Business

Saturday June 20, 2009

When inflation is a threat

By CECILIA KOK


An environment of low interest rates and rising commodity prices is stoking inflation fears

IT seems that most people are convinced the green shoots that have sprung up in the global economy in recent months have taken root.

As it is, many policymakers are already declaring victory over the “great recession”.

They foresee their economies returning to positive territory, albeit at meek growth rates, by the fourth quarter of the year.

However, the International Monetary Fund and World Bank issued a warning early this month.

They said the path to economic recovery was rife with risks, and the onus was on policymakers to avoid runaway inflation and other pitfalls that could derail the process.

So, it pretty much sounds like when we jump out of this frying pan, there could be another challenge awaiting us. Managing the economy is indeed a tough feat.

There are always precautionary indicators and expectations that require policymakers to constantly strategise and switch policies to keep their economies in a healthy balance.

While most economists regard the IMF and World Bank’s statements as more relevant to developed nations, particularly those that are still carrying some viruses in their financial systems, it is best the developing countries also be more alert to the trends observed by the international financial agencies.

Currently, rising commodity prices, particularly crude oil, are stoking inflation fears.

And in an environment of low interest rates, there is certainly room for inflation to creep in.

This is because low interest rates can release ample liquidity into the market and increase consumers’ borrowing power, hence stimulating demand.

After all, inflation is also equated with too much money chasing after too few goods.

Independent economist Andy Xie wrote in a recent article that rising oil prices are a stagflation factor, as they cause inflation and weaken growth.

Earlier this year, there were fears of deflation threatening some economies. Now, some economists are pointing to the possibility of stagflation happening in the near future. (Stagflation is a dampening condition of inflation amid slow economic growth and relatively high unemployment.)

This raises the question whether the central banks of countries facing such a threat should halt their monetary stimulus programmes and instead raise interest rates sooner than expected to rein in the threat of inflation.

But to date, most countries have downplayed such a threat because the general prices of goods and services in their markets are still relatively tame.

This is evident in the recent release of the consumer price index (CPI), an indicator of inflation, in most economies.

For instance, the United States reported that its CPI for May rose only 0.1% from the month before, but on an annual basis, it fell 1.3%.

Britain’s CPI for May was up 2.2% from a year earlier, while that of the 16 euro-area nations dropped to zero.

According to RAM Holdings Bhd chief economist Dr Yeah Kim Leng, most developed countries are still facing deflationary pressures, while developing countries are experiencing disinflation.

Over the week, the Department of Statistics reported that Malaysia’s CPI for May registered an increase of 2.4% from the year before, and a modest 0.2% from the preceding month.

Local economists say that inflation is not a threat to Malaysia’s, or even Asia’s, economy at this juncture. As a matter of fact, they foresee Malaysia’s CPI turning negative in the second half due to high base effect.

This prompts Malaysian Rating Corp Bhd chief economist Nor Zahidi Alias to set his CPI target for the year within the range of 1% to 1.5%. Low capacity utilisation rate (particularly in the manufacturing sector), a weak job market and sluggish private consumption are factors that will prevent prices from surging too far, Zahidi says.

According to Bank Negara’s recent report, the overall capacity utilisation rate in the manufacturing sector in the first quarter was 59%, down from 66% in the fourth quarter of last year.

In the first quarter, export and domestic-oriented industries operated at 62% and 53% of total capacity, respectively, compared with 67% and 64% in the previous quarter. Full utilisation capacity should be around 80% to 90%.

The dented consumer and business sentiments have not fully recovered to propel private consumption to its previous healthy levels.

“Unless there is strong resumption of domestic demand, inflationary pressure remains subdued,” Yeah explains.

He believes that the low interest-rate environment needs to be maintained over the short term because priority should be given to improving consumer and business confidence, and ensuring ample liquidity to support domestic demand and sustain growth.

Nevertheless, he sees the need to be cautious of an inflation threat probably in the second half of next year, when the global economic recovery finds more solid footing.

Economic recovery combined with a rebound in commodity prices will pose an inflation threat in the future.

By then, policymakers are likely to have switched away from their monetary easing programmes and have increased interest rates to curb inflation.

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