The true cost of living

Subsidies have been slowly curbed and come Dec 1, the Government is scrapping the RON95 fuel subsidy, allowing prices to be based on a managed float system and better reflecting market rates.

IT’S hard for the average Malaysian wage earner to understand why the cost of living has risen when the rest of the world is seeing lower inflation given that global oil prices are trading below US$80 a barrel.

Simply put, people have gotten used to unrealistically low prices due to Malaysia’s subsidies regime covering fuel, basic necessities and electricity. This regime has distorted market pricing.

Critics argue that if oil prices have fallen, why are prices going up? After all, fuel is an important component of the cost of goods and services.

But in recent years, subsidies have been slowly curbed and come Dec 1, the Government is scrapping the RON95 fuel subsidy, allowing prices to be based on a managed float system and better reflecting market rates.

People will have to come to terms with paying for the real prices of goods and services. In other words, Malaysians are now facing the true cost of living and local firms will now have to pay for the true cost of doing business.

AllianceDBS Research chief economist Manokaran Mottain says Malaysians will have to get used to the higher cost of living. “It may take them some time to adjust but this is the reality,” he tells StarBizWeek.

The dean of Malaysia University of Science and Technology’s business school Dr Yeah Kim Leng, an economist, says next year’s inflation will have a negative impact on the real income of the 40% of Malaysian households with monthly incomes of less than RM3,000.

“This group tend to spend proportionately more on ‘essential’ items such as food and fuel. Price changes of these items tend to be higher and more volatile. Since income of this group tends to be relatively fixed, the 5% expected rise in inflation will squeeze their savings or increase their debt level to the limit,” he says.

To appreciate how much costs will rise, remember when older family members used to reminisce about how much cheaper everything used to be?

The disconnect between CPI and cost of living

The latest consumer price index (CPI) data released by the Statistics Department on Nov 19 showed October headline inflation (which includes volatile food and energy costs) rising marginally to 2.8% year-on-year after having moderated to 2.6% in September.

This looks like prices are coming down given that in August, inflation was up 3.3% while in February and March, inflation spiked to 3.5%. On a year-to-date basis, inflation averaged 3.3%.

However, as economists point out, this is just a statistical calculation, given the high base of inflation in September 2013, when the Government cut the RON95 fuel subsidy by 20 sen.

In reality, people still face rising prices due to cost-push inflation because businesses will pass the higher costs to consumers.

Besides the fuel subsidy cuts last September and this October, businesses have had to contend with the full implementation of the minimum wage and the hike in electricity tariff rates from Jan 1. Then there is the looming deadline of April 1 next year, when the goods and services tax (GST) will be implemented.

The World Bank’s senior country economist for Malaysia Dr Frederico Gil Sander says in an email reply that the impact of subsidy cuts to the cost of living for low-income households is between 2% and 9%.

Citing a study done by the Global Subsidy Initiative, he says this includes both the direct impact of higher prices from goods such as fuel and indirect impact, such as the cost of transportation of goods.

“In many cases, indirect impacts are even larger than the direct impact,” Gil Sander says, adding that in respect to Malaysia, price increases will not impact low-income households as much since the GST will not cover goods consumed by this group.

“Overall, one could expect a modest impact in the cost of living to the poorest households that could be effectively offset with targeted cash transfers,” he adds.

However, to the ordinary wage earner, the cost of living will still be higher at the end of next year and going into 2016 due to a combination of low-wage pressures and the continued adjustment of prices to market levels. And this is despite Bank Negara’s forecast of inflation normalising to 3% towards end-2015 after spiking to 5% in the first-half of the year.

A major cause of the average Malaysian wage earner’s concerns are likely due to what Yeah says is the divergence between the CPI and the cost of living inflation.

He points out that CPI inflation is not the same as cost of living inflation, which measures the change in expenditure needed to maintain a certain standard of living.

Yeah says cost of living varies across households and social strata, with price mark-ups and changes varying markedly for the higher quality or branded segments.

“Not surprisingly, therefore, the cost of living increases and people’s perception of inflation diverge sharply from the official CPI statistics,” he says.

That perception is underpinned by the fact that almost 70% of Malaysian households live in urban areas, because they have been impacted by the rapid rise in residential property prices and rentals in urban areas over the past four years.

Yeah noted that education, medical and transport services costs have risen more sharply compared with the national average captured in the CPI.

In addition, high household indebtedness coupled with low savings has eroded the affected families’ discretionary spending power. Households and businesses saddled with high debt servicing payments will find it harder to cope with rising prices and interest rates.

“The inability of household income increases for a large segment of society to keep pace with the rising cost-of-living, therefore, has caused people to question the veracity of the official CPI inflation rate,” he adds.

However, Yeah says while the divergence is real, there are psychological biases in the perception of inflation.

“Individuals tend to give more weight to price increases than declines. In other words, people prefer no change in prices than the off-setting changes of two prices, one up and one down,” he adds.

Furthermore, consumers tend to notice large but infrequent changes in price-controlled items and people tend to associate rising inflation with the price changes for daily use items such as food and fuel and ignore the decline in prices of computers, hand phones and other consumer durables, which are purchased less frequently.

Productivity and wages

To help ordinary wage earners cope with the cost of living, the Government continues to have subsidies for basic necessities and electricity. For eligible households and individuals, the Government has, since 2012, given out cash under the 1Malaysia People’s Aid or BR1M programme.

Manokaran says there is an urgent need to address the issues faced by the lower income group. “They can’t make ends meet,” he says. The recent Khazanah Research Institute report titled “The state of households” shows how much households earn in this country.

“If the economy is to grow, then those in the lower-income group must see their wages rise so that they can help boost private consumption,” Manokaran adds.

The authors of the Khazanah report noted that 23% of households earned less than RM2,000 per month while at the individual level, based on Employees Provident Fund (EPF) data from 2013, the median monthly salary was RM1,700.

“This is consistent with the data from the EPF that show that 62% of active EPF members earned less than RM2,000 per month and 96% earned less than RM6,000,” they noted.

Therein lies the dilemma. For wages to rise, productivity and output must rise but while Malaysia is steadily transforming its economy, it looks as if inflation is rising faster than wages.

Productivity remains an issue, admits Manokaran and that is also reflected in economic growth. In the aftermath of the 1997/1998 Asian financial crisis, policymakers had recommended that the Malaysian economy should move up the value chain.

The Economic Transformation Programme (ETP) is addressing this issue but, judging from wages alone, while there have been improvements they are still slow.

Dr Yeah says based on the rising investments in higher value-added, more technology-intensive and skills-based industries attracted under the ETP, there are grounds to be optimistic that these industries will be able to pay wages that are higher than the existing industries.

“In turn, a tighter labour market will result in the desired gradual increase in wage levels as industries will have sufficient time to adjust by raising productivity,” he noted.

But Yeah says the concern is still the large pool of unskilled and cheap foreign labour in the country.

“This dependence will have the undesirable effects of retarding technological upgrading, upskilling and wage increases,” he says.