Malaysia’s headline inflation has been moderating in recent months. The pace of consumer price increases has come off steadily from 4.2% in the latter half of 2022 to below 2% since August 2023. Although core inflation also exhibited a downward trend, its most recent reading at 1.9 % in December 2023 is still high by historical standards, and higher than headline inflation.
Domestic price pressures have abated in line with the easing of global supply chain disruptions, a decline in global commodity prices, and tighter financial condition. Accordingly, Bank Negara Malaysia (BNM) has kept the policy rate unchanged at 3% since July 2023, after gradually raising it from its record low of 1.75% in May 2022 as the economy rebounded from the Covid-19 pandemic.
At present, market pricing indicates expectations of BNM staying on the sidelines in the coming months and leaning toward a 25-basis point rate cut a year from now. We assess the current policy rate to be broadly aligned with our growth and inflation projections for Malaysia in 2024, where gross domestic product (GDP) is expected to pick up to 5% in 2024 from an estimated 3.8% in 2023 while inflation is seen to stay in line with last year’s average of 2.5%.
Although inflation has cooled nicely, it would be premature for Malaysia — and the rest of world — to declare victory against high inflation just yet. There are five global and domestic factors that could potentially disrupt this much-welcome decline in Malaysia’s inflationary pressures:
- Combined effects from El Niño and global warming. Extreme weather events arising from the interaction of the ongoing El Niño conditions and global warming could dampen agricultural yields and heighten food insecurity, reversing the recent declines in global food prices. For instance, Malaysia has not been immune to the surge in global rice prices despite a price cap on its locally produced variety. Export restrictions by India, the world’s top rice exporter, and broader concerns over the impending impact of El Niño have pushed global rice prices to record levels since the 2008 food crisis. Some forecasts indicate an over 90% chance of the strong El Niño persisting through February 2024 before weakening gradually, and scientists predict global warming to worsen this year after last year’s record-breaking surface temperatures.
- Geopolitical tensions. Container freight rates have seen a renewed surge, rising by 170% since mid-November 2023 when Houthi rebels launched attacks on cargo vessels in the Red Sea. Encouragingly, freight rates remain far lower than at the height of the global supply chain disruptions in 2021–2022, while crude oil prices have been relatively stable despite the conflict in the Middle East. Global food prices have also withstood the collapse of the Black Sea Grain Initiative in July 2023, supported by declining input costs and ample harvests in other parts of the world. Nevertheless, ongoing geopolitical tensions in Europe and the Middle East could readily deal fresh blows to global food markets.
- Currency depreciation. Sustained depreciation of emerging market currencies against the US dollar makes imported commodities dearer. Although a wide array of consumer goods is subject to price controls and subsidies, the 7% depreciation of the ringgit against the US dollar since end-2022 could raise headline inflation by nearly half a percentage point over a period of 3-10 months, based on our estimates.
- Robust consumer demand. In the domestic sphere, robust private consumption is keeping core and services inflation sticky. Malaysia’s consumer spending continued to record above-trend sequential growth in 2023, backed by the recovery of the labour market, drawdown of excess household savings accumulated during the pandemic, and government subsidies and social assistance. While external demand has been weak, its anticipated recovery in 2024 could spill over to wages and private consumption, potentially driving up consumer prices. Measures to increase the labour income share to 45% of GDP from 32% in 2022, such as minimum wage increases and the proposed Progressive Wage Model, could also add to inflationary pressures.
- Fiscal consolidation. Lastly, plans to rationalise energy subsidies in 2024 is the biggest wild card for Malaysia’s inflation outlook. Our estimates show that removing 50% of fuel subsidies beginning in July could increase headline inflation by 0.6 percentage point in 2024. Given the high government expenditure on subsidies, amounting to an estimated 3.5% of GDP in 2023, subsidy rationalisation is crucial in reducing the government deficit and putting debt on a more sustainable path going forward. However, implementation of targeted subsidies is contingent on the successful rollout of the Central Database Hub (Padu) to identify eligible households. Given the teething issues faced during the launch of Padu, there is considerable uncertainty on the timing and scale of its implementation. In addition, the increase in the services tax from 6% to 8% as well as new taxes on luxury goods and low value goods will put upward pressure on prices.
With these five potential disruptors, inflationary pressures could re-emerge in Malaysia and complicate future monetary policy decisions. The combination of demand and supply-side factors that drive Malaysia’s inflation underscores the need for fiscal and monetary policy coordination as well as comprehensive supply-side reforms.
Diana del Rosario is a senior economist and Wee Chian Koh is an economist at ASEAN+3 Macroeconomic Research Office (AMRO).