KUALA LUMPUR (June 7): The nature of cost-push inflation limits the effectiveness of conventional monetary policy while the government’s various price control efforts will impose an exorbitant fiscal cost, RAM Ratings has cautioned.

Higher oil-and-gas-related revenues will be insufficient to fully offset the fiscal strain, it observed, noting domestic supply-side policies including improving domestic logistics and production capabilities, favourable trade agreements with suppliers of key commodities, and streamlining administrative bottlenecks, would be crucial in managing inflationary pressures.

In a statement on Tuesday (June 7), the rating agency said it expected Bank Negara Malaysia (BNM) to mainly adjust interest rates on the basis of economic recovery while also responding to the risk of demand-pull induced second-order effects and inflation pervasiveness.

As secondary inflation risks remain limited at this juncture, RAM also expects the overnight policy rate (OPR) to gradually normalise to end the year at 2.25% in line with the pace of economic recovery, from 2% at present.

“Inflation is expected to pick up this year as the effects of ongoing global supply chain disruptions are transmitted to Malaysia’s consumer prices.

“In Malaysia, the degree of cost pass-through from companies to households is somewhat mitigated by existing subsidies and price controls.

“However, as labour-intensive and commodity or import-dependent firms will be most affected by current conditions, the degree of cost pass-through would be significant for these firms,” it said.

RAM also pointed out that second-round price effects or a wage-price spiral is not immediately evident as labour market conditions have yet to fully recover.

Nevertheless, rising food prices is a policy concern as at least 20% of the expenditure of most Malaysian households goes towards food.

In particular, the general price of food is expected to climb faster than the 4% uptick registered in the first four months of the year, if supply conditions remain unresolved.  

“The fiscal cost of managing subsidies and mitigating price pressures is substantial.

“Higher oil-and-gas-related revenues will be insufficient to fully offset this fiscal strain, thus necessitating the realignment or consolidation of various operating expenditure items.

“This may have implications for some federal government-led support programmes,” it explained.

RAM also believes that given the nature of current price pressures, a near-term normalisation of inflation conditions is not expected.

“Domestic supply-side policies — such as improving domestic logistics and production capabilities, favourable trade agreements with suppliers of key commodities, and streamlining administrative bottlenecks — will be key in managing inflationary pressures this and next year,” the rating agency shared.