ANALYSIS OF INTERNATIONAL OIL PRICE PASS-THROUGH TO INFLATION AND ITS TRANSMISSION CHANNELS IN MALAWI

Abstract

Rising oil prices have adverse effects especially to a non-oil producing economy such as Malawi. However, fuel prices in Malawi are relatively stable which implies that they do not give a true reflection of the volatility of oil prices on the international market. This study therefore investigated the pass-through of international oil price shocks to inflation and its transmission channels in Malawi. Within the environment of Vector Autoregression (VAR) modelling, variance decompositions and impulse response functions were analyzed. The study found low and incomplete pass-through of international oil price shocks to domestic inflation. Only 2.5 percent of the variations in inflation are due to oil price shocks and the cumulative pass-through coefficient was found to be 0.296. This gives room to conclude that the automatic pricing mechanism (APM) for fuel prices and the price stabilization policy, exchange rate movements as well as the high content of food in the consumption basket among other factors play a significant role in limiting the level of oil price pass-through to domestic inflation. The study also found the impact of international oil price shocks on urban inflation to be higher than that on rural inflation. Furthermore, the results weakly support the channel that international oil price shocks are passed through to food inflation, transportation inflation then to headline inflation. A significant channel was found to be that international oil price shocks pass through to domestic fuel prices which are then passed-through to non-food inflation. The study also found that international oil price shocks significantly affect industrial output which is evidence of supply-side cost push inflation.