This article first appeared in The Edge Malaysia Weekly on September 28, 2020 - October 4, 2020

BANK Negara Malaysia clearly thinks it is premature to discuss the possibility of quantitative measures or unconventional monetary policy being employed in Malaysia.

At the time of writing, the central bank has yet to revert to questions sent by The Edge on Sept 14 seeking comment on its recent bond purchases and whether the bank had been tapped by the government to do more than maintain the current accommodative monetary policy.

This was in the light of discussions surrounding larger bond purchases undertaken by a number of central banks in emerging markets, including in neighbouring Indonesia — a subject that has not only warranted a paper by the Bank of International Settlements (BIS), which serves central banks, in June but also a note by credit analysts at S&P Global Ratings. (See also: “Will quantitative measures follow Bank Negara’s dovish pause?” in Issue 1336, Sept 14, 2020.)

In a note headlined ‘Emerging market central banks risk reputations with bond-buying programmes’ dated Sept 13 that does not mention Malaysia, S&P credit analyst Andrew Wood and his colleagues in Singapore told clients that “large-scale sovereign bond purchases are no longer the preserve of the major central banks” but are now being employed in some emerging markets to ease fiscal strains faced to finance aggressive stimulus measures to counter Covid-19-induced economic pain.

While the large sovereign debt purchases by the central banks of India, Indonesia and the Philippines “have so far not triggered high inflation or spikes in financing costs in these economies” and investors seem to show “patience for aggressive action in the face of the pandemic”, the S&P analysts warned that “price stability and other risks could arise with implications for sovereign rating”, should these institutions “push their purchases too far”.

“If investors begin to view government reliance on central bank funding as a long-term, structural feature of the economy, these monetary authorities could lose credibility. In this scenario, the central banks are effectively ‘monetizing’ the fiscal deficit by using money creation as a permanent source of government funding,” the S&P note read.

Without saying whether quantitative easing (QE) or the level of bond purchases at advanced countries have reached a level deemed to be “long term” (read: tough to unwind), the credit analysts also saw it necessary to highlight the difference between advanced and emerging markets as it noted a list of attributes that allow certain central banks to maintain large government bond holdings without losing investor confidence, creating fear of high inflation or triggering capital market outflows: “Advanced countries typically have deep capital markets, strong public institutions — including independent central banks, low and stable inflation, and transparency and predictability in economic policies.”

In Indonesia, monetary policy has clearly shifted to the unconventional path with the government naming its central bank as standby buyer as well as the payor of interest for debt issued by the government to fund Covid-19 recovery schemes and fiscal deficit in the archipelago. As discussions over the longevity of unconventional measures gained prominence, the Indonesian government assured investors that the central bank’s independence will not be compromised.

“Markets are keen to gauge the longevity of these measures, with Bank Indonesia playing a balancing act as they see this year’s participation as a ‘one off’ but plan to remain as a standby buyer next year, if recovery turns out to be elusive. Clarity on the eventual exit from this debt purchase programme and implication on liquidity will also be sought. With investors likely to watch this space closely, the need to maintain favourable rate differential will be key. Odds are, thereby, tilted towards a rate pause for the rest of the year, with an emphasis on effective policy transmission,” DBS Bank economist Radhika Rao wrote in a Sept 18 note that noted “unease in the rupiah’s underperformance against the US dollar” after Bank Indonesia expectedly paused its key rate at a record low of 4% for a second consecutive month following 100 basis points cut this year and 100 basis points cut last year.

Asked how to determine if the central bank has gone too far, Wood tells The Edge in an email reply that “the scale and longevity of such bond purchases will be important factors in determining whether or not there is an impact on these central banks’ credibility in managing inflation. Bond-buying programmes might be considered as less temporary in nature if governments forestall deficit reduction, and central bank holdings of government debt continue to rise at a fast pace even after the economy has recovered”.

