Cef2009 Adb Eng

8/8/2019 Cef2009 Adb Eng

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Kelly Bird and Edimon Ginting

Presentation to the Cambodia Economic Forum

5 February 2009

Phnom Penh

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1. Surge in inflation in 2008 provides opportunity to take stock of range of available policy levers to address shocks to the Cambodian economy and tomitigate the effects on the poor

2. The 2008 inflation episode also reminds us that Cambodia like any small openeconomy is vulnerable to external food price shocks

5. The global economy right now is highly uncertain

i. The threat of deflation in some economies in 2009/2010

ii. The threat of subsequent bouts of inflation in the medium term associated with thelarge amounts of liquidity pumped into banking systems of developed countries

7. It also helps to educate the community about inflation, how to measure it

and the role of policy

9. It also helps to design appropriate programs to mitigate the effects on thepoor

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1. Food price inflation explains most of the variation in Cambodia’sinflation (about 80%)

2. And this is primarily linked to food price developments in major tradingpartners in the region (Thailand and Viet Nam)

3. Core inflation – excludes volatile food and energy prices from the index

- is the better measure of underlying inflation in Cambodia and thisshould be monitored closely

4. Money supply growth matters in influencing core inflation, especially in2007 when the economy showed signs of ‘overheating’.

5. The exchange rate does not appear to be a significant factorinfluencing domestic inflation - outcome of heavily dollarized economy(?)

6. While currently limited, there is a role for monetary policy, andespecially over the longer term. Fiscal policy is an important policylever

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1) Some Facts About Cambodia’s PriceInflation

2) Core Inflation as a Measure of UnderlyingInflation in the Domestic Economy

3) Demand Pressures on Core Inflation4) Causes of Inflation in Cambodia – Empirical

Results

5) Policy Implications

i. Short termii. Long term

iii. Mitigating the Impacts on the Poor

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• Three measures of inflation used in the paper

1) Headline inflation rate – calculated from themonthly consumer price index or CPI (surveycarried out by NIS in Phnom Penh every month)

3) Food price inflation calculated from the food

index in the CPI

5) Core inflation – ADB calculated two core inflationmeasures:

(i) Core_EF = CPI excluding food

items (ii) Core_ EFFT = CPI excludingfood, fuel and transportation

• Core inflation is more likely to be driven by domesticand demand factors

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• Demand factors – two measures used in thepaper

1) The Output Gap, measures the difference between actualGDP and estimated potential GDP.

• If the output gap is positive then this tells us that thereare excessive demand pressures in the economy, which

in turn may increase inflation

3) Monetary Aggregates and private sector lending.

Monetary aggregates include:

• M1= riel currency in circulation and demand deposits

• M2 = M1 plus term deposits and foreign currency depositsin commercial banks• Faster growth in money supply, higher inflation

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1. Historically, low inflation with ratesranging between 2% and 7%, perannum (Figure 1).

2. Food is the main contributor toinflation, accounting for over 80% of

inflation between 2002 and 2008.

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3. Food price inflation in Cambodia closelytracks inflation in Thailand and Vietnammore than other countries.

• Therefore, price developments in these two countries are more directly relevant in explaining domestic inflation in Cambodia

than international food indicators.

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4. Core inflation has been relatively low,averaging about 2.5% from 2003 to

mid-2007• It surged above 5% in early 2008

suggesting second round effects were

beginning to emerge from the global

food price shock

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In assessing inflation in Cambodia the following factors are taken

into account:1) Cambodia is a small, open economy so domestic inflation will

be influenced by international prices.

2) Cambodian economy is integrated with economies of Thailandand Viet Nam through trade, so we expect price developmentsin these two economies to be more relevant to Cambodia thaninternational price indicators

3) The tradable goods sector dominates the economy and theCPI index (so expect international prices to be dominant indomestic inflation).

4) Cambodia’s economy is substantially dollarized – limited rolefor monetary policy and limited exchange rate pass-through tothe economy

5) Financial sector, whilst improved a lot in the last decade, is

less developed and financial intermediation still shallow – thislimits the kinds of monetary instruments available toauthorities.

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• Complete transmission from Thai and Viet Nam inflation toCambodia’s inflation – 10% increase in trading partners’ inflation leads to about

10.7% increase in Cambodia’s headline and food inflation

• Money supply M1 does matter for influencing core inflation,especially in 2007, i.e., the period associated with the possibilityof ‘economic overheating’

– A 10% increase in money supply growth leads to a 1.7%increase in core inflation in 2006/07; prior to 2007 the impactwas 0.8%

• Exchange rate did not have any impact on inflation

– Might be due to exchange rate effects transmitting throughThailand and Viet Nam’s inflation rates

– International studies show that exchange rate pass-througheffects are reduced/diminished when countries participate incommon currency arrangements or currency boards, and thismay be true for Cambodia

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• Food price developments, which explain most of thevariation in headline inflation is linked to pricedevelopments in major trading partners (Esp.Thailand and Viet Nam).

• Core inflation is a better measure of underlyinginflation/deflation and should be closely monitored –

useful to publish the core measure like the Thai andPhilippines central banks.• The transmission of domestic macroeconomic policy

(monetary and fiscal policy) to domestic inflation isthrough the prices of non-tradable goods andservices, and reflected by movements in the core

inflation measure.• Fiscal policy is an important policy lever to influenceinflation in the short term (i.e., fiscal policy should becountercyclical).

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• As the Cambodian economy develops and gets more sophisticated it may be

essential for authorities to expand monetary instruments.

• In this context, international experience suggests that the move towardsmoney market instruments for the conduct of monetary policy requiresthree initial conditions to be fulfilled over the longer term:

– Continued sound fiscal policy

– Sound and competitive financial system with adequate supervisory

framework, and – Operational capacity and a sufficient degree of institutional autonomy of the central bank

• To establish these three initial conditions in the longer term the papersuggests: – NBC take stock of existing market infrastructure, develop action plan to

address existing weaknesses, and adjust the mix of policy instrumentsas progress is made

– NBC develops a medium term action plan for developing its mix of instruments, which would include actions to stimulate the developmentof an inter-bank market.

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• Fiscal policy can be used to mitigate effects on the poor.• In designing relief measures the paper suggests:

– Indirect tax relief is poorly targeted and not recommended

– Export bans or taxes redistribute gains from farmers toconsumers and are not recommended as it undermineslonger term domestic supply

– Food subsidies are poorly targeted and not recommendedexcept in food emergencies

– Direct social assistance such as unconditional cash transfers(UCT) and or conditional cash transfers (CCT) as inIndonesia and other countries have shown to be moreeffective in reaching target groups and generally cheaper toadminister.

– The conditional cash transfer -which links assistance withschool attendance and or immunization of children in thehousehold promotes human capital development of childrenand escape from poverty.

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Cef2009 Adb Eng

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