By Ranjit Singh
LOW interest rates, according to economic theory, will encourage borrowing and investments and provide a catalyst to economic growth. However, when the economy is as weak as it is now, will low rates provide borrowers the impetus to borrow to expand their businesses?
Will Bank Negara Malaysia (BNM) cut interest rates for the third time this year? Will another cut help to revive the economy?
Given the lethargic state of the economy and with limited “ammunition” in its arsenal to stoke it, the central bank is largely expected to cut rates again when its Monetary Policy Committee (MPC) meets on May 5.
So far this year, BNM has slashed rates twice in its meetings in January and March. On both occasions, it cut the Overnight Policy Rate (OPR) by 25 basis points (bps). The OPR now stands at 2.5% and is largely seen to be at 2% at year-end.
Malaysia’s interest rate was at 2% during the Global Financial Crisis (GFC) of 2008/2009 and in the current environment, it is expected that the rate would go down to that level again.
BNM has projected the country’s gross domestic product (GDP) growth to be between -2% and 0.5% for 2020 and the Malaysian Institute of Economic Research (MIER) is even more downcast in its economic outlook with a forecast of -2.9% growth.
The Covid-19 outbreak has sent the economy into a tailspin by interrupting businesses and causing massive unemployment. The government has introduced an economic stimulus package to the tune of RM260 bil to mitigate the economic impact of the pandemic.
Further proof of the weakening of the economy is the projected inflation rate by economists of 0% for 2020.
This is mainly due to the negative output gap and a plunge in oil prices which are currently hovering below US$30 per barrel.
While other economists also expect further monetary policy easing given the downside risks to the country’s economy, they do not foresee BNM allowing the OPR to go lower than 2% by year-end.
Private consumption is anticipated to remain weak for the remainder of the year and will be another drag on economic growth.
The impact of the two rate cuts by BNM will only be felt when the first quarter 2020 GDP is released in May.
It’s too early to say that the previous two cuts did little to stimulate the economy as the 1Q20 GDP figures have not been released yet. However, it is expected that the 1Q20 GDP growth will be lower than that of 4Q19 due to the Covid-19 pandemic as we had the first two weeks of the Movement Control Order (MCO) in 1Q20.
MCO simply means there was a shutdown in most economic sectors hence contributing less to economic growth.
To gauge the effectiveness of reducing interest rates as a monetary tool, we can look back at the GFC. When the crisis first hit in 2008, BNM cut OPR by only 25bps in its final MPC meeting of the year. It did not manage to arrest the slowdown in the already slowing economy and GDP growth stagnated in 4Q08 compared to the solid 5.1% year-on-year growth in 3Q08.
BNM then quickly cut another 75bps in its next meeting in January 2009. It was the largest one-time reduction on record. This was followed by another 50bps cut the following month and maintained at 2% for the rest of the year. As the impact may take few months to be felt, the economy plunged by -5.8% yoy in 1Q09.
However, the economy started to gradually recover in the following quarters (2Q09: -3.7% yoy; 3Q09: -1.1% yoy) with a rebound to positive territory in 4Q09 (4.5% yoy).
As the economy slows considerably in light of the Covid-19 pandemic and depressed oil prices, the central bank does not have much room to resuscitate the economy. It will, in all likelihood, proceed with interest rate cuts to provide the much-needed boost.
Given that the government has imposed a loan moratorium of six months from April to September, this may give BNM some time to impose a cut in interest rates but whether such a move will prove to be effective remains to be seen. — April 24, 2020
