Time to change course
Lee Heng Guie 
BNM’s confidence over growth prospects next year is validated by its overall assessment that the country’s economic expansion has become more entrenched

Following the last Monetary Policy Committee (MPC) meeting on Nov 9, Bank Negara Malaysia (BNM) has laid the groundwork to prepare the market for a change in monetary course next year if necessary.

BNM said the stance of monetary policy remains accommodative at the current overnight policy rate (OPR) level. “Given the strength of the global and domestic macroeconomic conditions, the MPC may consider reviewing the current degree of monetary accommodation. This is to ensure the sustainability of the growth prospects of the Malaysian economy,” it added.

The central bank’s statement does not signal a strong dose of hawkishness, but rather underlies the need for the MPC to take stock and review the current monetary accommodation, taking into account prospective global and domestic economic conditions, price expectations and global monetary conditions.

BNM has kept the OPR unchanged at 3% for over a year, after a surprise 25 basis point cut on July 13 last year to cushion the slowing domestic economy (4.1% in Q1 and 4.0% in Q2 2016) from lingering global uncertainties post-Brexit’s shock.

Since then, the economy has gained steady momentum, climbing from 4% GDP growth in Q2 to 4.4% in H2 last year to 5.8% in Q1 and 5.8% in Q2 this year. All signs point to another strong quarterly growth of estimated 6.1% in Q3. The higher growth was underpinned by resilient domestic demand, especially private consumption and export upswing.

The central bank’s confidence over growth prospects next year is validated by its overall assessment that the country’s economic expansion has become more entrenched. Its optimism is premised on favourable external economic prospects, sustaining private consumption and investment.

On inflation, the trajectory looks pretty uncertain as oil prices can have a profound impact on inflation if energy and fuel prices continue to rise, resulting in more expensive goods and services. So, with Brent crude price hovering at US$63 per barrel, market expectations of domestic inflation have risen as consumers get wary of the cost pass-through effect following fuel price increase four weeks in a row since Oct 19. The retail price of RON95 jumped 40 sen per litre from the week ending July 5 to Nov 15.

While BNM has consistently not reacted to cost-induced inflation, it is more wary of demand price pressures or wage price spiral. In this current environment of still resilient consumer demand, there is a real possibility that demand-driven inflation could set in next year.

The central bank’s policy statement alluded to this, stating that underlying inflation, as measured by core inflation, will be sustained by robust domestic demand. The RM6.8 bil cash handouts, RM1.5 bil tax savings from a 2% cut in personal tax rates and special financial payment of RM3 bil to 2.3 million public civil servants and pensioners are expected to help consumer spending.

Headline inflation ratcheted up to an average of 4.0% in January-September, leading to negative real rate of return on fixed deposits. If this persists for an extended period, it could discourage savings culture, distort resource allocation and penalise savers, especially pensioners.

While one should remain wary of the state of capital flows and exchange rate pressure triggered by the US Federal Reserve’s (Fed) continuation of rate hikes and shrinking of its balance sheet, onshore ringgit stabilisation measures, including stopping offshore ringgit trading and export proceed conversion rules are expected to provide some buffer for the ringgit against the dollar.

It must be noted the current interest rate differentials of 175 basis points between Malaysia (OPR of 3.00%) and US (Fed rate of 1.25%) will continue to narrow next year if the Fed ends the year with a 25 basis point increase as well as proceeds with its guidance of three more hikes in 2018.

With a sense of foreboding and weighing on the fundamental assessments, the MPC believes the time has come to communicate and prepare the market for a change of course. The first decision by the central bank for a gentle removal of monetary accommodation is expected around the turn of next year.

While strengthening economic conditions and robust outlook help bring normalisation of interest rate into view, some would caution a rate hike could endanger the sustainability of high household debts, though loans have moderated in recent years. An uptick in home mortgage rate could dampen house buyers’ sentiment.

The economy is strong enough to absorb a measured pace of rate hikes, starting with 25 basis points and restoring the level of monetary accommodation to 3.25% last seen in 2014-15 till July 12 last year. At 3.25%, it is still considered accommodative to support domestic demand.

The market must prepare for more rate hikes to a neutral level that would not discourage consumption, economic activities and investments if the following conditions are met throughout next year:

▶ If the global growth and domestic economy continues to sustain at strong levels, supported by domestic demand;

▶ Anchoring inflation expectations should headline and core inflation continue to remain at elevated levels as oil prices remain a wild card. BNM has to stay ahead of the inflation curve; and

▶ Balancing yield gaps should the Fed hike rates aggressively.

For now, investors must pay close attention to the wording of the MPC’s policy statement for clues on the timing and pace of rate hikes. The following developments warrant close monitoring:

▶ External developments, especially the pace and magnitude of the Fed’s rate hikes; and

▶ Domestic current and lead indicators such as exports, industrial production, consumption and investment, prices as well as credit growth. 

Lee Heng Guie is the executive director of Socio-Economic Research Centre (SERC), an independent research organisation

This article first appeared in Focus Malaysia Issue 259.