Inflation Hitting 5% in 2008 ?

It is with considerable horror and trepidation that I picked up today’s edition of “Weekend Today” newspaper and saw the headline on the front page stating that Trade and Industry Minister Mr. Lim Hng Kiang had commented (in Parliament) that inflation is expected to hit a historical 25-year high of 5% next year ! As the paper mentioned, it was only on October 30, 2007 that MAS mentioned that inflation would hit 4%; his comment on 5% would mean a 25% increase over the 4% forecast, which is shocking to say the least. This would mean that an item costing S$10 would cost S$10.50 by next year (5% increase) if this scenario came to pass.

As readers may know, the concept of inflation has been around for the last couple of hundred years, but it only came to greater prominence with the development of economic theory by the great Nobel Prize Winners John Maynard Keynes and some other important people (of which I will not bother dredging the names of !). Simply put, inflation is what happens when the prices of goods and services increase; meaning that the same dollar can buy less goods over time. This has a lot to do with aggregate demand and aggregate supply, but since this is not an economics 101 class I will spare readers the details and dive straight into the implications.

Inflation is part and parcel of the growth of an economy and cannot be distinctly separate from it. As long as there is economic growth and GDP growth, there is bound to be some measure of inflation. In fact, economists believe that steady inflation is actually healthy for an economy, as it shows that the entire economy is becoming more healthy and that people have a greater propensity to spend. Chronically high inflation or the opposite of inflation (i.e. deflation) is not healthy as the former situation signals the fact that price is increasing too quickly for the common man to cope with, resulting in decreased consumption and hence slower growth; while the latter scenario has occurred in Japan over the last decade, and caused businesses to suffer a result of decreased prices. So the general argument would be that inflation is necessary and healthy, so why is there such a hue and cry over the recent 5% announcement? Perhaps it is because 5% is seen as a threshold which is bordering on “high” instead of “healthy”. Traditionally, for Singapore, inflation has held steady at between 2.5% to 3% per annum, and most of the time real wages have also increased by between 3-5% (including in the civil service) to keep pace with this inflation. If inflation really hits 5%, then real wages may not increase enough to compensate this increase in inflation, even though nominal wages are increasing (real wages are what economists refer to as “inflation-adjusted wages”, while nominal wages are the simple dollar value of wages without accounting for inflation). This would inevitably cause hardship to the lower income families and retirees who may find the cost of basic necessities like rice, bread and water rising.

In fact, some recent personal examples I can quote of evidently rising prices include a trip to Old Chang Kee (who, incidentally, are considering a listing on SESDAQ). A normal curry puff there used to cost S$1, but now it’s S$1.10. When quizzed about this apparent 10% increase in price, the staff just gave me a blank look as if I were an idiot asking obvious questions. Another lunch visit to a nearby café close to my office made me discover that my favourite curry chicken rice had “inflated” from S$4.50 to S$5.00. A quick query on the sudden price increase of 11.1% was met with “my boss told me to adjust the price, go ask him !”. I have not been to the supermarket recently but I am sure the same might be happening in NTUC Fairprice, Cold Storage, Carrefour and Giant. I would appreciate if readers can give their feedback on whether this is happening (i.e. rising prices of basic goods).

So what can the common man on the street do to counteract the effects of this inflation ? Putting your money in a bank is obviously the worst way of growing it, as most banks give interest rates ranging from 0.25% per annum (POSBank) to 1.68% per annum (Maybank iSavvy account). Even fixed deposit rates do not get more attractive than 2.25 to 2.5% per annum unless it is a foreign currency time deposit (which will then be subjected to currency risk as well). The most logical solution would be to purchase a high yielding equity such as a REIT, some of which promise yields as high as 7% (e.g. Saizen REIT) or to purchase equities in companies at a decent margin of safety. Thus far, I have a REIT which yields about 7.5% dividend yield at my 2004 purchase price, as well as some companies which are paying a 5% dividend yield at my purchase price. Other suggestions from readers on how to combat inflation will be most welcome !

Note: Just yesterday, on November 16, 2007, I saw value emerging in China Fishery Group (CFG) and purchased a couple of lots at a price of S$1.54, which I feel offered a decent margin of safety. I will detail the reasons and rationale for purchase as well as computations of expected growth and risks of my investment in a subsequent posting.