In Malaysia, the question of whether QE had begun here was sparked by a sharp rise in the central bank’s bond purchases from April. After all, QE witnessed never-before-seen large-scale bond purchases by the US Federal Reserve and its peers in mature markets like Japan and Europe that had lowered interest rates to near zero (and some into negative territory) following the global financial crisis.

Before April, Bank Negara’s holdings of government debt papers only exceeded RM3 billion between November 2016 and January 2019, the highest being just under RM6 billion in March 2017. Recall that central bank reserves also declined in November 2016 when it clamped down harder on speculative activities in the non-deliverable forward (NDF) market while looking to provide forex traders greater flexibility “in a controlled environment” onshore.

Still, at RM10.9 billion as at end-August this year, the central bank’s holding of Malaysian Government Securities (MGS) is merely 2.5% of the outstanding RM431.7 billion.

So, while Bank Negara’s holdings of government debt papers have charted new all-time highs for five straight months since rising in April this year, it is too early to say QE has begun.

“It is not QE in my book. Bank Negara is still within the limit prescribed for stabilising the domestic bond market in terms of liquidity and yield,” says Suhaimi Ilias, regional head of economic research at Maybank Investment Bank in Kuala Lumpur, noting that the central bank still has room to trim the overnight policy rate (OPR) from the current 1.75% should that be deemed necessary.

Bank Negara’s recent bond purchases, he reckons, are meant to “stabilise the market amid broad sell-offs in the capital markets” owing to the Covid-19 pandemic.

“The pace of purchases has slowed considerably as yield dropped and foreign investors returned to the bond market,” adds Suhaimi, noting a “self-imposed” limit of 10% on bond purchases by Bank Negara to further enhance liquidity in the domestic bond market without distorting prices.

Foreign holding of ringgit-denominated debt securities fell RM22.4 billion over three months to RM185.85 billion as at end-April from RM208.2 billion as at end-January this year, central bank data show. The decline was heaviest in March at RM12.3 billion, before receding to RM1.98 billion in April. By May, however, net inflows turned positive again and foreign holdings of ringgit papers as at end-August of RM208.97 billion was higher than that in end-January before the earlier net outflows, official data show.

The bulk (about 80%) of foreign holdings of ringgit-denominated papers is in MGS.

While S&P’s Wood concurs that Bank Negara’s purchase of government debt securities was at a “faster pace this year, especially in March and April”, he also reckons that “it’s likely that Bank Negara has been aiming to curb excessive volatility in the debt market and provide more liquidity during periods of stress”.

The Malaysian government, he adds, “still maintains a net asset position with the central bank”.

“Malaysia is currently enjoying an unusually low yield environment. Though the government’s rising stock of debt puts upwards pressure on its interest payment bill, lower interest rates help to mitigate the impact. This trend is likely to evolve over time, especially as the economy recovers from 2021 onwards. Along with its strong external position and sound long-term growth prospects, we consider Malaysia’s well-established monetary policy credibility as supportive to its sovereign credit ratings,” Wood says.

Last Friday (Sept 25), FTSE Russell acknowledged Malaysia’s efforts to improve the liquidity and accessibility of its bond and foreign exchange markets but decided to keep the country on its “negative watch list” for potential downgrade (which risks exclusion from the World Government Bond Index) following its annual review, with the next assessment happening in March 2021.

As economists point out, the pace of Bank Negara’s bond purchases have slowed and it still has room for further rate cuts, if necessary.

There is also ample liquidity in the market for the government to borrow. Rates remain favourable, with trading yields for 10-year MGS (3.885% coupon) closing at 2.72% on Sept 24, though higher than 2.51% on Aug 24 and 2.6% on July 24, central bank data show.

While low oil prices and lockdown-related demand slump globally have hurt earnings for Petroliam Nasional Bhd (Petronas), the national oil company still had RM156.86 billion cash as at June 30, up from RM141.62 billion as at end-2019.

