MARKET MOVER - BNP PARIBAS - Investment Services India

inflation is on an upward trend because export-led
growth is narrowing the output gap, this is not the
case as prices have become unresponsive to
changes in the gap.
Reactor shutdown could raise core CPI by 0.6pp
As indicated above, energy prices are the main
reason why Japan’s inflation rate is positive. And with
demand for fossil fuels for thermal power generation
sure to remain strong as the inability to restart idle
nuclear reactors increases Japan’s dependence on
thermal power, energy prices – especially electricity
rates – will continue to push prices upward.
According to METI estimates, fuel costs could rise
more than JPY 3 trillion a year if the power
companies try to completely offset idle nuclear
reactors with thermal power generation. If the higher
costs are passed on in full, electricity rates could rise
roughly 20% (JPY 3 trillion represents roughly 20%
of the sales that Japan’s 10 utilities stand to lose if
the costs are not defrayed).
This in turn could raise the core CPI by 0.6pp
(electricity’s weight in the index is c.3%). But the
likelihood of rates being raised so much is low.
Government authorisation is required for rate hikes
resulting from changes in the source of energy, and
the authorisation process entails public hearings with
the concerned ministries and the price stability
committee.
By the way, compensation for the Fukushima crisis is
expected to ultimately come from higher electricity
rates. To help Tepco pay what promises to be a huge
compensation bill, the government has submitted
legislation to create an entity into which funds will be
channelled by both the government and the utilities
that operate nuclear power plants.
Under the proposed legislation, the utilities would be
allowed to pass these costs onto the consumer
without separate authorisation.
Next CPI release will feature 2010 base year
The CPI report released on 29 July was the final
official release using the base year of 2005. From the
26 August release of the national CPI data for July
(and the Tokyo CPI data for August), the CPI’s base
year will shift from 2005 to 2010. Index rebasing,
which occurs once every five years, involves an
overhaul of the CPI market basket (adding or
eliminating products); a revision of the calculation
and survey methods; and the resetting of the weights
and price index levels for all products (see “Japan:
Impact of CPI Rebasing in 2011”, Market Mover, 25
November 2010).
Rebasing is necessary to correct the upward bias
that the index assumes over time. For instance,
products with continuous, significant price decline
such as PCs and flat-panel TVs end up being
understated with the passage of time. Take notebook
PCs as an example: in 2010, the index level was just
12.5. After resetting to 100, the index contribution will
eight times greater (hence its current contribution is
only one-eighth of what it should be). Because
rebasing corrects this upward bias, the negative
contribution from these items is enlarged – resulting
in downward revision of the core CPI’s rate of growth.
Rebasing likely to lower index by 0.8 pp
Based on the new 2010-base weightings, announced
on 8 July, we estimate that the core CPI could be
lowered by roughly 0.8pp. Specifically, we expect
there will be a significant increase in the negative
contributions of products such as TVs (-0.34pp
contribution), locally made cigarettes (-0.10pp),
mobile phones (-0.13pp), notebook PCs (-0.04pp),
video recorders (-0.04pp) and desktop PCs
(-0.03pp). While lower prices for IT/digital products
thus play a large role, policy measures (eco-point
system) also caused a surge in consumer electronics
purchases in 2010 that has enlarged the weightings
(and index contributions) of the products affected.
Incidentally, the previous rebasing (from 2000 to
2005) resulted in the core index being revised down
0.5pp, reflecting (1) the greater weight assigned to
mobile phones and the use of discount plans in
pricing this item; (2) the addition of products with
marked price decline such as LCD TVs; and (3) the
recalibrating to 100 of indices for products such as
PCs that had dropped dramatically in price.
This time around, the downward revision is expected
to mostly reflect the resetting of weights and index
levels. In any event, the impact will become clear on
12 August when CPI data for January 2010-June
2011 that have been retroactively adjusted for the
new base year will be released.
CPI to return to around zero
Our current CPI forecasts – 0.5% for 2011 (0.8% on
a FY basis) and 0.7% in 2012 (0.6%) – are based on
the 2005 price index and do not factor in possible
electricity rate hikes. Price forecasts by other
economists and the BoJ are also based on the 2005
index.
If we were to switch to the 2010 base, our forecasts
would be roughly -0.3% in 2011 (about zero on a FY
basis) and -0.1% in 2012 (-0.2%). In a similar vein,
the BoJ’s current median projections of 0.7% for both
FY 2011 and FY 2012 would be around zero under
the new index.
Ryutaro Kono, Azusa Kato 4 August 2011
Market Mover
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