This article first appeared in Corporate, The Edge Malaysia Weekly, on July 18 - 24, 2016.

BANK Negara Malaysia’s move to cut the overnight policy rate (OPR) was indeed a surprise to all. But it is the central bank’s stated reasoning for this move that is prompting more ripples of concern over the state of the economy.

First off, it was not entirely unexpected that the central bank would reduce rates when it did so last Wednesday. What caught the market offguard was the timing as most economists had expected it to happen in September, when the Monetary Policy Committee (MPC) next meets.

Secondly, the 25 basis point cut — bringing the OPR to 3% — was by no means drastic.

Bank Negara has not reduced the OPR since the global financial crisis six years ago, when the rate was cut from 3.5% in 2008 to a historical low of 2% in February 2009. And in the last 10 years, there have been seven upward revisions of OPR, with the most recent being in July 2014, when the rate was hiked by 25 bps.

Though the latest monetary move was a small reduction, the easing measure highlights the central bank’s concerns over the health of the global economy and potential impact on the domestic economy.

Is the latest OPR reduction a portent of tougher times to come for the Malaysian economy? Few would disagree these days.

GDP growth under pressure?

According to the central bank, the OPR adjustment is so that the “degree of monetary accommodativeness remains consistent with the policy stance to ensure that the domestic economy continues on a steady growth path amid stable inflation, supported by continued healthy financial intermediation in the economy”.

Bank Negara’s latest monetary policy statement certainly adopts a more subdued tone than its previous ones.

It had warned: “Global growth prospects have also become more susceptible to increased downside risks in light of possible repercussions from the EU referendum in the United Kingdom. International financial markets could also be subject to greater volatility going forward. In this light, global monetary conditions are expected to remain highly accommodative.”

“Overall, while the domestic economy remains on track to expand in 2016 and 2017, the uncertainties in the global environment could weigh on Malaysia’s growth prospects,” Bank Negara said in its monetary policy statement.

Bank Negara and the government have maintained their guidance for GDP growth at 4% to 4.5% this year. But some foreign economists are cutting Malaysia’s projected GDP growth rates to under 4% in the wake of the recent UK referendum in favour of leaving the European Union.

Fear for global contagion remains and Malaysia is unlikely to be spared.

Export numbers don’t look good

In its monetary policy statement, Bank Negara did warn that Malaysia’s exports are expected to remain weak following more subdued demand from key trading partners.

The latest data shows that the fears are not unwarranted. Export numbers for May 2016 showed an unexpected dip by 0.9% year on year from a 1.6% increase y-o-y in April.

This was due to reduced exports to China and Singapore — two of Malaysia’s major trade partners — as well as lower sales of crude oil and liquefied natural gas.

Analysts point out that a weaker ringgit ought to help exports but given the less than encouraging economic growth prospects globally, export recovery is still on fragile ground.

The Nikkei Malaysia Manufacturing Purchasing Managers Index (PMI) shows that local manufacturing activities have been flat-lining at 47.1 to 47.2 for the last three consecutive months.

IHS Global Insight Asia-Pacific chief economist Rajiv Biswas warns that the worst of the negative impact from Brexit on Malaysian growth is only expected next year. This lag is to account for the effects of trade and investment flows with the UK and European Union to filter through.

Malaysia’s exports to the UK are a small share of total exports but the EU collectively is the country’s third largest export market and accounts for 10% of Malaysia’s merchandise exports.

“Given the backdrop of China’s economic slowdown and the negative effects of slumping oil prices on Malaysia, Brexit will add to global financial markets’ uncertainty, creating another downside risk to the Asia-Pacific and Malaysian growth outlook for 2017, says Rajiv.

Scepticism over domestic stimulus

By cutting OPR, Bank Negara is hoping to counter increasing downside risks for growth by somehow stimulating domestic demand, which it reckons to be Malaysia’s main driver of growth.

The central bank maintains that private consumption will be supported by growth in income and employment, and measures implemented by the government. It also expects ongoing infrastructure projects and capital spend in the manufacturing and services sectors to offset moderating oil and gas investments.

Bank Negara, however, maintained inflation projections at 2% to 3%, helped by low global energy and commodity prices as well as generally subdued global inflation.

To offset the expected weaknesses in exports and investments, Bank Negara’s pre-emptive easing is aimed at encouraging private consumption, which makes up about 52% of total GDP, and ensuring that it does not fall short of the central bank’s projected 5.1% growth for this year, AllianceDBS Research says.

But analysts are mixed over whether domestic consumption will be helped at all.

UOBKayHian, for one, maintains that the surprise OPR cut does not materially change the research house’s market earnings forecast as the lower interest rates would not “meaningfully” lift domestic consumption.

In a note, AmInvestment Research analyst Cheryl Tan says the latest OPR cut and expected low inflation rates of 2% to 3% should spur domestic consumption.

As Tan points out, approvals for credit cards and loans to the household sector were at the higher end of their respective 10-year ranges (34% to 97% and 39% to 73%, respectively) during the last rate cut period while personal loan approvals remained healthy, hovering close to its 10-year average of 45%.

“That said, we expect the positive impact to be limited given Malaysia’s already high household debt-to-GDP ratio of 89% and still soft consumer confidence (1Q2016’s 72.9 points below the 100-point threshold),” AmInvestment Research says.

According to AllianceDBS Research, domestic consumption indicators moving forward — including household credit, consumption, wholesale and retail sales index — would be important macro data points to gauge Bank Negara’s future monetary policy stance.

Since last year, consumer and business confidence has been lacklustre.

While it is true that 1Q2016 confidence indicators as tracked by the Malaysian Institute for Economic Research (MIER) have shown some recovery on both consumer and business sentiment, both indices are still below the threshold of confidence.

MIER’s Consumer Sentiment Index rebounded marginally by 0.3 points y-o-y to 72.9 in 1Q2016 and by 9.1 points from the preceding quarter after it hit a record low of 63.8 in the preceding quarter. MIER’s Business Confidence Index, meanwhile, gained 5.8 points quarter on quarter to 92.9 points, but shed 8.1 points y-o-y.

According to a local economist, it is highly debatable how helpful monetary easing would be given Malaysia’s structural economic issues.

“Yes, you can cut OPR. But the fact remains that businesses and people have not been feeling confident in a while. The key question is how competitive are Malaysian businesses? Are the Malaysian people feeling like they are prosperous enough to spend, especially on big ticket items? Probably not yet.”

This is in spite of some earlier initiatives by the government to put more disposable cash in the hands of Malaysians. Budget 2016 included some tax relief measures for the middle income group. Additionally, the Budget 2016 recalibration in January this year also put in place an opt-out reduction in EPF contributions, a move aimed at boosting disposable income. 

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