Despite Ukraine war, inflation could stay manageable

Global equity markets have been volatile lately, with the Philippines’ PSEi index correcting by as much as 10 percent since Russia invaded Ukraine.

This is not surprising considering the negative impact of the war on commodity prices. Prices of oil, coal, nickel, wheat, and numerous other commodities have gone up sharply this March due to Russia and Ukraine’s sizeable share of global commodity exports.

The significant increase in commodity prices could in turn push up inflation, hurting both businesses and consumers’ ability to spend. It might also force the BSP to aggressively raise interest rates to control price increases, leading to higher borrowing costs for Filipinos, further slowing economic growth.

Nevertheless, there are reasons to be hopeful that inflation will remain under control despite a prolonged war between Russia and Ukraine.

The sharp increase in commodity prices might not be sustained. Although the supply disruption caused by the war justifies higher prices, other factors were also responsible for the sharp and abrupt increase earlier this month, including speculation and short covering.

Even if the war continues, the increase caused by these nonfundamental factors is not sustainable. Moreover, if high commodity prices persist, they will lead to weaker demand and encourage more supply.

For example, there are now increasing calls for energy conservation and a faster shift to renewables because of high oil, coal, and natural gas prices. Meanwhile, shale oil companies in the United States have been increasing their production, with the oil rig count in the country now exceeding 500 after falling to as low as 172 in July 2020.

Another reason why inflation could stay manageable in the Philippines is the economy’s early stage of recovery.

Because the economic recovery is still in a fragile state, businesses would most likely be more cautious in passing on higher costs as sales could deteriorate. As such the threat of higher commodity prices leading to second round effects is much less, which is what the BSP is most concerned about.

Finally, the government is taking administrative measures to control inflation.

For example, instead of allowing public utility vehicles to increase fares, it is providing fuel subsidies for the public transport sector and the farm sector. That way, the drivers and the farmers will be protected from higher fuel prices, while most of the public will not suffer from higher costs.

The government also plans to take steps to control the increase in food costs. This is crucial given that food and non-alcoholic beverages account for around 39 percent of the average Filipino’s consumption basket.

Proposed measures include supporting farmers through the provision of targeted fertilizer vouchers, reducing tariffs and increasing the amount of rice, corn, pork, fish, and other soft commodities that can be imported.

The next few months is critical as it will determine whether efforts to control inflation will succeed. If inflation turns out to be a non-issue, investor sentiment should improve, allowing the stock market to resume its uptrend even if the war in Ukraine continues.