OVERVIEW

The Consumer Price Index (CPI) persisted at a rate of 3.7% YoY in February, marginally surpassing market expectations, while the core inflation rate, which excludes volatile and administered price items, maintained a steady YoY growth of 3.9% in the same month. We anticipate that headline inflation in the country is likely to average between 3.0% and 3.5% in 2023 (MOF forecast: 2.8% to 3.8%), with the caveat that any amendments to the cap on retail oil prices or implementation of price control measures may affect this projection. The budget allocation for subsidies this year stands at RM58.6bn, representing a reduction from the RM67.4bn allocated in 2022, which we attribute to a decline in commodity prices and the potential shift towards a more targeted subsidy scheme later in the year. Despite alluding to a progressive strategy for targeted subsidies, there is currently no clear plan for subsidy rationalisation, except for the already-implemented targeted electricity subsidies.

Food and hospitality costs surge in February

The Consumer Price Index (CPI) registered a sustained rate of 3.7% YoY in February (3.8% in December 2022), albeit slightly exceeding market expectation. Notably, the persisting increase in headline inflation is attributed to the upswing in food inflation, which reached 7% YoY in February, up from 6.7% in January. Against this backdrop, the government launched the Rahmah

Menu initiative on 31 January, as part of a range of new measures to alleviate the cost of living. Additionally, to secure a stable supply of chicken eggs, the Ministry of Agriculture and Food Security (KPKM) extended its subsidies for eggs and chicken until June 2023. The cost of restaurants and hotels displayed an upward trend, recording 7.4% YoY in February (compared to 6.8% in January). This increase was mainly driven by the rising prices of hotel rooms during the school holiday season, as well as the implementation of the Imbalance Cost Pass-Through (ICPT) mechanism in Peninsular Malaysia, which led to a surge in electricity tariffs for all industrial and commercial sectors from 1 January to 30 June this year. This move has translated into significant fiscal savings of approximately RM4bn for the government. Conversely, the transportation group experienced a deceleration in inflation growth, falling from 4.0% YoY in January to 3.7% in February. This was due to stable average fuel price of RON97, which was recorded at an average of RM3.35/litre in February. Additionally, the fuel price of RON95 remained capped at RM2.05/litre.

Core inflation rate, which excludes administered and volatile price items, remained at 3.9% YoY in February (4.1% in December 2022). Nonetheless, the highest increase was still recorded by the food and non-alcoholic beverages (+7.6%, Jan: +7.8%) segment. Excluding fuel for vehicles (RON95, RON97 and diesel), the inflation rate rose moderately by 4% YoY in February.

Six (6) states/areas registered CPI readings higher than the national average of 3.7%, with no surprises of it again being Wilayah Persekutuan Putrajaya (+4.7% and Jan: +5.9%), Selangor (+4.3%, Jan: +4.2%), Johor (+4.1%, Jan: +3.8%), Sarawak (+4.0%, Jan: +4.3%), Pahang (+4.0%, Jan: +3.8%) and Perak (+3.8%, Jan: 3.6% YoY). High F&B costs (Selangor: +8.6%, Sarawak: +8.1%, Johor: +7.5% and Pahang: +7.4%) remained a drag. Meanwhile, other states showed an increase below the national inflation of F&B costs of 7% YoY in February.

Urban CPI (+3.8%, Jan: +3.7% YoY) remains ahead of rural (+2.9%, Jan: +2.7% YoY), given the more robust urban consumption patterns and presumably higher levels of disposable income, in addition to greater exposures to relevant sub-sectors that are seeing more pronounced increases (ie. food and beverage, restaurants and hotels, and transport). On a monthly basis, both CPI for urban and rural registered a higher increase of +0.3% MoM in February. CPI for the income group below RM3,000 increased 3.7% YoY in February.

OUTLOOK: INFLATIONARY PRESSURES TO REMAIN BUT GRADUAL

We anticipate that the country will continue to face high inflationary pressure in the short term, although the growth rate is expected to slow down in 1H 2023 due to the stabilisation of non-food item inflation in line with the guidelines provided by BNM in its recent MPC meeting. The Ministry of Finance's economic outlook report predicts that PPI growth will moderate as global input costs stabilise, which suggests that producers' pass-through to consumers will not exacerbate inflationary pressure going forward. Subject to adjustments in the cap on retail oil prices and price control measures, we project that the country's headline inflation will average between 3.0% and 3.5% in 2023, compared to MOF's forecast of 2.8% to 3.8%. The budgeted amount for subsidies is expected to decrease to RM58.6bn this year from RM67.4bn in 2022, mostly due to lower commodity prices and a potential shift towards a more targeted subsidy scheme later in the year, as the government is still exploring the mechanism for such subsidies. Despite references to a progressive approach to targeted subsidies, there is no clear plan for subsidy rationalisation yet, except for the already implemented targeted electricity subsidies. Additionally, we estimate that eliminating fuel subsidies for the T20 income group (which accounted for 35% of all fuel subsidies in 2022) would increase inflation by an additional 0.45-0.75ppts annually.

Given BNM's recent warning on the increased downside risks associated with both internal and external factors affecting economic growth, coupled with the lingering effect of subsidies, it is our contention that BNM will likely maintain its cautious approach by abstaining from any further modifications to MPC meeting. While future decisions will be contingent on relevant data, we anticipate that the likelihood of a 25bps increase to 3.00%, bringing it in line with pre-pandemic levels, is plausible in 2H 2023, but this is subject to potential fuel subsidy rationalisation, possibly excluding the T20 income group, as hinted in the 2023 Budget, as well as the course of global commodity prices and price controls.

Source: PublicInvest Research - 27 Mar 2023