and softening global demand and the prices of key commodities such as oil and agricultural products are projected to average lower and contribute to lower headline inflation. On the domestic front, if pent-up demand that had in part supported household spending in 2022 dissipates at a faster rate, inflationary pressures may abate,” it said.

BNM Governor Tan Sri Nor Shamsiah Mohd Yunus said that the Bank’s priority in the past year was to ensure that monetary and financial conditions remained supportive of a firm path to recovery for the Malaysian economy. This meant recalibrating monetary policy in a gradual and measured manner to maintain price stability and thus preserve sustainable growth. With interest rates reduced to an all-time low in response to the unprecedented economic shocks from the pandemic, avoiding a ‘too low for too long’ interest rate environment was important to mitigate a build-up of future risks.

This is especially when economic growth has been sustained and signs of demand-driven price pressures have started to emerge. Against this backdrop, the Bank has remained focused in its policy response on managing risks that could undermine the long-term health of the economy and the well-being of the people.

Along with the recent re-tabling of Budget 2023 and BNM’s owns measures to help reduce the high cost of living for each Malaysian many have to do without as there is less disposable income left in every pocket the caused by the higher cost of living.  

Inflation evolution

Over the past two years, consumer price developments shifted from being disinflationary to inflationary in particular, the pandemic led to changing demand and supply dynamics which led to rising prices and inadvertently.

In 2020-2021, inflation dynamics were driven mostly by pandemic developments. In 2022, however, inflationary pressures began to be observed in most Consumer Price Index (CPI) items, suggesting that other factors beyond the pandemic were at play. The CPI measures the monthly change in prices paid by consumers.

This turn of events reflected additional shocks, which coincided with pent-up demand following the reopening of the economy and the general rebound in economic activity. The resulting inflation was evident across most consumer items, most acutely for food. Nevertheless, there are signs of moderation in price pressures after a year of rising inflation Monetary policy was gradually calibrated throughout 2022 given firmer economic recovery and amid signs of demand-driven inflation.

BNM said the role of monetary policy is to maintain price stability that is conducive for sustainable growth. This, in turn, ensures that purchasing power is preserved. Higher inflation in the past two years affected all Malaysians. Lower-income households were most impacted, given their higher spending on food. The short-term measures have helped to partly alleviate the burden, but are not a substitute for structural reforms to create higher paying jobs and improve social protection.

Inflation and the Exchange rate

In 2022, the ringgit exchange rate experienced a period of sustained depreciation against the US dollar. While small movements in the ringgit exchange rate are common, large fluctuations in the level can create lasting impact for businesses, households and the economy.

BNM highlighted that as the ringgit against the US dollar hovered close to levels last experienced during the Asian Financial Crisis (AFC) , this became a concern. There were even some calls for the ringgit to be pegged to prevent it from falling further.

To understand the role of the exchange rate in the Malaysian economy, it is worth noting that movements in the exchange rate will influence households’ and businesses’ decisions, and thus in aggregate, will impact economic activity. For a country with a flexible exchange rate like Malaysia, the ringgit can periodically appreciate and depreciate.

Over the longer term, the exchange rate should be determined by our economic fundamentals relative to key trading partners. In a financially integrated world, short-term movements in the exchange rate are also strongly influenced by cross-border financial flows and investor risk sentiments, which are often affected by global developments and are not necessarily refl ective of our country’s economic fundamentals.

This was certainly the case in 2022 when the US Federal Reserve raised its policy interest rate aggressively by 425 basis points to a target range of 4.25-4.50% to address inflation. With this in mind, the effects of the exchange rate on the Malaysian economy are not only determined by developments in the bilateral exchange rate against the US dollar. As a trading nation that also has key investment relationships with many countries, assessments should consider ringgit movements against our major trading partners. This would provide insights on whether Malaysia’s relative competitiveness has been affected by movements in the exchange rate.

Whether the exchange rate appreciates or depreciates, there will always be winners and losers in the  domestic economy. A depreciation in the ringgit hurts those who consume imported goods and services, and if sustained, can lead to a rise in the overall cost of living. At the same time, a weak ringgit could increase exporters’ earnings.

On the other hand, when the ringgit appreciates, it benefits those who import goods, services, and travel abroad, but hurts exporters and the domestic tourism industry. When these exchange rate movements occur, it is important for the adjustments to be orderly to ensure that economic activity can continue. The focus of the country’s exchange rate regime should not be on picking sectoral winners or losers.

Instead, the goal is to ensure long-term benefits for the overall economy.

In 2022, the flexible exchange rate regime similarly helped the Malaysian economy to adjust to shifting external conditions without disrupting our economic recovery. Despite a major external shock in the form of fast and sizeable adjustments of interest rates in the US which led to the rapid appreciation of the US dollar against most currencies, Malaysia’s competitiveness was relatively unaffected. The domestic economy remained on its recovery path, registering a growth rate of 8.7% for the year.

Reforms and policy measures have since been implemented to reduce Malaysia’s external vulnerabilities. Businesses and banks’ balance sheets are much more resilient no than they were back then. Domestic financial markets are also much more developed and capable of withstanding external fi nancial shocks without affecting banks’ capacity to support economic activity….but, these takes time to be realised on the ground.

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