Bank Negara turns dovish on growth concerns

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THE move last Thursday by Bank Negara Malaysia to hold the overnight policy rate (OPR) steady at its Monetary Policy Committee meeting may have given credence to concerns that the economy is moderating after achieving strong growth in the first half of the year.

To recap, Bank Negara kept the OPR unchanged at 3.25% after raising it by 25 basis points in July — the first increase in almost four years — subsequent to the economy chalking up an impressive growth of 6.3% in the first half of the year. It is worth noting that inflation had also been picking up, hitting 3.5% in February and March.

“We believe Bank Negara has turned more dovish this time around. It clearly states that private consumption is likely to moderate in the near term while export growth, although supported by the recovery in advanced economies and demand from regional countries, is expected to post slower growth,” says Afzanizam Abdul Rashid, chief economist of Bank Islam Malaysia Bhd.

In the first half of the year, Malaysia’s economy was boosted by sustained domestic consumption as well as higher export growth. Exports grew an average 12.6% year on year during the period, while imports increased an average of 7.2%.

However, the trade numbers for July cast some gloom on the economic outlook. Exports slowed by 0.6% y-o-y after growing 7.9% y-o-y in June. On the other hand, imports of intermediate goods, which signifies the strength of future exports, grew 2.6% y-o-y in July compared with 2.3% in June.

Another dark cloud looming on the horizon is the slowdown in the Industrial Production Index (IPI) to a marginal growth of 0.5% y-o-y in July, from a 7% y-o-y increase in June. On a month-on-month basis, the IPI fell 3.8% in July, according to the Department of Statistics.

All these indicators point to a slowing economy, which is one of the concerns outlined by Bank Negara. In its monetary policy statement last Thursday, the central bank said domestic demand and private consumption are expected to moderate going forward.

“It is possible that Bank Negara does not want to disrupt the momentum of the economy, after the better-than-expected first half,” says an observer. “Bank Negara is probably taking a wait-and-see approach on the economy, both from an internal and external aspect.”

On the domestic front, inflation remained stable as at August at 3.3% y-o-y, compared with 3.2% in July. As long as the government does not introduce more subsidy cuts for the rest of the year, inflation is expected to remain stable, says Manokaran Mottain, economist at Alliance Research.

“We believe that the current OPR remains accommodative to growth and is adequate to address the inflationary concern and financial imbalances in the short term,” Manokaran said in his report last Friday.

Inflation could still move higher this year, if the federal government decides to undertake another round of subsidy cuts. If it does so, consumers will be dealt a double whammy, as the Goods and Services Tax will take effect next April.

Lau Zheng Zhou, senior economic analyst at the Centre for Public Policy Studies of the Asian Strategy & Leadership Institute, says Bank Negara takes a longer view when making adjustments in the monetary policy, such as the OPR and curbs on lending growth.

“Bank Negara has at its disposal various tools to promote a balance between inflation and growth. Given that inflation is well managed and that the previous cooling measures are still taking effect, raising OPR now would be premature and cause an unintended drag on the overall growth,” says Lau.

Bank Negara has put in measures to contain credit growth in the country, especially in the housing market, by restricting the loan-to-value ratio for the third property onwards at a maximum 70%, while tightening the eligibility criteria to get financing.

Lending growth to the household sector also moderated in July, increasing 11.1% y-o-y compared with 11.5% in June. Bank Negara reported that net financing to the private sector grew at a slower pace of 8.7% y-o-y in July, compared with 9.7% in June.

“As such, we believe household debt may have peaked at 90% of GDP this year (2013: 86.8% of GDP) and should moderate thereafter as households would be inclined to deleverage,” says Afzanizam of Bank Islam.

Against a backdrop of peaking household debts as well as moderating inflation and economic growth, both Afzanizam and Manokaran expect Bank Negara to maintain the OPR when the MPC meets again on Nov 6.

However, the OPR trajectory is expected to be on the high side in 2015 as the source of inflation would be a cost-push one, although the effect of wage increases is likely to be muted, says Afzanizam. The operating environment for companies is likely to be more challenging next year, he adds.

“… negative real interest rate following higher inflation in 2015 and threats of capital outflow due to interest rate hike in the US would serve as compelling reasons for Bank Negara to raise the OPR,” he said in a report dated Sept 18.

This article first appeared in The Edge Malaysia Weekly, on September 22-28, 2014.