Too early to claim victory

Judging from the 16 analysts that BusinessWorld surveyed for their forecasts of January’s inflation, we get a sense that inflation expectations continue to skew closer to the Bangko Sentral ng Pilipinas’ (BSP) own forecast of 2.8-3.7%. A dozen of them placed their forecasts higher than the low end of the BSP’s estimate. But if it is a measure of their whole year view, the median forecast at 3.1% was much lower than the BSP’s 3.7% projection for 2024. Aside from their own reasons for their respective forecasts, the analysts must have been influenced by the potential base effects, given that the January 2023 inflation was the peak of the year-on-year monthly inflation for 2023 at 8.7%.

The market then must have rejoiced a day after the announcement by the Philippine Statistics Authority (PSA) that the actual January 2024 inflation rate stood at 2.8%. This is low by historical standard, the lowest January reading in the last six years.

The disinflation process has barely begun.

If we go by the month-on-month change, the price index for January rose by 0.6% so if we annualize this, that could translate into a high 7.2%. Trimmed of seasonal factors, the month-on-month growth declined to 0.1% or an annual drop of 1.2%, something too difficult to imagine happening at this time.

While showing some easing, January’s inflation is only the fourth month that inflation has begun to ease and only the second month that it has returned to the target path of 2-4%. This will certainly not qualify for the BSP’s condition for easing monetary policy rate — that inflation should be firmly within the 2-4% target. Inflation has 11 months more to prove it is capable of cruising within the target, even as the BSP itself had already announced last December that its risk-adjusted forecast for 2024 is 4.2%.

Risks to disinflation continue to be on the upside.

True, domestic inflation moderated last month due to the slowdown in food and non-alcoholic beverages prices, but what is more foreboding in the near future is the sustained huge increase in prices of both regular and well-milled rice. Rice inflation alone further accelerated in January to 22.6% from 19.6% in December.

With a weight of nearly 9% in the consumer basket, the rice supply has been affected by the prolonged El Niño dry spell, and even if supported by more imports, the higher global prices of rice have more than outweighed their mitigating influence. El Niño is not unique to the Philippines.

Structural and governance issues prevent a more decisive resolution of the rice problem in the Philippines, even with rice tariffication. We have not felt whatever stopgap measures have come out of the Inter-Agency Committee on Inflation and Market Outlook. It seems limited to monitoring prices and providing recommendations like higher import volume. More imports of rice would not be effective today because global rice prices have also risen on account of El Niño, with some major sources of supply like India curtailing their exports to other countries including the Philippines. It would be foolish for them to export when their rice supply is also likely to show some shortfall, or to charge the same price for exports.

As the BSP declared the other day, the risks are not singular. “Key upside risks are associated with potential pressures emanating from higher transport charges, increased electricity rates, higher oil prices and higher food prices due to strong El Niño conditions.”

In addition, we have yet to see demand pressures getting entrenched on the downside. Core inflation, while easing, remains higher than headline inflation. In fact, at 3.8% in January, it’s close to the upper end of the government target.

And if we must go back to our 16 analysts, it looks like inflation expectations are more firmly revolving around the BSP baseline forecasts. Whether this is more adaptive may be an issue, but adhering closely to the BSP’s view means inflation expectations may be guided by the periodic pronouncements of the monetary authorities on the prospects of Philippine inflation. It is crucial, however, for the BSP to remain circumspect about any policy reversal lest their credibility as an inflation buster is dented.

As to consumers and businesses, we have the BSP’s 4th quarter 2023 consumer and business expectations surveys, both of which reflect their respondents’ view that inflation could remain high. This could affect the disinflationary path, especially when economic agents modify their buying and selling decisions, or their saving and investment behavior. More frequent increases in the selling price of goods and services, for example, could trigger negative buying decisions. If consumers are not exactly price sensitive, that could encourage more price changes and prevent further disinflation.

Finally, there is a cautionary tale against premature celebration of an economy’s victory against inflation.

In the December 2023 issue of the International Monetary Fund’s (IMF) Finance & Development Magazine, IMF economists Anil Ari and Lev Ratnovski published an article that drew on an IMF Working Paper, “One Hundred Inflation Shocks: Seven Stylized Facts.” Written by the two of them with Carlos Mulas-Granados, Victor Mylonas, and Wei Zhao, the paper studied 100 inflation shocks since the 1970s and offered important lessons to policymakers.

First, their account of history demonstrates that inflation is persistent. Being persistent, it would take years before inflation is decisively vanquished and restored to the rate before the initial shocks. Ari and Ratnovski claimed that 40% of countries covered in their study “failed to resolve inflation shocks even after five years.” For the rest, an average of three years was what it took to slide back to pre-shock rates.

Second, and this is for all of us, countries that celebrated a premature victory against inflation also quickly unhinged their policy rates from elevated levels. The IMF economists pointed out that this was wrong because inflation came back with a vengeance. They cited Denmark, France, Greece, and the United States as among those 30 countries in the sample that claimed an early victory and launched an early pivot to a loose monetary policy. This was right after the 1973 oil-price shock. What is more significant lesson here is that “almost all countries in our analysis (90%) that failed to resolve inflation saw price growth slow sharply in the first few years after an initial shock, only to accelerate again or become struck at a faster pace.”

We agree with the IMF economists that central banks are right when they don’t buy populist views to start loosening monetary policy when only one or two months show some initial easing of price pressures, or shocks are more supply than demand.

The right examples of how to respond to persistent inflation, according to the IMF economists, would be Japan and Italy which implemented tighter-for-longer policies after the 1979 oil-price shock. These two economies focused their monetary guns on the inflation shocks and kept their policies tight through several years, ensuring a firm hold on inflation.

Successful inflation control is also anchored on good management of inflation expectations as much as on the central banks’ track record in keeping stable prices. The BSP’s carefully crafted press statement after each monetary policy meeting, as well as its forward guidance, are instrumental in keeping the markets closer to the BSP’s own assessment of where inflation is going. Inasmuch as its pronouncements are close to reality, or consistent with what it will do next, and the outcome is positive, the BSP gains more credibility. It will continue to have a better batting average putting down inflation, as in the past.

We can also take to heart what the Fund stressed, and this is the possibility that resolving inflation could have short-term costs in terms of lower economic growth. Over the medium term, however, economic growth and employment would begin to rise to more sustainable levels. But failure to keep inflation down leads to macroeconomic instability and inefficiency.

The last word may be prescient: “If history is a guide, inflation’s recent decline could be transitory.” Let’s not claim an early victory against inflation.

Diwa C. Guinigundo is the former deputy governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was alternate executive director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.