This article first appeared in The Edge Malaysia Weekly on January 29, 2018 - February 4, 2018

IN an expected move, Bank Negara Malaysia lifted the overnight policy rate (OPR) by 25 basis points to 3.25% last week. It was the first rate adjustment since July 2016, when the rate was revised downwards to 3% to pre-empt headwinds from Britain’s unexpected vote to leave the European Union.

“With the economy firmly on a steady growth path, the monetary policy committee decided to normalise the degree of monetary accommodation. At the same time, the MPC recognises the need to pre-emptively ensure that the stance of monetary policy is appropriate to prevent the build-up of risks that could arise from interest rates being too low for a prolonged period of time. At the current level of the OPR, the stance of monetary policy remains accommodative. The MPC will continue to assess the balance of risks surrounding the outlook for domestic growth and inflation,” Bank Negara says in a statement last week.

The hike signalled that Malaysia, like the rest of the economies around the world, is moving out of the decade-long low interest rate environment, which had stemmed from the US subprime crisis-induced 2008/09 global financial crisis.

The questions now are, how soon will subsequent rate hikes follow and can businesses, individuals and institutions cope with the higher financing cost — and are they prepared to wean themselves off debt that looks set to become more expensive? After all, debt levels for both individuals and businesses went up during the low interest rate environment.

The good news is that most economists polled by The Edge see a limited impact on most businesses and individuals, and most do not expect more than one hike this year.

“The interest rate hike will add to the borrowing cost. The impact will vary depending on the individual level of leverage. Currently, at the macro level, given the favourable domestic economic condition, improved labour market, encouraging wage growth and moderating inflation, the hike will provide a breather to consumers,” says MIDF Research chief economist Kamaruddin Mohd Nor.

Nomura Research Southeast Asia economist Brian Tan expects the OPR increase to have a limited impact on the economy given that underlying domestic and external demand has strengthened.

“We wouldn’t exaggerate the impact of a 25bps rate hike as it would just be reversing Bank Negara’s incrementally more accommodative stance, which had been in effect for only about 18 months since the 25bps rate cut in July 2016,” he says.

Meanwhile, Socio-Economic Research Centre executive director Lee Heng Guie emphasised the word “gradual” and believes everyone can absorb a 25bps increase.

“A 25bps hike will cause a small increase in additional interest rate. Maybe it will impact the lower income group a little but they will adjust to it,” he says.

Even so, it would be wise to keep in mind that interest rate “normalisation” is happening “gradually” because there are pockets of vulnerabilities across the globe, including in Malaysia.

The World Bank, for instance, highlights in a report released last December that Malaysia could be vulnerable to an abrupt tightening of global and domestic conditions in the context of a slowdown in growth. And this is despite the slowdown in credit growth, which had seen the corporate debt-to-GDP ratio stabilising.

“Therefore, close monitoring is required to avoid systemic problems, since high levels of leverage make the financial system highly sensitive to changes in fundamentals. Similarly, although current corporate debt levels are far from those recorded during the Asian financial crisis, careful monitoring and supervision is required due to the potential ramifications of corporate debt to the whole economy,” it explains.

According to the report, household debt levels stood at 85.6% of gross domestic product as at 2Q2017 while non-financial corporate debt levels were at 105.4%. During the Asian financial crisis in 1998, corporate debt levels stood at 131% to GDP.

Even so, economists may not shrug off further interest rate hikes as easily, especially if the increases come faster than expected.

“In our view, a 50bps hike should be manageable and not affect borrowers’ ability to service higher interest costs … However, a larger hike at too quick of a pace could create risks of higher non-performing loans (NPL) and provisions,” says AllianceDBS Research.

Interestingly, AllianceDBS Research also points out that when the OPR was increased by a total of 75bps in 2010, there was an observable uptick in NPL while provisions or credit cost rose in tandem. NPL increased from 2.2% in March 2010 to 2.5% in July 2010. Thereafter, it trended downwards. As at November last year, NPL stood at 1.2%.

As businesses cope with higher financing charges along with other cost increases, capital-intensive sectors with thin margins may be in a more vulnerable position — especially if the companies do not have strong operating cash flow and face slower demand.

Slower property demand and oversupply in certain pockets of real estate naturally places some property developers in the spotlight.

A quick check on Bloomberg shows that companies on the Bursa Malaysia Property Index saw their aggregate net debt to Ebitda (earnings before interest, taxes, depreciation and amortisation) rise over the last three years even as earnings per share shrunk. Between 2015 and 2017, Bloomberg data shows that average net debt to Ebitda rose from 1.15 times to 3.31 times while EPS slid from 261.57 sen to 105.87 sen.

Housing affordability has been an issue since at least 2014 and analysts do not see a full recovery for the property sector. In fact, they believe the rate hike could further dampen sentiment of potential homebuyers.

CIMB Research estimates that the 25bps increase will likely lead to a 20bps to 30bps rise in the floating mortgage loan rate, translating into RM60 to RM70 more per month on a loan of RM500,000. This could result in a knee-jerk reaction from buyers.

That said, analysts still think most developers can weather the rate hike.

“Most of the developers are in a net cash position or only have minimal borrowings, hence we do not expect the OPR hike to impact their earnings. For developers with a higher gearing level, such as Eco World Development Group Bhd and Eastern & Oriental Bhd, the direct impact on earnings is minimal as most of their borrowings are capitalised,” it says.

Meanwhile, companies on the Bursa Malaysia Construction Index saw their average net debt to Ebitda doubling to 6.6 times from 3.3 times in three years. EPS also saw a declining trend over the same period, falling from 17.7 sen to 13.7 sen.

CIMB Research opines that the sector will be impacted due to its high borrowing cost, saying that big-cap diversified contractors will see their FY2018 EPS reduced by 1% to 3% while small and mid-cap players in its coverage will see a FY2018 EPS reduction of 2% to 3%.

Another analyst points out that it is important to look at whether companies’ borrowings largely consist of fixed interest rates or floating rates.

One reason analysts and economists remain generally positive is individuals and businesses have expected a rate hike for some time.

UOB Malaysia economist Julia Goh says businesses have been cautious in recent years — they have deleveraged or have sought other forms of financing, including bond issuances.

Securities Commission Malaysia statistics show that new corporate bond and sukuk issuance has increased over the past few years. New issuance of corporate bonds rose from RM20.54 billion in 2014 to RM33.52 billion as at November last year. As for new sukuk issuance, the amount increased to RM77.65 billion as at last November from RM65.43 billion in 2014.

More importantly, the liquidity of the financial system remains stable and the overall financing activity to support the economy continues to hold up, says Goh. “Hence, we concur that a rate hike at this juncture is akin to normalising rates as opposed to tightening monetary conditions.”

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