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Return to previous inflation target is unlikely

"I have my doubts."

 

 

The inflation rate as measured by the CPI (consumer price index) continuously rose through the first three quarters of 2018, peaking at 6.7 percent in September. Thereafter it headed downward, ending the year at 5.1 percent.

The inflation-rate target of the BSP (Bangko Sentral ng Pilipinas) is 2.5 percent to 4.0 percent, and the head of that institution has expressed confidence that the inflation rate will return to that range this year and remain there until 2020. The Duterte administration’s economic managers are similarly confident.

The confidence of these officials stems from three sources, namely, (1) the measures that the Duterte administration has taken to deal with the shortages of rice and other food items, (2) the recent downward movement of world oil prices and (3) the belief that the impact of the excise taxes imposed by Package 1 of the TRAIN (Tax Reform Acceleration and Inclusion) law had already been fully absorbed by the Philippine economy. They appear to believe that, with these developments, it will now be smooth sailing for the inflation rate through 2019 and even into 2020.

Are this country’s economic officials correct in thinking that the inflationary surge of 2018 is steadily becoming a thing of the past and that a return to price stability has begun to happen? Is an inflation rate between 2.5 percent and 4 percent within sight?

I have my doubts.

I like to think that a lesson has been learned about the management of this country’s rice supply and that there will be no recurrence of the rice shortage of last year. An inflationary surge is usually easier to deal with when it is of the cost-push rather than of the demand-pull kind; the rice shortage of 2018 was a cost-push price phenomenon. Once rice tariffication is in place, traders operating on the basis of market instinct will see to it that the nation will always have an adequate rice supply.

The world oil market is one of the most volatile commodity markets in the world. The extent of the volatility was demonstrated by the abrupt rise of the Dubai posted price, toward the end of 2018, to $80 per barrel, the triggerpoint for the suspension of TRAIN I’s fuel excise tax. The price has since gone down to around $60, but could quite easily happen again, given the tensions surrounding geopolitical relations between the West, Russia and the Middle East.

The consumption element of higher fuel prices—represented mainly by the prices of gasoline and kerosene—is relatively easy to track and deal with. The 10 or so oil companies can decide to adjust, to be compelled by public clamor to adjust, their retail prices.

Far more complicated is the production element of fuel price increases. The reason for this is that certain kinds of fuel—diesel oil and bunker fuel, for instance—are inputs for production processes and became parts of production costs once they are comingled with other production inputs to make goods and services. If the cost of fuel rises, prices of products are usually adjusted upward even if the prices of the other inputs have not increased. Fiscal policy planners tend to forget that fuel is used to produce factory electricity and to drive the delivery equipment of manufacturing and agricultural establishments.

When inflationary psychology takes hold—as it clearly did in 2018—producers begin to act in a defensive or anticipatory manner. If a producer believes that the cost of a major production input, as fuel, is going to rise, he will either anticipate the price increase or seek to stay competitive by likewise adjusting his prices upward. Inflation is essentially a matter of psychology; producers generally act on the basis of instinct.

The inflationary psychology that was brought into play by the negative cost and supply factors of 2018 have, in my view, not completely dissipated. This explains why the economic managers’ and BSP’s leadership’s expectation of a return, in 2019 to an inflation rate between 2.5 percent and 4 percent is unlikely to be realized.

Topics: Inflation , Rodrigo Duterte , Economy , Bangko Sentral ng Pilipinas , consumer price index
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