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Excess money pushes up basic inflation

Excess money pushes up basic inflation

Wednesday 12, 02 2020
The goal of controlling inflation at an average of 4% this year is challenging, not only because of rising pork prices but also because of the excess of money.

​Inflation threat posed by pork

The General Statistics Office has just announced the inflation situation in January - 2020, with the consumer price index (CPI) increasing by 1.23% compared to December 2019. This is the third month in a row that inflation has risen sharply to around 1% / month (November 2019 increased by 0.96%; December 2019 increased by 1.4%). This result has pulled the annual CPI (YoY) in January-2020 to 6.43% over the same period of 2019.

The price of pork (which in January-2020 was still up to 8.29% compared to December 1919) along with the prices of many other commodity groups that increased periodically on the occasion of the Lunar New Year is making the ability to control the average inflation of about 4% in 2020 very challenging.

On the afternoon of January 31, Deputy Prime Minister Vuong Dinh Hue had to convene an extraordinary meeting of the National Price Steering Committee. This is an urgent meeting because the steering committee normally only meets once a quarter. The purpose of this meeting is to find solutions to stabilize pork prices in the future.

Accordingly, in just the last four months, from October 2019 to January 2020, the price of pork has increased by 54.4% compared to the time before the African swine cholera outbreak in May 2019. Fresh meat, in which pork accounts for the largest weight, currently accounts for about 5% of Vietnam's CPI basket of goods. As a result, rising pork prices are threatening the Government's goal of controlling inflation in 2020. 

The worrying issue is the increase of basic inflation

Along with the high increase of overall inflation (Headline CPI), the core inflation (Core CPI) is also increasing accordingly.

The core inflation in January 2020 increased by 0.76% compared to December 2019 and by 3.25% over the same period in 2019. This figure is much higher than the average of about 2 % for the whole of 2019.

If recent high inflation has been driven by a shortage of pork, due to the impact of African swine cholera, this factor is no longer likely to have a strong impact on inflation in the coming months as businesses are stepping up the reorganization as well as the Government are promoting the import of meat from abroad. Therefore, total inflation will tend to decrease in the coming months.

However, the evolution of basic inflation is in a different direction when food and government-controlled goods will not be used to calculate this index. It is estimated that the items in the commodity basket that comprise the core inflation index account for about 40% of the total items in the commodity basket in the CPI calculation.

Therefore, the increase or decrease in inflation basically correlates closely with the amount of money circulating in the economy. Normally, the increase in the money supply will put pressure on basic inflation and vice versa. The State Bank of Vietnam (SBV) bought 20 billion USD in 2019, which means that the economy has received about 450,000 billion VND.

It is likely that this is the time when the latency of the cash flow is directly affecting the underlying inflation when the volume of goods produced is not equal to the amount of money injected into the economy. To put it simply, this is the phenomenon of excess money in circulation.

Pressure on monetary policy

If commodities such as pork and food increase continuously, businesses will increase their output by boosting their stock and/or importing from abroad, according to the law of supply and demand, dragging the prices of these items down to an equilibrium point.

Meanwhile, basic inflation is directly attributable to the surplus of money in the economy. This is a difficult problem for central banks in the world because it is difficult to have an optimal solution in this case.

The narrowing of money supply means the implementation of a tight monetary policy, which can push interest rates in the economy to increase.

The increase in interest rates, which may lead to an increase in the cost of production and business of the enterprise, will reduce the motivation for business expansion and eventually will directly affect the growth of the economy.

Conversely, if central banks do not narrow the money supply, inflation will tend to increase continuously.

People will feel the decline in currency value in relation to the price of goods, thus encouraging them to shift to safer assets like gold or US dollars. The current situation is putting a lot of pressure on the State Bank in managing monetary policy.

The current movements of inflation have forced the agency to gradually narrow the money supply through the issuance of 91-day treasury bills (SBV notes) from January 20.

In order to avoid having to narrow the money supply at a high level in a short time, the State Bank may simultaneously control more tightly the credit capital flowing into non-production sectors such as real estate, consumption or securities investment. ... Therefore, the loan risk factor for real estate business has also been increased from 150% to 200% as stipulated in Circular No. 22/2019 / TT-NHNN taking effect from January 1st, 2020.

With the above solutions, perhaps the money supply will gradually be narrowed, interest rates may face slight upward pressure in the near future, while sectors such as real estate and consumption will also be restricted from disbursement from banks' credit.

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