This article first appeared in The Edge Malaysia Weekly on January 18, 2021 - January 24, 2021

THE two-week Movement Control Order 2.0 (MCO 2.0) beginning Jan 13 that was imposed on six states, coupled with a strong likelihood of an extension should Covid-19 cases in the country continue to rise, could hasten a policy decision on key interest rates.

Most economists have projected Bank Negara Malaysia’s first decision this year on the overnight policy rate to be a reduction of 25 basis points. Should such a projection come about, it will result in the OPR falling to a new low of 1.50% when policymakers meet on Wednesday.

The last reduction to the OPR was in July last year when the key rate was cut, also by 25bps, to 1.75%. In total, the OPR was reduced by 125bps last year.

“With the MCO 2.0 expected to cause a short-term dent on a still-healing economy and domestic demand, Bank Negara may consider cutting its OPR by 25bps to 1.50% when the Monetary Policy Committee (MPC) meets on Jan 20, to provide some insurance against the risks of weak sentiment,” says Associated Chinese Chambers of Commerce and Industry of Malaysia’s Socio-Economic Research Centre executive director Lee Heng Guie.

“The continued one-off cash assistance, ongoing enhanced targeted loan repayment assistance, the EPF Account 1 (i-Sinar) withdrawal facility, and other financial assistance for SMEs, including the wage subsidy programme, are expected to soften the impact [of MCO 2.0],” he adds.

Another rate cut would lower borrowing costs, which aids debtors but deters savers as it results in lower fixed deposit rates.

Lee does not expect a rate reduction to have a visible impact on inflation as he says Malaysia is still mired in a deflationary trajectory with the Consumer Price Index declining for nine consecutive months, albeit at a smaller magnitude of -1.7% year on year in November 2020 from -2.9% in April 2020.

“Core inflation, which measures the underlying inflation excluding volatile fuel and food prices, trended down to 0.7% in November 2020, the lowest reading since May 2019, mainly caused by lower rental increases. Inflation is expected to normalise into positive territory, between 1.0% and 1.5%, in 2021 partly due to the low base effect and also in tandem with the improved economic growth and higher crude oil prices,” he says.

In a note to clients, UOB Malaysia senior economist Julia Goh and economist Loke Siew Ting say, assuming that the six states under MCO 2.0 — Selangor, the Federal Territories (Kuala Lumpur, Putrajaya and Labuan), Penang, Melaka, Johor and Sabah — are put under at least four weeks of strict movement restrictions and that essential business sectors operate up to 70% capacity only, this is expected to shave off about 1% from the country’s 2021 gross domestic product, given that the areas affected by the tighter MCO contribute 66.3% to the country’s GDP.

UOB Malaysia has cut its 2021 GDP growth forecast from 6% to 5% following the stricter movement controls. “Every two weeks of MCO could shave 0.4% off GDP growth, with estimated losses of RM5 billion,” Goh and Loke say in the note.

“In view of the worsening pandemic, tighter containment measures and weaker growth outlook, we have pencilled in another 25bps policy rate cut at the upcoming MPC meeting,” they add.

ING senior economist for Asia Prakash Sakpal believes that the sooner a cut is made, the better it would be to soften the impact of the latest MCO on growth.

“Indeed, the accelerated Covid-19 spread in recent months is going to derail recovery … the Malaysian economy suffered from an unprecedented slump in 2020. I believe this raises the odds of Bank Negara resuming its easing cycle with a further cut to the OPR.

“I have pencilled in a 25bps OPR cut in the current quarter. I would imagine it coming in as early as [this] week,” he says.

Bank Islam chief economist Dr Mohd Afzanizam Abdul Rashid also believes that an OPR cut is in store, and does not rule out a reduction to the statutory reserve requirement (SRR). For clarity, the SRR is an instrument to manage liquidity, whereby banking institutions are required to maintain balances in their statutory reserve accounts equivalent to a certain proportion of their eligible liabilities (EL), this proportion being the SRR rate. The SRR ratio was last lowered by 100bps in March last year, to 2% from 3%.

However, he says it is important to note that changes to the SRR should not be construed as a signal of Bank Negara’s monetary policy stance as the OPR is the sole indicator.

“The SRR could also be reduced in order to provide more liquidity to the system [thus] lowering the cost of funds. Chances are the MCO might be extended as the number of new cases are expected to remain elevated and the vaccination programme has yet to be rolled out.

“Given that the transmission of monetary policy to the economy will take a while, typically more than a year, the central bank might want to react faster by reducing the SRR rate,” he opines.

A rate cut would result in bond prices trading upwards, says Malaysian Rating Corp Bhd (MARC) senior economist Firdaos Rosli. “An OPR cut would increase the appeal of holding bonds. More investors would prefer to purchase existing bonds as the coupon rates would be higher than newly issued ones. This will ultimately reduce the cost of borrowing.”

