expectations – Page 2 – the _

[2364] Subsidy reduction and inflation expectations have to be managed more prudently

The Najib administration is committed to long-term reduction of subsidy. The Prime Minister said so.

I do support reduction and even elimination of subsidy. There are exceptions, but I do support anti-subsidy policy generally. So, I do take comfort from the Prime Minister’s statement.

Yet that does not mean I would support however the reduction is done. This is due to my concern for inflation expectations.

The Najib administration’s commitment to gradual reduction of subsidy is something that should be inspected closely. Gradual is the key word because the rate will create sustained inflation expectations. Inflation expectations itself will affect actual inflation in a big way.

It is not at all a problem if the gradual liberalization involves only small yearly increases. Such small increases will create limited inflation expectations. And a low inflation rate — as the economic wisdom goes and what goldbugs failed to understand — greases the economy.

But as I have shown earlier, sugar prices have increased by about 28% per year in the past two years. Other subsidized items like fuel that contribute to the Consumer Price Index have yet to be accounted for.

A sustained inflation expectation at that rate can be disastrous to the economy. I do not think anybody would want to see the Bank Negara playing a catch-up game with its monetary policy.

To prevent the sustaining of high inflation expectations, the rate of liberalization just has to slow down.

Alternatively, the government can eliminate all subsidies once and for all. That will create a one-off inflation. Yes, this is a crazy policy option but at least the inflation expectations will not be as bad as it is developing into right now. A one-off inflation spike is better than a sustained high inflation expectation because it will not leave a mark on the economy in the long run.

[2278] Of capital control, expectations and policy irrelevance

There has been a low clamoring for capital control for a while now. The latest call was made by Member of Parliament Charles Santiago of DAP.^[1] Regardless of the pros and cons of capital control, its imposition, if it is to be imposed, needs to be done relatively quickly without much warning. Slow imposition in form of heated debate among policymakers may reduce its effectiveness. Here is why.

Proponents of capital control fear hot money in a sense that when it is withdrawn, it would affect the local economy badly. While capital control is aimed typically at hot money, it also affects other flows that are more innocent in nature in the eyes of these proponents.

Liquidity is important. With the reduction of liquidity that what capital control causes, individuals, foreigners especially, will be less willing to bring in money into a country that imposes control. Those who already have money in a country where there is risk of capital control might want to take money out to preempt the control.

The greater the call for capital control, the greater the risk of actual implementation will be. Forward-looking owners of fund will do the necessary to reduce their risk of low liquidity. This means the impact of capital control can be as devastating as the impact of withdrawal of hot money under a system of no control. Money flows out either way. It is just a matter of when. That may make capital control as a tool as somewhat irrelevant.

Capital control can be relevant if the announcement and implementation are done in a sudden move. Sudden implementation preempts expectations build-up.

But there lies the catch-22. Talk about it and it becomes irrelevant. Not talk about it and there is no call for control, hence no control. For a secretive government that does not tolerate free speech however, this might not apply.

Mohd Hafiz Noor Shams. Some rights reserved

^[1] — KUALA LUMPUR, Nov 23 — A DAP MP wants Putrajaya to impose capital controls like that which former prime minister Tun Dr Mahathir Mohamad enacted in 1997 to prevent what he called an impending surge of hot money into the local market would put Malaysia into a tailspin similar to the Asian Financial Crisis.

Klang MP Charles Santiago explained that this time the hot money would come from the US Federal Reserve’s move to spend a whopping US$600 million (RM1.8 trillion) to purchase US Treasuries over the next eight months under its quantitative easing programme. [DAP MP wants Malaysia to impose capital controls. Clara Chooi. The Malaysian Insider. November 23 2010]