Friday, April 5, 2024

Not whether consumer price rise, but how much?

Economists: Targeted fuel subsidies will impact consumers



Star Online Thursday, 04 Apr 2024

PETALING JAYA: As Putrajaya pushes on with the implementation of the Central Database Hub (Padu), the immediate issue that jumps into the minds of Malaysians is another impending “unavoidable” – the targeted petrol subsidy initiative.

Or rather, it can be said that the public is concerned about the inevitable inflationary effects that will follow when the government reduces its petrol subsidies to a significant portion of the population.

Economists are unanimous that petrol subsidy rationalisation is almost certainly going to bring about a general increase in the prices of goods and services, and even the World Bank Group is estimating that a complete removal of fuel subsidies is likely to cause a 9% increase in consumer prices.

Executive director and veteran economist at the Socio-Economic Research Centre (SERC) Lee Heng Guie has no doubt that the gradual removal of petrol subsidy via targeted rationalisation will stoke inflation, as fuel and transportation carries a weight of 8.5% and 14.6%, respectively, in the consumer price index (CPI) basket.

This is because the increase in petrol and diesel prices will have indirect effects on prices of goods and services, which are related to fuel and transportation, he said.

“The magnitude of price increases, which will contribute to headline inflation, will depend on the degree of the petrol price adjustment, which we believe will be on small steps rather than an outright free floating of the RON 95,” he told StarBiz.

Lee believes that as the current inflationary pressure and high cost of living are being exacerbated by the impact of a weakening ringgit, a complete removal of fuel subsidies would exert significant price and cost pressures on the households and businesses.

While all households will be affected by the increase in petrol prices, he nonetheless reiterated the fact that the targeted fuel subsidy intiative remains part of the government’s overall fiscal reform.

“This would be carried out with other rationalisation of other subsidised items and expenditure, as well as revenue enhancement to consolidate the fiscal deficit,” he said.

The World Bank Group approximated in a February report that if only half of the petrol subsidies were removed, then the inflationary impacts would be halved as well.

More importantly, it noted that the indirect effect through sectoral input-output linkages plays a key role in propagating the effect of the fuel price climb, which is evidenced by a much lower direct effect of fuel price increases on consumers and other prices.

It said: “Sectors with a higher share of fuel input, such as chemical and transport, are expected to experience a large price increase upwards of 20% following the removal of fuel subsidies.

“On the other hand, services sectors such as telecommunications and insurance which rely less on fuel as input are likely to be only marginally affected by fuel price increases.”

Like SERC’s Lee, senior economist at UOB Global Economics & Markets Research Julia Goh opined that the extent of the effects stemming from the fuel subsidy rationalisation will depend on the size and timing of the implementation, while adding that the scope of the targeted assistance aimed at easing the burden from higher cost of living will also be a factor.

However, she shed some light on a different perspective, sharing her concern with StarBiz that she is cautious of potential inflationary pressure from rising demand, which could fan indirect or secondary repercussions.

In a note that was co-written with economist Loke Siew Ting, they brought up the wage-price spiral inflationary risk as the unity government will be pilot testing its progressive wage policy from June while also reviewing the pay scheme of civil servants, which is expected to be announced in the coming Budget 2025.

These are of course in addition to the targeted cash aids to mitigate the adverse impact of subsidy rationalisation, if necessary.

“All these, associated with the ongoing supply shortages to some extent, will potentially lead to stronger demand as well as pervasiveness and persistence of price increases that would then necessitate monetary policy action to ensure sustainable growth and price stability over the medium term,” they said.

Meanwhile, providing insight into some important numbers, professor of economics at Sunway University Dr Yeah Kim Leng reported that the average monthly household expenditure on petrol amounted to RM305, based on the 2022 Household Expenditure Survey.

Assuming a 20 sen to 30 sen rise in RON95 pump price, Yeah said the direct or “first round” impact would see the average household incurring a RM30 to RM45 increase in monthly spending.

“The spending increase is less than 1% of total monthly expenditure of RM5,150 for the average household,” he told StarBiz. He said the estimated rise in monthly household expenditure, which is spread over a three to six-month interval, suggests that the subsidy rationalisation will not be overly disruptive to the middle class, given that average real income or wage is projected to rise at 2% to 3% annually.

This should soothe concerns for the M40 group, who are often in the no-man’s land of having to cope with elevating costs but are not penurious enough to receive government aid.

On the other hand, Yeah acknowledged the second and third round of impact from the increase in pump prices are hard to estimate, as they depend on the extent of cost pass-through by businesses, change in inflation expectations and the overall price environment.

With last year’s consumer price inflation having been relatively low at 2.5%, Yeah said Bank Negara is projecting a rise of between 2% and 3.5% this year.

“In the first two months of this year, the headline CPI has been relatively low, averaging 1.7%, indicating a favourable timing in the coming months for the commencement of the fuel subsidy rationalisation,” he observed.

Centre for Market Education chief executive Carmelo Ferlito suggested for the implementation of the rationalisation to begin as a modest experiment.

“The mechanism (of the execution) is yet to be tested and may need to be fine tuned. To avoid too harsh an effect, a small-scale test should be carried out, after which it may be developed according to the operational feedback,” he said.

Ferlito pointed out that it makes sense for the rationalisation of subsidies to be a permanent feature, as a dependance mentality has been created over time and the Malaysian economy has evolved in a way in which subsidies have been considered a constant element.

“To switch models will take time but it is unavoidable. It will not happen without disruptions and therefore the way in which the rationalisation is implemented matters a lot,” he said.

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