January inflation clocked at only 1.0% from a year ago while in December it was 2.7%. That was a pretty drastic slowdown that I bet someone will cry deflation wolf somewhere soon.

The cause of the slackening is easy to explain. It is unambiguously due to the drop in retail petrol and diesel prices. RON95 fuel price, the most popular fuel in Malaysia by far, in January dropped from MYR2.26 per liter to MYR1.91 in December. Diesel went down 30 sen to MYR1.93 per liter in the same period. In January 2014, RON95 was MYR2.10 per liter.

At this rate, Malaysia might be seeing actual deflation this month. In February, both RON95 and diesel went down further to MYR1.70 per liter. The drop in yearly terms in February 2015 is greater than that seen in January because in February 2014, RON95 was MYR2.10 still. In January 2015, it fell 9% YoY. In February 2015, it decreased 19% YoY.

In fact, on monthly terms, we are already in deflation. This is not your monthly, seasonal price fluctuation that people usually ignore and say, ah, it is nothing. This is a clear deflation.

Is this deflation something to worry about?

No. I do not think so.

Deflation these days connotes bad news. Japan and Europe are trying hard to avoid deflation. In Singapore, deflation played a role in convincing the monetary authority there to loosen up its forex policy, which is their monetary policy. And the last time Malaysia had a deflation, it was during the 2009 recession.

But not all deflation are the same.

In Japan and Europe and Singapore today, and Malaysia in 2009, deflation came about from reduced economic activities. There was less demand and so, price pressure was weak and that pulled prices down. It was demand-driven. In fact, we really are worrying about demand rather than price itself. Price changes — inflation or deflation — are usually a symptom of something else.

Unlike in 2009, the (possible) February deflation would be supply-driven. The weakening in prices has been supply-driven in the sense that technological improvement — all the talk about shale mining that is turning the US into the world’s largest oil producer — has created oil glut in the market.

I do not worry because this is the same pressure that forced computer prices down over the decades. It is a kind of pressure that makes a typical person feels richer because he or she could now buy something else with the same amount of money and still afford the same quantity of fuel or more. Or save them. I do not see a price-wage spiraling down out of control here. The price deflation does not make them feel poorer because the deflation does not come about from them losing them job or suffering a pay cut. There are news of some retrenchment in the oil and gas sector but the size is small so far, as far as I know and besides, the sector is not the biggest contributor to the Malaysian economy. Indeed, the biggest sector, electronics, is having swell of a time and being ignored by the press.

I also do not worry about deflation because fuel is not something a typical consumer can live without for too long. Deflation can be disastrous to the economy in the sense that people would stop buying or postpone their purchases until prices fall further to stabilize at some low prices. But with fuel, I do not think you can do that to the point it would adversely affect growth. Fuel is an essential good and you just have to use them, especially in a society that is so dependent on combustion-type vehicles. If you do wait out, then you might not be able to drive or get to somewhere at all. You just need them and you will keep buying it even when you know prices are falling.

More importantly, the postponement of purchase is dangerous to growth especially when consumers do not know when prices would bottom out. So, they keep holding back and then not making purchases at all. This can be particularly devastating for fixed assets like homes and durable goods. In the case fuel prices, it does appear prices have bottomed out, especially since the prices used for the determination of petrol prices in Malaysia is lagged by a month, as I have explained previously. If global crude prices hold at the current level at about $60 per barrel compared to $45 in mid-January, it is very likely that retail petrol prices will be higher in March next month. So, a February deflation will be temporary. This also means people would line up at the gas stations at the end of this month preempting the loophole that comes with Malaysia’s imperfect dirty float system. So, instead of being encouraged to postpone purchases, they will hoard them instead.

Before I end, I am not saying there is no problem with demand. I still worry that consumption growth is slowing despite the surprisingly strong expansion last quarter. But the possible deflation in February is very much driven by the supply-side, and not demand.

So, do not worry about the deflation.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved
p/s — I am tempted to say yet another reason why I was not worried about deflation, but decided the argument is problematic. That argument goes: core inflation is still more than 50 basis points above headline inflation. Since core inflation is more reflective of demand, and since it strips fuel away and therefore free from supply-driven inflation/deflation seen in January, it suggests demand is going well. But I checked the data from 2008-2009 and core inflation was somewhat healthy despite the fact there was a recession. This probably shows core inflation is an imperfect measurement of demand change.

I am putting it at the postscript to catalog my own thoughts on the matter and revisit it later.

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