Tuesday, November 27, 2007

Taming Inflation

Taming inflation
With inflation hitting a 16-year high of 3.6 per cent and likely to go up to 5 per cent next year, Erica Tay looks at what can be done to rein in rising prices


IF IT seems that eating out and getting around town has become more expensive these days, the latest hard data from official number-crunchers confirms that indeed it has.
Prices in October, as measured by the consumer price index (CPI), are 3.6 per cent higher than a year ago - the fastest rise in 16 years.

The rate of increase in the CPI - known as the headline inflation rate - has literally been making headlines as Singaporeans gripe about higher food prices and bigger petrol bills.

Hawker centre meals cost 2.8 per cent more compared to a year ago, statistics show.

Restaurant food costs 5.1 per cent more, and transport expenses have also gone up by the same percentage.

Staying at home and eating in? That is not getting cheaper either.

Prices of non-cooked food have crept up 5.6 per cent over the past year, with prices of dairy products and eggs up 9.9 per cent.

Is there any respite for workers who find that they are buying less with the same pay cheques?

What can policymakers do to tame rising inflation?

To understand how to tackle inflation, it is important to understand what is causing rising costs in the first place.

The drivers include July's goods and services tax hike, higher oil and food prices worldwide, and wage and rental increases fuelled by Singapore's red-hot economy.

These factors all play a part in explaining why a plate of chicken rice now costs $3 instead of $2.

But while they all result in higher prices, dealing with each factor requires a different prescription, say economists.


Good and bad news

THE good news is that inflation is set to come down by the end of next year.

The bad news? It is likely to climb higher before coming down.

Trade and Industry Minister Lim Hng Kiang recently told Parliament that inflation could go as high as 5 per cent in the first quarter of 2008 before moderating for the rest of the year.

On Monday, the Monetary Authority of Singapore predicted inflation for all of next year to range between 3.5 and 4.5 per cent.

'We think inflation will surge past 5 per cent early next year, and average 4 per cent for the whole of 2008,' predicted United Overseas Bank economist Suan Teck Kin.

An inflation rate of 5 per cent will be Singapore's highest in more than two decades, surpassing the 4 per cent peak seen in July 1991, noted Standard Chartered Bank economist Alvin Liew.


A perfect storm

A CONFLUENCE of factors is fanning inflationary pressures on several fronts, said Mr Suan.

Since July this year, one factor has been the 2-percentage- point hike in the GST.

That has the effect of lifting inflation for 12 months, until June next year, after which the effect will wear off, he said.

Another reason for escalating prices has been the sizzling economy.

Rapid expansion has been using up spare capacity in the economy and putting a squeeze on the supply of labour and other resources. Higher wages and rents then get passed on as higher consumer prices.

'The economy is not just getting hotter. It has gotten too hot,' said Citigroup economist Chua Hak Bin.

Singapore is running at full employment and this is driving up wages, he noted.

A shortage of commercial space is pushing up business rents, and new buildings, although under construction, take time to be completed.

Housing costs, too, are on the rise.

A hike next January in the annual assessed values of HDB flats by the tax authorities will push the CPI up by 1.5 to 2 percentage points, estimated Dr Chua.

Besides these domestic factors, along came other unexpected pressures.

The price of crude oil - a raw material for petrol and plastics - has shot up to a whisker shy of US$100 a barrel.

Also, the cost of food and commodities has been surging globally.

As HSBC economist Robert Prior-Wandesforde puts it: 'Prices are being pulled higher by an almost perfect storm of rising energy and food commodity prices, higher rents and the impact of July's GST rise.'


The impact

WHAT are the implications of accelerating prices?

For one, real wages and real interest rates will be hit, explained DBS Bank economist Irvin Seah.

If salaries go up by 5 per cent a year, but consumer prices rise by 5 per cent too, it brings workers back to square one, as their purchasing power stays the same.

Second, if inflation outstrips interest rates earned on deposits, the purchasing power of savings will be eroded, giving rise to 'negative real interest rates', he explained.

A pick-up in inflation would leave low-income workers more vulnerable, said Dr Chua.

Mr Seah said: 'The lowest income group will be hardest hit. The inflation faced by this group has typically been higher, and the recent spate of increase in food prices and hike in bus fares will certainly hurt their pockets a lot more than the rest.'

Mr Liew added: 'Although wages have generally been rising, lower-income workers typically don't get as much wage growth as the top earners, so their real income may go down quite a bit.'


What can be done?

ONE way to combat rising prices is for the central bank, which manages the Singapore dollar's exchange rate against a basket of currencies, to tighten monetary policy - that is, to let the Singdollar strengthen at a faster pace.

'External sources of inflation are something we can do little about, except by appreciating our currency,' said Fortis Bank strategist Joseph Tan.

'A faster rising Singdollar makes imports cheaper, and more drastic tightening might be called for at the next policy review in April,' he added.

But Citigroup's Dr Chua said monetary policy is unable to directly tackle domestic price pressures, particularly coming from a tight property market.

Initiatives have been taken to increase the supply of commercial and residential property, he noted.

Recent government moves to alleviate the squeeze on resources by postponing public projects were useful, said Mr Suan.

Mr Prior-Wandesforde pointed out: 'While denying that the economy is overheating, the government has clearly shown its concerns for the future via the various measures designed to cool the housing market as well as the delays in several construction projects, an increase in immigration and a contraction in real government spending as reported in the national accounts.'

On the demand side, policies to further cool the property market may be needed, said Mr Tan.

'There are different ways you can skin the cat, and the cat, in this instance, is the property market,' he said.

Aside from big-picture policies, economists also advocated that more be done in the Budget early next year to help low-wage earners cope with rising costs.

'There can be rebates targeted at low-wage families,' Mr Liew said.

Mr Tan pointed out: 'In the next Budget, we will need to look after those in the lower-income bracket. They are the ones typically caught out by higher inflation.'

ericatay@sph.com.sg

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