Friday 29 Mar 2024
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This article first appeared in The Edge Malaysia Weekly on September 7, 2020 - September 13, 2020

WITH two meetings left for the year in September and November, all eyes will be on Bank Negara Malaysia’s Monetary Policy Committee (MPC) and its decision on the overnight policy rate (OPR).

The MPC will make its penultimate OPR decision for the year on Thursday (Sept 10), but it will be a tricky one on whether to lower the key interest rate further or to leave it unchanged, given the myriad of unknown factors at play — the uncertainty of another wave of Covid-19 infections, how fast an effective vaccine can be developed and commercialised, and the economic repercussions once the loan moratorium period comes to an end this month.

Given this scenario, economists are split over whether the central bank will cut the OPR further, which has so far undergone a cumulative 125 basis points (bps) cut this year to 1.75% — the lowest level since the OPR framework was introduced in 2004.

The arguments for a rate cut

ING Asia senior economist Prakash Sakpal says the sharp 17.1% contraction in the year-on-year gross domestic product (GDP) growth seen in the second quarter (2Q2020) is reason enough for the central bank to cut the OPR further.

“Things may be looking better going into 3Q2020, with a second straight monthly export bounce in July [which] sent the trade surplus soaring to an all-time high of RM25 billion. While this bodes well for GDP growth, a couple more quarters of negative growth still looks inevitable,” he tells The Edge.

“Substantiating the rate cut argument further is the negative inflation streak that’s likely to prevail through the rest of the year. Even though the policy rate is currently sitting at an all-time low of 1.75%, the negative inflation has left the real interest rate to [be one] of the highest among regional economies, which isn’t a good backdrop for recovery. Hence, the need for a further OPR cut next week,” he says.

Vishnu Varathan, head of economics and strategy at Mizuho Bank in Singapore, says Malaysia’s negative inflation slump and measured rate cuts relative to the other central banks in the region have led to an elevated real policy rate.

“Most Asean central banks’ rates are significantly below their global financial crisis (GFC)-level lows, whereas Bank Negara is a mere 25bps below its GFC OPR low of 2%.”

“All else [being] equal, this creates additional scope for rate cuts, so as to foster a better recovery,” he adds.

In an Aug 18 note, UOB senior economist Julia Goh and economist Loke Siew Ting do not rule out another cut in the OPR, given official remarks regarding the pace of economic recovery, downside risks to growth, and concerns over the impact on borrowers when the loan moratorium ends in September.

“Bank Negara has revised its 2020 GDP projections to -3.5% to -5.5% (versus -2% to 0.5% previously) and expects growth of 5.5% to 8% in 2021. [The central bank] has also guided that the loan moratorium is expected to contribute about one percentage point to 2020 GDP, and cumulative OPR cuts of 125bps year to date (YTD) to contribute less than one percentage point, while the overall fiscal stimulus is projected to contribute around 3.4 percentage points.

“In a nutshell, we have pencilled in one more 25bps rate cut at the September monetary policy meeting, bringing the OPR to 1.50% by year-end,” they wrote.

DBS Group Research senior economist Irvin Seah and strategist Duncan Tan also foresee another rate cut from Bank Negara, premised on the disinflationary pressure building up and the widening of the negative output gap amid the recessionary economic conditions.

A negative output gap occurs when an economy is producing less than what it potentially can, or, in other words, the economy is producing less than its full capacity.

“Full-year inflation is projected to average -1.1% before rebounding to 1.8% in 2021. With the projected inflation dynamics in the coming months, the real policy rate will remain elevated, effectively negating the effects of the earlier rate cuts by the central bank.

“With growth surprising on the downside and an arduous recovery path ahead notwithstanding, there is room for further monetary easing to support growth in the coming months. As such, we now expect one final 25bps cut by Bank Negara, as early as in the forthcoming September meeting, to better align the risks in both inflation and growth,” they wrote in an Aug 31 note.

The arguments against a rate cut

Associated Chinese Chambers of Commerce and Industry of Malaysia’s Socio-Economic Research Centre executive director Lee Heng Guie is not counting on any further rate cuts from the central bank this year.

“Bank Negara is likely done with its rate cuts for the year, with high-frequency data suggesting the economic stabilisation and recovery has started taking shape, albeit gradually, after hitting the trough in 2Q2020.

“The cumulative interest rate cut of 125bps YTD is deemed appropriate for now, and along with the other fiscal support, financial assistance and relief measures have helped to shallow the economic damage. The limited monetary space should be reserved for future economic shocks,” he says.

AffinHwang Investment Bank Bhd chief economist Alan Tan concurs. “We think that the current rate of 1.75% is supportive of economic growth. Apart from the YTD 125 bps interest rate cut, Bank Negara has also introduced measures to pump liquidity into the system. Combined with the fiscal stimulus measures and the recovery in the global economy, this points towards a possible pause from Bank Negara [in lowering rates] at the next MPC meeting,” he says.

Tan adds that the environment of negative inflation seen in the past few months, which is the result of low petrol prices, is likely to be temporary.

“Underlying inflation is likely to improve because of the improvement in domestic demand. We are seeing an improvement in private consumption, which should lead to some inflationary pressure [towards year-end],” he says.

SERC’s Lee notes that the US Federal Reserve’s (Fed) major policy shift towards setting inflation expectations and the unemployment mandate signals that it would allow an ultra-low interest rate environment for some time.

“The Fed’s low-rate setting scenario would provide a respite for the central banks in emerging markets to keep their rates lower to resuscitate the economy without worrying about the implications on capital flows and exchange rates.

“While Bank Negara’s monetary policy is largely dictated by domestic economic and financial considerations in supporting economic growth and maintaining price and financial stability, it also needs to weigh on the monetary path in advanced economies, given their considerable influences on the two-way flow of global capital and assets allocation,” he says.

Bank Islam Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid opines that in deciding the best course for the OPR direction, it is important to ascertain the issues that are plaguing the economy and the type of policy response that would effectively address the problems.

“If the issue is cash flows, especially among the affected businesses and individuals, the targeted moratorium may seem to be the right policy choice and the price of money, which is the interest rate, is already low.

“And those who are facing the cash crunch may not regard the interest rate as the main consideration as they would be indifferent. What matters to them is the availability and access to credit, and how soon they would get it. So, ascertaining the main issue at hand is also paramount beyond the standard assessment, which is based on growth and inflation,” he says.

Dr Kwek Kian-Teng, associate professor at Universiti Malaya’s Department of Economics, says that in essence, keeping a low interest rate policy is a necessary central bank action as it is to avoid any massive deflation in asset prices or balance sheet meltdown.

“Against the current pandemic crisis, many policymakers will admonish a further interest rate drop. But I would admonish to keep policy rates unchanged at 1.75%. [We should not] send pre-emptive signals when the economy is struggling to push up its steam.”

She adds that the economy is already fragile due to Covid-19 and lowering interest rates in an environment of rising prices of goods would only aggravate the situation further.

“By lowering the interest rate further, [this] would only create “deep middle class poor” and “urban poor” groups in society, while the poor group [becomes] poorer, as a low interest rate policy with rising prices would hurt the rakyat, who are fundamental savers for the real economy,” she says.

With many factors at play and stakeholders to protect, it will definitely be an uphill task for the MPC in deciding the best course of direction for the OPR.

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