The announcement of the 4-percent inflation for January was much higher than anticipated. Our own forecast conservatively puts it to about 3.4 percent representing a modest increase from December and already taking into consideration the initial impact of the Tax Reform for Acceleration and Inclusion (TRAIN) Law. In our previous column two weeks ago, we cited the Department of Finance (DOF) maximum estimated impact of adding about 1 percent for the full-year average. Our own initial estimates show that TRAIN impact will add more than 1 percent to average inflation rate and that full impact would come in around April to July, where we see it going beyond 4 percent and then gradually going back to the 3.2-percent to 3.6-percent range toward the end of the year.
The higher-than-expected increase comes at a time of global market corrections led by the biggest one day drop of the DOW last week. The trigger of the global correction is also inflation. The US added much larger wage jobs than expected, raising interest rates spread. The Philippines, as one of the preferred emerging markets for foreign equity funds, also suffered a huge correction in the last three days. In our previous column, we talked about two major sources of inflation: cost push and demand pull. Cost push is due to higher cost of production that can come from different policies and doing-business activities, while demand-pull is due to rising income, which can cause people to buy or demand more goods/services than what is available. The US and the developed economies were spooked by the latter. The developed countries are now growing consistently showing that they have fully recovered from the 2008-2009 global financial crisis. Similar to a car, a strong growth that triggers a larger-than-expected demand pull due to more jobs created can lead to overheating. We also talked about a third force in inflation called expectations. Expectations can have higher impact because it can cause herd behavior change. This is when people’s anticipation becomes larger than reality and so lead to unexpected outcomes.
In this latest inflation reports, we have reviewed our numbers and our assumptions on how TRAIN will impact prices for the rest of the year and beyond. We already imputed in our earlier forecasts the demand-pull impact, which is about P13 billion a month created by the tax cuts. Similarly, the cost-push impact was conservatively imputed affecting mainly the sin taxes, oil products and a pass through for the rest. The increases actually came from these, but the increases were much larger in the sin products, where the month-on-month increase was 5 percent. In the pass-through particularly for food, the increase was 1 percent. But since food comprises about half of the inflation basket, it easily pull up the rest. Contrary to perception, the increases in food prices were not similar across the board. Rice and bread increased according to estimates, but fish, cooking oil, fruits and vegetables recorded much higher than past months. Likewise, eating out represented by restaurant inflation already posted large increases. This is significant because eating out is about 12 percent of total inflation. Inflation for this group increase by 3.7 percent as compared to the annual average of only 2.2 percent for 2017.
From the data, inflation has increased faster because the pass-through effects on food were higher. This is not due to low production, as agriculture continued to post higher growth even during the fourth quarter of 2017. Likewise, demand-pull impact was much higher as people with more purchasing power now preferred eating out. Because of this, we have rerun our numbers and we are seeing that inflation will now average about 4.5 percent for the year. This means that we will not see it go back below 4 percent for the rest of the year. This, considering that full impact will have been absorbed by the economy by the second quarter of this year. We also take into account that all government workers will
receive further salary increases due to SSL III and this will add to demand-pull. Likewise, public transportation and electricity rates have not yet adjusted their rates and they could put more pressure on overall prices. This will make the Bangko Sentral ng Pilipinas adjust rates faster and possibly higher than 1 percent this year (the Monetary Board should have made a decision by this time, as this was written before their meeting).
The higher than expected impact of TRAIN may have to do more with expectations than actual pass-through rates as estimated. As we have pointed out in our Eagle Watch briefing on January 25, inflation expectations are like “self-fulfilling prophecies.” In the recent days, media has been talking about the lack of NFA rice in some Metro Manila markets. As this is seen on national TV, the impression is now there is lack of rice in general.
The herd behavior can naturally lead to higher demand not much different than the one we saw in 2008 when we had double-digit inflation due to rice. The latest report shows we have good agricultural production in 2017 and rice prices have not gone up significantly this January 2018. The government, the private sector and the buying public should work together to tame inflation expectations if we want the TRAIN to run its course for everybody’s benefit.