By: Alvin Ang, PhD
The past two weeks saw successive changes in the prices of basic commodities. Rice, garlic and oil have exhibited increases that have extended beyond the ordinary consumers to the financial markets. This is because the levels of the increases show clear signs of inflation pressures. They are significant threats to the current low-interest rate regime that the Philippines has been enjoying for the last three years. Nevertheless, in the recent meeting of the Monetary Board of the Bangko Sentral ng Pilipinas (BSP), the expected uptick on interest rates did not happen. Instead, the BSP maintained its key policy rates and only adjusted upward the special deposit accounts’ rate by 0.25 percentage points.
What are the possible reasons for this decision? Was this type of adjustment a response to certain inflationary pressures that we are currently experiencing? First, monetary policy is focused on managing inflation, which it has a direct impact on. In this case, it is important to distinguish between headline inflation (the one regularly announced every month) and core inflation. Core inflation differs from headline inflation in such a way that it removes “temporary disturbances and shocks” that are not directly related to monetary policy. Specifically, it removes seasonal shifts in agricultural supply and the international price movement of oil. Those excluded in core inflation are rice, corn, meat, fruits and vegetables, and gas. These components represent about 20 percent of headline inflation. Therefore, core inflation can represent a long-term trend of upward price movements against the short-term nature of headline inflation.
A case in point was the sudden increase in the price of rice in April 2008, which eventually eased after about six months as supply conditions normalized. Core inflation was about 4 percentage points lower than the headline inflation during its peak in July 2008. The core inflation in May 2014 was 3.1, 1.4 percentage points lower than the headline inflation. This could have shown an upward pattern that is well within the Monetary Board’s expectations. The increase in reserve requirement last month may have already been sufficient to counter any inflation pull from the demand side.
Second, inflation pressures have already been factored in for the aggregate forecasts for this year. The specific threats, however, remain unclear. Our view is that we should look at two key components of the Philippine consumer basket: food (38 percent) and housing (23 percent). Together, they comprise about 61 percent of total inflation. The recent spike in inflation may be traced from here. Garlic, as a subcomponent of food, is lumped with vegetables, comprising only about 0.6 percent of the total. On the other hand, rice contributes about 9 percent; gas, about 0.7 percent. Hence, for garlic to have a significant impact on inflation, it has to show a significant increase in consumption. Data from the Bureau of Agricultural Statistics show that per-capita consumption of garlic actually fell from about 600 grams in 2006 to 200 grams in 2012. This decline in consumption may have impacted the local production of garlic, which dropped from a peak of 20,000 metric tons (MT) in 1997 to only about 8,500 MT in 2012. This made imports a significant source of supply, accounting for about 70 percent of total supply. Thus, products that are dependent on imports are highly susceptible to price fluctuations.
Third, what may be more critical to observe are the prices of rice, gas and electricity. Unlike garlic, rice is not heavily dependent on imports, but continues to be saddled by internal institutional challenges. Our heavy dependence on imported gas also puts a lot of strain on inflation. Gas has a pass-through effect on many consumer products, as it serves as a key input in transportation, as well as in electricity. The internal strife in Iraq has already pushed local pump prices higher by about 2 percent in a week’s time. Without strategic reserves and a mass alternative, our economy will always be affected by global oil-price adjustments.
Clearly monetary policy has no direct effect on these external pressures that are pushing headline inflation. Inflation, therefore, is not just a responsibility of the monetary authorities. As in the example of garlic, our local competitiveness clearly needs to be strengthened as we prepare for the Association of Southeast Asian Nations economic integration. This requires a composite governmental approach involving the trade, agriculture and planning departments. It also requires the participation and better understanding of local governments in using their regulatory capacities to facilitate, and not create bottlenecks in, the movement of goods and services. There is a need for consistency in the application of customs regulations. It was observed that the current increases in garlic and rice prices are due to the customs authorities’ stricter policies to curb smuggling. Integrating all these processes into a cohesive perspective on prices is the long-term approach to manage headline inflation. It involves active monetary policy (as it is now), sustained domestic production of key agricultural products and facilitative local governments.