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This article first appeared in The Edge Malaysia Weekly on May 1, 2017 - May 7, 2017

WHEN Bank Negara Malaysia cut the overnight policy rate (OPR) to 3% in July last year, it caught the nation by surprise as it was the first cut in the benchmark rate since 2009.

In its monetary policy statement then, the central bank said the OPR cut was in line with downside risks to global growth, with possible repercussions from the UK referendum in June, in which a majority voted to leave the European Union.

Since then, it has been a guessing game of sorts whenever Bank Negara’s Monetary Policy Meeting (MPC) looms, on what the central bank’s next move will be or, more importantly, what will trigger a potential rate hike or cut, though the former is a more likely bet given the improvement in global growth.

The central bank has kept the OPR pat in its first two MPC meetings this year, and with the third set to take place on May 12, the usual questions arise as to which economic indicator will be strong enough to trigger momentum in the benchmark rate. In March this year, inflation came in at 5.1% — the highest level in eight years — indicating that we are in negative real interest rate territory, given that the prevailing OPR is 3%.

However, economists believe that Bank Negara, just like the US Federal Reserve, is going to go with the growth mandate rather than focus on inflationary pressure in making its decision on the key rate.

This is not surprising, given indicators like the high level of household debt in the country. According to Bank Negara’s 2016 Financial Stability and Payment Systems Report, household debt grew 5.4% to RM1,086.2 billion last year from 2015.

Equally worrying is Bank Negara’s observation on Malaysians’ long-term financial planning, that more than 75% have difficulty saving RM1,000 for emergency needs, considering the economic uncertainties and high cost of living.

Affin Hwang Investment Bank Bhd chief economist Alan Tan says Bank Negara is highly unlikely to raise the OPR at the next meeting.

“We think the Bank Negara mandate will focus on economic growth to ensure stability, as inflation in March was due to a cost push factor because of higher domestic and retail petrol prices, which make up close to 8% of the Malaysian Consumer Price Index basket.

“Judging from the latest economic indicators, such as the global Purchasing Managers Index, the OECD Composite Leading Indicators index and the healthy global demand for semiconductors, all these are pointing to some stability in the domestic economy, and as domestic demand is currently at a healthy level, we think Bank Negara will likely hold rates unchanged,” Tan tells The Edge.

The central bank will maintain an accommodative monetary policy to support domestic demand and underlying economic growth, he adds.

“However, the upside potential to Malaysia’s gross domestic product growth will be dependent on external demand ... the downside risk to external demand is US President Donald Trump’s [protectionist] trade policies,” says Tan.

Senior vice-president of Global Economics and Market Research at UOB Malaysia, Julia Goh, opines that Bank Negara will make monetary policy decisions based on forward-looking expectations of how the economy and inflation will evolve for the rest of the year.

“As such, despite the 5.1% inflation in March and 4.3% average in the first quarter of 2017, the path of inflation is expected to moderate in the second half of this year, so, we reckon Bank Negara is unlikely to take a hurried approach to raise interest rates at this juncture,” she says.

Undoubtedly, the central bank’s decision at the two-day MPC meeting will be closely watched. However, a past decision taken by Bank Negara — namely, its initiative to develop the onshore financial market — has borne fruit in the form of a stronger ringgit performance last week.

The ringgit closed at 4.3468 against the US dollar last Thursday, up 3.35% compared with the beginning of the year when it was 4.4975 against the greenback.

“Bank Negara’s measures announced in December last year, such as requiring exporters to convert export proceeds back to ringgit are slowly taking effect, with some repatriating their proceeds early to take advantage of the 3.25% per annum interest rate offered to exporters via a special deposit facility,” says Tan.

He adds that other domestic factors, such as the easing of foreign selling of Malaysian Government Securities and the increase in foreign buying interest in Malaysian equities, have also led to the ringgit’s gain.

Socio-Economic Research Centre executive director Lee Heng Guie says the ringgit’s strength also stems from developments in the US — from Trump’s comments on the US dollar being “too strong” to the likelihood of his tax reforms going through.

“There were concerns that Trump’s reflationary policies could increase inflation risks in the US and thus lead to a more aggressive rate hike by the Federal Reserve than the guided three rate hikes for this year.

“But there are also concerns about the pressure on the US budget deficit with the tax reforms, and whether the reforms will get the buy-in from the US Congress, [considering that] Trump’s plans to repeal Obamacare did not [get congressional support],” Lee tells The Edge.

With the recovery in foreign sentiment and renewed interest in domestic bonds, UOB Malaysia has revised its end-period USD/MYR outlook to 4.35 by the second quarter of 2017 (2Q2017) from 4.46 previously and to 4.32 by 3Q2017 from 4.48 previously.

“One key risk to watch, which we think has not been priced in by markets, is the fate of the Fed’s balance sheet, whereby a more hawkish stance would elevate US Treasury yields and strengthen the US dollar,” UOB Malaysia writes in an April 27 note.

UOB’s Goh says a strengthening currency could have a tightening effect on the economy, which would not be exactly the case for the ringgit.

“In the case of the ringgit, it is undervalued and coming from a relatively weaker level, as such the ringgit’s recent gains should not be a negative for the economy.

“Note that higher inflation and cost of living are partly attributed to the currency’s weakness as producers pass on some of the higher input costs to consumers. If anything, the ringgit’s gains should aid a recovery in sentiment, particularly for consumers and importers,” she says.

Given the high level of household debt, a decision to stay pat on the OPR would at least not add to the rakyat’s debt burden.

 

 

 

 

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