However, not everyone is on the same page in calling for an OPR cut. Standard Chartered chief economist for Asean and South Asia Edward Lee sees Bank Negara staying pat on the key rate at 1.75% this year.

“The [economic] risks have certainly increased but we are still leaning towards a hold on the OPR for the moment. We think that the effect that this MCO has on the economy is a lot less [severe] compared with that of the second quarter of last year, as the restrictions this time around are a lot more targeted, both geographically and sector-wise.

“Also, if you come from the perspective of cutting rates to give the economic recovery a boost, we think that a rate cut now doesn’t really make good use of the [monetary policy] bullets, because with the [lockdown] restrictions, you can’t take advantage of the lower rates. So, we think it’s not the time yet for Bank Negara to cut rates. Probably they can conserve it and assess how the economic momentum is a few months down the road. So for now, we see Bank Negara keeping the OPR unchanged,” he says.

Last Tuesday, Yang di-Pertuan Agong Al-Sultan Abdullah Ri’ayatuddin Al-Mustafa Billah Shah consented to the government’s request to declare a nationwide state of emergency until Aug 1 to control the spread of Covid-19.

Analysts do not expect the declaration of emergency coupled with MCO 2.0 to dent foreign investor confidence in Malaysia, or to lead to an outflow of foreign holdings in government bonds.

“If we think about the developments in the last few weeks, with the rise of Covid-19 cases and the MCO 2.0, foreign investors might want to take a wait-and-watch approach.

“However, I do not think that this is immediately going to lead to outflows, simply because the technical backdrop for flows remains quite positive, as we are still in an environment where the amount of negative yielding debt globally is close to US$17 trillion dollars, and against that universe of increasing negative yielding debt, Malaysia actually still offers meaningful yields pickup, not just in nominal terms but also in real terms,” opines Standard Chartered head of Asean and South Asia FX research Divya Devesh.

MARC’s Firdaos is also of the view that the state of emergency is likely to have little impact on foreign interest in local bonds in the immediate term. “Bank Negara’s liberalisation measures to improve liquidity are still in place and FTSE Russell has viewed the central bank’s efforts favourably in its last review in September 2020.

“Furthermore, with MCO 2.0 in place, Malaysia could continue experiencing negative inflation and low growth. Coupled with heightened expectations of further rate cuts, we do not see foreign interest in local bonds diminishing significantly.

“Malaysia’s high real yield would appeal to foreign investors seeking higher returns in a low interest rate environment. As it stands, Malaysia is still rated more favourably compared with its Asean peers except Singapore,” he adds.

Standard Chartered’s Divya has an “overweight” recommendation on the ringgit, which he sees trading at 3.9 to the US dollar at the end of the year. At press time, the ringgit was trading at 4.03 to the dollar.

“We think that the ringgit will perform strongly, on the premise of an improvement in global growth and global trade, and a recovery in commodity prices. Crude palm oil and LNG (liquefied natural gas) prices have both recovered strongly and this should help Malaysian exports, which will be a positive for the ringgit.

“Second, we feel that the ringgit is significantly undervalued at its current levels compared with other Asian currencies. Though commodity prices have recovered, the ringgit has not appreciated enough to reflect this improvement in commodity prices.”

The MCO and emergency order may exert downward pressure on the ringgit due to heightened risk premium but this will likely be offset by the firmer crude oil and commodity export prices and trade surplus, says Sunway University economics professor and senior fellow at the Jeffrey Cheah Institute on Southeast Asia Dr Yeah Kim Leng.

“Moreover, given its close relationship, the ringgit may benefit from the strengthening of China’s renminbi due to stronger growth recovery expected this year,” he adds.

From an academic standpoint, Prof Datuk Dr Rajah Rasiah, distinguished professor of economics at the Asia-Europe Institute of University of Malaya, opines that if the government is keen to control the cost of capital to benefit the disadvantaged, an OPR cut would help.

“However, a cut in rates without commensurate measures to check capital flight and adequate outlets for businesses to appropriate synergy from it will undermine growth. The government will have to see that the opening of several industries to function will not be affected by the new SOP (standard operating procedure).

“There must be serious efforts to smoothen connectivity and coordination between producers, logistics firms, communication firms, and the enforcement authorities to avoid slowing down the pulse of economic operations. This will be a tall order, though.”

He adds that the rising ringgit could affect the competitiveness of several industries, unless the rise is reflected in rising value added per worker.

“It is too early to tell if industrial upgrading has set in now apart from the emergence of the glove firms, which actually still invest little in research and development.

“The continued rise in the ringgit in the absence of upgrading will eventually affect our balance of payments. It will seriously undermine our food industry especially, which has experienced a growing deficit since 1989.”

See also Special Report on Page 54

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