The Next Crunch

Oil prices have seen a steady increase since the end of the Asian financial crisis in 1997. However, over the initial quarters of 2008, oil prices accelerated to reach a lofty $140 a barrel by the end of July. The main attributable causes are mainly a weakened US dollar, a fast growing demand outpacing production and supply, political instability in oil producing regions and market speculation. Given the galloping increase in oil prices many, if not all, countries would have seen an impact on their respective local economies.

Initial Impact in Malaysia

Due to the acceleration in prices, Malaysia made the economically viable albeit unpopular decision of reducing subsidies on domestic fuel consumption. Had the subsidies continued, Malaysia would have had to pay a record US$ 17billion in subsidies alone, which would have been four times the amount spent on healthcare, education and national defense combined.

Thus with the reduction in subsidies, Petrol and diesel saw a price appreciation of 41% and 63 % respectively. As a further repercussion, the fuel price change brought on an increase in inflation to reach a 26 year high by the end of June 2008. Using the previous year as base the consumer price index rose by 8.5% the end of the 3^rd quarter. This is in line with a poll conducted by Dow Jones news wires on thirteen economists who estimated that the CPI would rise 8.4% from a year earlier.  [1]

                              The above graph illustrates the changing rate of inflation on a year on year basis.

An estimate made by Citibank analysts showed that for every 10% rise in fuel prices the Consumer Price Index (CPI) would be raised by 0.7% on a month by month basis.  

However, what should be noted is that the rise in inflation over the period could not be blamed entirely on the rise in fuel price. The food price index, a component with of the CPI calculation, increased by 8.2% over May; bringing inflation to 22 month high. [2]

The silver lining

The following graph breaks down the estimated inflation rate by each quarter of 2008:

As can be derived from above, 2008 was expected to see a dramatic increase in inflation. However, with the onset of the credit crunch, global growth rates have been revised downward with many financial institutions facing a possible bleak future. It has been expected, that the repercussions of the credit crisis would not only be felt by the large corporations but by individual consumers as well. Thus, with a high demand for credit on a global scale in turn, causes a reduction in demand for oil, which therefore causes market oil prices to fall. 

Thus the silver lining for Malaysia came in the form of reduced petrol prices at the pump. Petrol prices were reduced by 3.9% with a 4% reduction in diesel prices on the 24^th of September. The reduction in prices should cause an ease in inflation over the 4^th quarter of 2008 given that interest rates remain the same. A statement by the chief economist of CIMB bank, Lee Heng Guie, states that inflation would moderate between 7% to 7.4percent over the 4th quarter of 2008.  [3]