Yellow Pad

The recent news that the inflation rate increased from 2.7% in January 2017 to 3.95% in January 2018 (year over year or YOY) raised alarm bells.

About a year ago, I wrote a similar column on inflation titled “Is current inflation worrisome?” (13 February 2017, BusinessWorld). My answer was no.

Let me quote that article:

“We must resist the bias for or obsession with so-called “low-inflation” at any cost. Basic macroeconomics informs us that in the short run, a trade-off between inflation, on the one hand, and output and jobs, on the other hand, does happen.

“In the current context, consumer spending is heavy, which creates inflationary pressure. Production, however, is being constrained by bottlenecks in infrastructure and logistics. Thus, government needs to ramp up infrastructure spending, in which the resources will be generated from tax reform.

“The country has yet to reach its production potential. And the economy is far from overheating. In this case, a reasonable higher inflation rate can be accommodated to accelerate growth.”

My answer remains the same for the current situation: Inflation is not the main problem. And some people are using inflation as a bogeyman.

A year ago when I wrote the said column, the first package of the comprehensive tax reform was in the early stage of the legislative process. Now, the first package has become law. We have in previous articles analyzed the first package, concluding that on balance, it is a good law. It generates new revenue of PhP90 billion, in spite of significantly lowering the individual income tax rate. It corrects basic weakness in the tax structure such as lifting exemptions on the value-added tax (VAT) to make it efficient and adjusting excise taxes with fixed rates to inflation.

Nevertheless, TRAIN contains weaknesses, particularly in protecting vested interests with regard to a number of VAT items and the excise taxes. But the process has not ended, and the opportunity remains to pursue the reforms as part of package 2.

It goes without saying that the tax reform has raised consumption taxes and thus has increased prices. One question is whether inflation will rise steeply. The doomsayers make such a claim.

The first-round effect on prices can now be seen. The inflation rate in January 2018 is well within the target of the Bangko Sentral ng Pilipinas (BSP). The target’s upper bound is four percent.

Further, the increase in the inflation rate cannot be solely attributed to the tax reform (also known as TRAIN). Other factors like the rise in the world’s oil prices and bad weather contributed to the higher inflation rate.

It is interesting, for example, that tobacco among the different items measured in the consumer price index had the biggest price increase, equivalent to 17.41% (YOY). The increase in the tobacco tax rate for the first half of 2018 is equivalent to 8.33%. In other words, the jump in tobacco prices is explained by other factors as well, like the tobacco industry’s strategy of increasing non-tax prices. The increase in tobacco prices is still welcome, if the goal is to reduce smoking and promote health.

A food item whose price increased sharply was fish, with a rate of 11.97% (YOY). The main explanation is the stormy weather in the Visayas, leading to a significant drop in catch and hence much higher prices of fish.

The Department of Finance (DoF) and the BSP maintain that the inflation rate for one year that can be specifically attributed to TRAIN will be between 0.5 and 0.7 percentage point.

The DoF says that the four percent inflation rate is moderate. Moderate inflation does not harm growth; in fact, it accompanies growth. Higher consumer and government spending exerts upward pressure on inflation. Like it or not, inflation will increase as incomes and spending increase.

On the other hand, a very low inflation rate suggests a growth slowdown, and hence a decline, too, in jobs and incomes.

Still, I disagree with DoF in describing current inflation as “moderate.” It is low! To put things in perspective, again something that I wrote in “Is current inflation worrisome?,” economists of the first caliber, namely Michael Bruno and William Easterly and Rudiger Dornbusch and Stanley Fischer define moderate inflation as one with a lower bound of 15-20%.

Nowadays, inflation globally is tame. An inflation rate that is far from double-digit is low. Even if we assume that the inflation rate somewhat breaches the BSP target of containing inflation this year at four percent, we need not worry. We are far from having runaway inflation.

The BSP itself has expressed confidence in the current situation. It will not move to drastically check inflation; it will not take monetary policy action that will dissipate the growth momentum. In fact, the BSP just recently reduced the reserve requirement by 100 basis points, from 20% to 19%. If the BSP were too worried over inflation, it would not have reduced the reserve requirement at all.

Such move shows a confident and sophisticated BSP. It has signaled its policy preference for growth and jobs, even if it allows a little more inflation.

Beware of making inflation the bogeyman. We have more serious problems that challenge the economy. Look elsewhere. For instance, the infrastructure bottlenecks and the political uncertainty demand our attention.


Filomeno S. Sta. Ana III coordinates the Action for Economic Reforms.