The wildcard, so to speak, is the answer to the question of just how much the government needs to spend in order to protect people’s lives and livelihoods as well as stimulate growth to prevent permanent damage to the economy in a Covid-19-shaken world — especially if a resurgence of cases force another round of lockdowns.

During this time of crisis when there is real pain and need on the ground that warrant increased fiscal spending by governments around the globe, it is not hard to see the appeal of the heterodox Modern Monetary Theory (MMT) — which argues that government budgets are different because they have full control of their own currency and therefore can print whatever amount they need to spend to achieve full employment and stimulate economic growth — to some policymakers eager to “rescue the electorate” with helicopter money.

Owing to the pandemic, some observers reckon there may well be some room for governments to manoeuvre — provided that the market can be convinced that the safeguards in place are enough to ensure measures are temporary.

Mainstream economists, however, vehemently disagree and warn of the danger of hyperinflation and value erosion of one’s currency that ensue with such money printing — even if it is meant to spend one’s way out of a recession.

“The employment of quantitative measures would not only risk runaway inflation but also potentially negatively impact the ringgit, which is not a reserve currency like the US dollar. The potential downside from a loss of confidence in the ringgit and its consequence on the economy would outweigh the benefits of suppressing bond yields. It could potentially open a flood gate that may be difficult to close,” a seasoned economist says.

“There is still a lot of liquidity in the local financial system and investors are still confident buying Malaysian bonds, resulting in low bond yields in the country following a cut in interest rates by Bank Negara. I see more negative than positive in the central bank employing quantitative measures. It is better for the Malaysian government to bite the bullet and ensure that every cent it spends is worth the value and has a great impact on the economy. Also, it is better for the government to raise the money from the market rather than depend on Bank Negara to buy its bonds,” the economist adds.

There is no indication of Bank Negara being tapped by the government to help fund Covid-19 economic recovery schemes so far, but there are provisions in the Central Bank Act that allows it to provide “temporary financing to the government” should the need arise.

“Bank Negara can legally fund a budget deficit but subject to very strict terms and conditions, as stated in the Central Bank Act,” Suhaimi says, but reckons that the government “can tap the market” as there is “ample” domestic liquidity due to the high savings rate and the central bank’s liquidity injections.

Also citing “adequate policy space”, another seasoned economist notes that the allowance in the law is meant to be a “bridging loan” of sorts to cover any temporary or short-term cash flow shortfalls rather than permission to unleash unconventional monetary measures.

“The strict provisions in the Central Bank Act are there to ensure the central bank’s independence [from the government],” the economist says, reminding policymakers of the importance of safeguards that have been put in place.

Section 71 of the Central Bank Act states that Bank Negara “may extend temporary financing to the government on terms prevailing in the market in respect of temporary deficiencies of budget revenue” and the funds extended “shall be repaid as soon as possible and shall in any event be payable not more than three months after the end of the financial year of the government in which it is extended”.

“The power of the [central bank] to extend further financing in any subsequent financial year shall not be exercisable unless and until the outstanding financing has been repaid,” the provision reads. The aggregate amount of financing extended, excluding securities held solely for monetary policy operations, “shall not at any time exceed twelve and a half per centum of the estimated receipts” (revenue) of the federal government in the financial year in which the financing is to be extended.

In the event there is a difference in policy between the central bank and the minister that cannot be amicably resolved, the matter will ultimately be brought to parliament, Section 72 reads.

While the unprecedented nature of the Covid-19 situation does call for central banks’ monetary policy and government’s fiscal policy to complement each other to rebuild confidence as well as stimulate the economy, collaboration can and needs to happen without compromising the independence of central banks.

“Any direct central bank support of government fiscal deficit or stimulus programmes must be conditional and have proper governance to avoid abuse,” Suhaimi says.

Whether or not quantitative measures would be employed in Malaysia, all policy measures employed — conventional or otherwise — must not unleash new problems bigger than the ones they seek to solve.

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