Should we be afraid of flood-induced inflation?

This may come as no surprise to many of us as the ongoing worst flood crisis in decades has played a part in temporarily driving up prices.

Headline CPI held steady at 4.19 per cent higher than the same period last year, on the back of an upswing in food price inflation which recently hit peak growth at 10.21 per cent (the highest growth rate over the last thirty four months). These food prices were driven up by flood-related food shortages and higher logistic costs. Non-food prices, on the contrary, continue to decelerate, with a mere 0.54 per cent growth rate.

Measured over the same period last year and setting aside volatile raw foods and energy prices, core inflation hovered at 2.90 per cent and this remained well within the Bank of Thailand’s policy target range of 0.5 to 3 per cent. Although the impact of the flooding on inflation is real and already evident, flood-induced inflationary pressure going forward is not as daunting as some may assume. The effect will not only be limited but also temporary because of the following reasons.

Firstly, the flood impact on prices is not broad-based across the country but rather concentrated in certain areas, mostly the central provinces, and affecting certain goods, especially vegetables and fruits which normally have short production cycles of one to four months. As such, price hikes are likely to swiftly revert to their long-term levels. Accordingly, pass-through of rising input costs to final prepared food prices is expected to be subdued.

Secondly, some affected goods, such as construction materials and cleaning products, command only small weights in the CPI basket, amounting to less than 3 per cent. Their price increases due to the post-flood restoration demand, thereby, would not shake the overall price stability.

Lastly, most of flood-affected good prices – such as those of rice, meats, poultry, and dairy products – are being monitored and administered by the Commerce Ministry. Some products such as eggs and instant noodles have been imported to relieve domestic shortages. These government measures can partially moderate the effect of the supply shock.

Other risks to inflation apart from the direct impact of the flooding also seem unthreatening. On the one hand, upside risks are expected from the upcoming demand-pull pressure stemming from the restoration of private sector’s confidence and potential government stimulus policies. These demands, however, are not yet of a great concern as they do not reflect higher purchasing powers, thus the risk of a second round effect. On the other hand, downside risks seem to be more apparent as a result of the worsening global economic prospects. This would help tame some of the demand-pull pressure as well as contribute to decelerating trends of global oil and commodity prices that in turn would help lessen pressure on the cost side. Addition-ally, the steady 12-month-ahead inflation and cost expectations (as of October) indicated that expectations have been quite well-anchored.

Overall, after assessing both the upside and downside risks to inflation, it can be reasonably anticipated that the inflationary pressure would persist but would still be well contained. This was in line with the Monetary Policy Committee’s latest assessment that the risk to inflation was outweighed by the risk to growth and that there was a room to implement a more accommodative monetary policy to shore up confidence as well as to support the economic restoration and investment. Consequently, a 25 basis point policy rate cut – the first in two years – was decided upon, bringing it down to 3.25 per cent per annum.

 

(The views expressed are the author's own.)

 

Chotima Sitthichaiviset is an economist of the Monetary Policy Group, Bank of Thailand.