Why prices of goods are not going down in Malaysia

PETALING JAYA - MIDF Research opines that a widely expected general decline in prices did not happen, despite reduction in fuel prices at the pump, due to inflexible contracts and menu cost, nature of the administered price mechanism (APM), sustained strength in consumer demand and low incidence of fuel in small and medium enterprise's (SME) cost structure.

"While cheaper fuel price may lower total operational costs, businesses usually enter into long-term contracts in order to reduce transaction costs, prevent supply and demand shift from affecting price stability and to reduce cash flow variability, which could explain the delay in transmission of fuel cost savings into lower prices," it opined in its report yesterday.

It added that the rigidity in price movement, could be the result of high cost associated with adjustment of prices and because of this expense, firms may view cost savings to be relatively minor compared to the cost of notifying the public of new price information. Therefore, businesses would rather temporarily exist in slight "disequilibrium" than incur the menu costs.

MIDF Research also believes that the APM which works to limit the impact of price change volatility on cost of living for the low and middle income group has also been working to limit the impact of supply shocks and external price developments on domestic prices.

It opined that robust demand has also placed upward pressure on prices. Cheap fuel has provided a positive wealth effect and resulted in consumers increasing the amounts and distribution of their consumption. Private final consumption expenditure ascended to 7.8% in Q4 2014 from 6.7% in the previous quarter, impelled by the higher consumption on food and beverages, communication and transport.

"With demand evidently robust, there is no compulsion for businesses to reduce product prices as consumers will be compelled to continue in making purchases at prevailing prices. But whether this is regarded as an act of profiteering is highly subjective. We think that this undesirable outcome is merely the result of free market forces."

In addition, although private consumption is expected to dwindle down once the Goods and Services Tax (GST) rolls out in April, businesses may foresee its impact as transitory. Consumers are likely to adjust to the new environment rather quickly, thus making any immediate price revision ineffective.

Fourthly, fuel is a small cost component for SMEs while other inputs such as wages have been on the rise. As a cost component, fuel, lubricants and gas for transportation, only accounts to about 4.4% of total cost to SMEs, where else employees' salaries, wages and training expenses contributed to 17.2% of total cost.

On this backdrop, the impact of lower fuel prices on SMEs total operational cost should be minimal. In fact, any fuel cost savings is offset by the electricity tariff hike in early 2014, which was estimated to increase the monthly bill of industrial customers by 17%. Moreover, employees' payrolls have been on an uptrend and manufacturing wages alone have risen by an average of 17.14% in 2014.

Lastly, food prices have stayed up mainly due to supply disruptions. Although fuel prices have declined, food prices continued to increase in November till January. In January, food prices spiked up by 1.2% month-on-month, attributed to the flood crisis during the period.

The flood in Cameron Highlands in early November, and the subsequent clampdown on illegal workers also led to a sharp decline in supply of vegetables. The increase in food prices has offset the decline in fuel prices, but this is due to supply factors and not structural in nature.

"Excluding the transport sub-index (with a weightage of 14.9%), we estimate that the adjusted consumer price index (CPI) actually rose 0.6% month-on-month, 0.1% month-on-month and 0.4% month-on-month in November, December and January respectively. This is evidence of the price rigidity phenomenon.

"Moving forward, we do not foresee general prices to taper. The government has announced the decision to reduce electricity tariff by 5.8% in March 2015, this will only be sustained for a four-month period before another revision is made and the hike will only be implemented a month before GST rolls out," MIDF said.

Moreover, hypermarket operators, wholesalers, traders, retailers, restaurants and food and beverage operators agreeing to reduce prices of their goods by 10% to 20% in accord to the price reduction programme initiated by the Ministry of Domestic Trade, Co-operatives and Consumerism will only act as a buffer against the inflationary impact of GST.

"With inflationary expectation heightened on GST and the frontloading of consumer spending to place upward pressure on prices as a result, we expect CPI in the first quarter of 2015 to show stronger readings. Overall, we estimate inflation rate to be 4.1% in 2015, reflecting a one-off effect of GST," said MIDF. - Sundaily