Uptick

Increased economic activity has an ugly twin: inflation.

Unless managed properly, inflation could run rampant. Price increases wipe out the purchasing power of fixed income earners. For the poor especially, inflation negates whatever advantages increased economic growth could bring.

Inflation sharpens inequality. It fuels poverty. This is why the first order of business for monetary authorities in modern states is to tame inflation.

The BSP, the institution tasked with checking the inflation rate, estimates consumer prices rose in January 2013 between 2.5% and 3.5%. At this inflation level, price increases eradicate interest rate on savings. That could discourage savings and therefore undermine investments.

To check rising inflation, the main instrument in the toolbox of monetary authorities is raising interest rates. That will bring up the cost of money and serve to discourage investments since the interest rate hurdle for profitability might prove too challenging.

It is generally conceded that the Monetary Board will no longer cut policy rates. The successive lowering of policy rates, not any other policy initiative of the executive branch, is generally considered the main driver of the higher economic growth posted in the past year. The executive branch is claiming credit it does not fully deserve.

If the inflation rate rises in the coming months, our monetary authorities are mandated to raise interest rates. That could cut the growth rate. The more severe the inflation rate, the less growth we will have to accept.

Over the past two years, for instance, China’s economic growth significantly fell. This was the outcome of higher interest rates aimed at taming inflation. The higher interest rates also served to strengthen the yuan, making Chinese exports less competitive. In the face of high growth combines with rising inflation rates, Chinese authorities chose the wiser option of a more moderate growth and a tolerable inflation rate.

Chinese planners also chose to be less dependent on exports and more dependent on domestic consumption. Domestic consumption demand can only be sustained with a low inflation rate.

There is such a thing as an “overheated” economy: one with high growth but intolerably high inflation rates. Eventually, an “overheated” economy worsens social imbalances and is self-limiting. Chinese authorities chose to cool down economic growth rather than face social unrest resulting from a steep inflation rate.

The main drivers of the higher inflation rate estimate for January, according to the BSP, are increases in the prices of electricity, water, liquor and cigarettes. Although the latter two may be dismissed as “sin” products, they are unavoidably part of the basket of goods used to compute increases in the consumer price index.

In the smaller basket of goods that the poor consume, alcohol and cigarettes take a bigger share of the total. It is among poorer consumers that the sharp increases in excise taxes on “sin” products are more severely felt. An uptick in the inflation rate is felt first at the lower income levels.

The impact of the recently imposed hike in “sin taxes” was magnified by the speculation the major increase induced. Although manufacturers have not yet reflected the new excise tax regime in their off-factory prices, hoarders and profiteers ran wild. Products subject to higher excise taxes disappeared from the shelves. Available supply were priced unjustifiably.

The hoarding and profiteering that came in the wake of the enactment of sharply higher “sin taxes” was not at all considered during the legislative deliberations. The matter ought to have been carefully considered when discussing the schedule of increases. The expectation of a higher price regime for certain products always induce hoarding and profiteering. That is how markets behave.

To be sure, all the hoarding and price speculation now going on will magnify the inflationary impact of the new excise tax regime. In the face of it, neither the DTI nor the BIR have lifted a finger against the hoarders, speculators and profiteers who must now be raking it in.

Having labeled them as “sin” products, no one seems inclined today to defend the sinners: those who consume tobacco and alcohol. The inaction, however, comes at the peril of an unexpected inflationary uptick. That unexpected inflationary uptick will have adverse consequences for the whole economy.

In a study done by the University of Asia and the Pacific (UAP) last year, it was estimated that a large jump in the prices of “sin” products could push up the inflation rate to 4.56%. Dazzled by the unfounded revenue projections put forward by advocates of a brutal increase in “sin” taxes, our legislators paid little attention to inflationary consequences. Even those who opposed the massive excise tax increases argued, in the main, on behalf of agricultural sectors such as tobacco farmers that might suffer dislocation.

Given the realities of globalization, effective benchmarks are established on what constitutes acceptable inflationary levels. An inflation rate of 3% is generally accepted as the upper threshold of what is acceptable as good housekeeping. The lower the inflation rate, the better managed an economy is considered to be.

We could post an inflation rate higher than 3%, courtesy of the steep increases in the prices of “sin” commodities. When that happens, our monetary authorities are commanded by their mandate to undertake a train of measures to cool down the economy, including raising interest rates that will undermine investments.

It will be such an irony if this whole episode ends up in accepting lower economic growth all because of a mad chase after an illusory revenue windfall.