Averting the risks of possible deflation

12:54 | 12/05/2020
The world is seeing numerous monetary stimulation packages applied by nations to support businesses suffering during the pandemic – however, too much money with too few goods could mean high inflation.
1491p2 averting the risks of possible deflation
Tran Ngoc Tho

However, evidence from the global financial crisis in 2008 has shown no high inflation coming from this situation, but demonstrated deflation in developed nations, despite tens of trillions of US dollars pumped into the economies by central banks. COVID-19 is forcing global goods prices to dive steep, with below-zero oil prices, massive unemployment, and slashed demands for goods and services.

According to Olivier Jean Blanchard, former chief economist at the International Monetary Fund (IMF), the pandemic will force people to tighten their belts, causing a prolonged frozen period in the global economy, with elongated recession and deflation.

However, some also argued that if the pandemic lasts long, there will be scarcity in goods and services, meaning strong price hikes and high inflation. Meanwhile, labourers suffering from supply chain disruptions will be unable to seek jobs.

In many cases, a reduction in goods demand coming from a supply shock can lead to consequences bigger than the supply shock itself. While supply declines but demand declines stronger, there will be deflation instead of inflation. This phenomenon was reported in a February study by US economist Veronica Guerrieri. For example, if a number of sectors like aviation, restaurant, and logistics are blocked, workers’ incomes in service sector will reduce, meaning they have to cut their spending. In this case, if other sectors such as medical equipment still remain operational, workers’ income in the medical equipment sector will theoretically be able to offset a spending drop in service sector.

However, according to the study, the problem is that the strong decline in spending in the service sector cannot be offset by a corresponding goods purchase at medical equipment stores. In this case, it is called a lack of alternative goods, then the economy will face a situation in which demand will fall deeper than supply.

A long wide-range reduction in goods prices will then lead to prolonged deflation.

Oxford Economics has estimated that expected inflation in the global economy in 2020 will be below zero, meaning deflation. According to the IMF, the consumer price index (CPI) in developed economies will increase 0.5 per cent on average in 2020. Meanwhile, South Korea, Singapore, and Thailand may fall into deflation.

So what should Vietnam do to shun a risk of deflation?

In Vietnpam, there are some risks that can drive the economy into deflation. Specifically, Vietnam is quite open to the global economy, so global deflation factors can have negative impacts on the country. Moreover, the world’s oil prices have plummeted and shown no signal of stoppage.

Due to feeble purchasing power, the CPI in April decreased 1.54 per cent on-year. In which the transportation group’s price witnessed the most decline, at 13.86 per cent on-year. Other groups’ prices also dropped, such as housing and building materials (2.33 per cent); entertainment and tourism (0.4 per cent); garments and footwear (0.17 per cent); posting and telecommunication (0.02 per cent); and other goods and services (0.13 per cent). The price reduction of six out of 11 groups of items used to measure CPI in Vietnam shows that there seems to be a signal of a supply shock, if there is no improvement in the time to come.

In the first quarter of this year, credit growth rate was only 0.68 per cent, a six-year low. Data shows that demand has slumped, with tens of thousands of enterprises leaving the market.

There has also been a big drop in investment in the stock market, with a frozen property market and unstable trend in gold trading.

The US dollar in the international market tends to appreciate strongly, while the VND has been pegged on the dollar, lessening the pressure on inflation imports. The IMF recently forecast that Vietnam’s economy may grow only 2.7 per cent this year, so it would be difficult to believe that inflation will be maintained in the context of low economic growth, which was earlier expected to be 6.7 per cent.

There are many factors causing inflation, such as fiscal and monetary support packages, a rebound in production and business, and a hike in the price of food and foodstuffs, especially pork.

These factors can push inflation up but they are almost weak and manageable. With a legal system in public investment and budget management, and a prudent monetary policy, as well as anti-inflation experience of the government, there is almost no reason to believe that high inflation can return now.

By Tran Ngoc Tho

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