This article first appeared in Forum, The Edge Malaysia Weekly on September 26, 2022 - October 2, 2022

If anybody is expecting Bank Negara Malaysia to follow the US Federal Reserve and embark on hefty increases in interest rates, they are wrong.

Malaysia cannot afford to have a high interest rate environment because it will cause the economy to go into a tailspin. The ratio of household debt against the economy is at a high of 89%, while that of the federal government debt to gross domestic product (GDP) is more than 63%.

According to a government study, in a financial stress situation, the percentage of distressed households will likely increase from 2.5% to 13.5%. Distressed and vulnerable households are those with more than 60% of their disposable income going towards loan obligations.

Moreover, higher interest rates will not necessarily stop the slide of the ringgit against the US dollar. Other major central banks, such as the Bank of Japan, have preferred to maintain rates in negative territory, which explains the weakening of the yen.

All over the world, central banks have given up the fight against a strengthening dollar. Thailand and Indonesia have raised interest rates only to contain inflation. Indonesia raised interest rates for the first time in four years in August while Thailand’s lending rate is less than 1% even after a recent hike.

Malaysia’s central bank has raised the overnight policy rate (OPR) twice by 25 basis points (bps) to 2.5%. Over the course of the pandemic, which ravaged the economy in 2020 and 2021, the OPR was brought down to 1.75%.

Economists are expecting another 25bps hike at the next monetary policy committee (MPC) meeting in November, largely to contain inflation, which is inching up. Headline inflation has averaged 2.8% year to date, although it is much higher in some parts of the country.

According to Bank Negara, inflation is expected to peak at 3% this year, which means the MPC may not necessarily stop at just another 25bps hike. 

The Malaysian central bank’s rate hikes are nothing compared with the aggressive path that the Fed has taken to tame inflation. Last week, the US central bank raised interest rates by another 75bps to bring the Federal funds rate to between 3% and 3.25%.

Fed chairman Jerome Powell has indicated another hike of 150bps by the middle of next year and for the first time, has sounded a warning that the world’s largest economy will likely tip into a recession. He is looking at a hard landing, which means a full-blown recession and job losses. 

A recession in the US will certainly cause pain in Malaysia. The pain inflicted on the Malaysian economy will depend on the pace of rate hikes and overall health of the global economy. The government, companies and households are relatively highly leveraged compared with a few years ago.

At 89%, Malaysia’s household debt as a percentage of GDP in December last year was among the highest in the region. Based on statistics as at September last year, only Thailand had a higher debt-to-GDP ratio at 89.3%. The ratio is 69.7% in Singapore, 17.2% in Indonesia and 9.9% in the Philippines.

The last time the household debt ratio hit the 89% level was in 2015. Bank Negara stepped in and raised the threshold for borrowers, especially to purchase houses. Prior to that, in 2011, the central bank had already started imposing curbs on households taking on unsecured loans such as personal loans. These combined measures reduced household debt-to-GDP to less than 84% in 2017.

As of last December, almost 56% of household debt is for housing obligations while another 25% goes towards repayment of car and personal loans. During the lockdown, the government yielded to pressure from certain personalities such as former prime minister Datuk Seri Najib Razak to allow Employees Provident Fund (EPF) members to withdraw money from their accounts.

The last withdrawal allowed was RM10,000 for those who wanted to in March this year.

Prior to that withdrawal, which the Datuk Seri Ismail Sabri Yaakob administration had initially resisted, households and individuals were already granted a six-month automatic moratorium on loan repayments, starting from April 2020, to tide them over.

Following the expiry of the automatic loan moratorium, targeted groups were allowed a further moratorium or reduction in repayment obligations, which went on until May 2021. Essentially, all the 

bullets that can be used in hard times have already been spent.

Bank Negara cannot afford to raise interest rates too much. Consequently, the ringgit will suffer. It has already breached the RM4.50 

level against the US dollar. As and when the Fed increases interest rates further in the next few months, the ringgit will continue to slide.

The implications for the economy are mixed. Exporters with limited import content will enjoy higher margins compared with exporters that have high import content. Producers who depend on local content for production will hardly feel the effect as Malaysia is a “ringgit economy”.

The biggest beneficiary will be the tourism industry, as its cost is mainly in ringgit while earnings are in the US dollar and other foreign currencies. This is why Thailand is raking in cash as the greenback strengthens. Prior to the pandemic, the tourism sector contributed about 17% to its economy.

While the ringgit has weakened against the US dollar, it has strengthened against other major currencies such as the pound sterling, euro and yen. However, it is a small consolation as the bulk of international trading is settled in US dollars.

Exporters, probably forecasting that the ringgit could weaken further, have been keeping their money in US dollars in the local banking system. The foreign currency account in the local banking system now stands at RM205.6 billion. These are proceeds from exports that were remitted back to Malaysia and kept in US and other foreign denominations. 

Foreign deposits in the local banking system came to RM192.3 billion a year ago, up from RM100 billion in March 2015.

Apart from a weakening ringgit, another reason to keep US dollar deposits in the local banking system is that they earn higher returns than ringgit deposits. Hence, it makes sense for exporters to not convert the proceeds that were remitted.

Two months ago, this column warned about an impending slowdown or recession hitting the Malaysian economy. That is inevitable now, with the backdrop of a weaker ringgit and an economy where the government and households are holding relatively more debt than other nations.

The euphoria on Bursa Malaysia has ended with many holding paper losses. The pain will get worse as the cost of funds go up, especially for those who bought shares on margin financing. Many will be in tears before they see any relief.

M Shanmugam is a contributing editor at The Edge

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