WHEN Bank Negara hosted a media briefing on Wednesday for the release of its 2013 annual report, there was naturally quite a number of overnight policy rate (OPR)-centric questions. After all, the central bank has kept the OPR at 3% since May 2011. The OPR is the benchmark rate to which commercial banks refer to price their rates on deposits and loans.
In the second half of last year, a number of economists expected the central bank to hike the OPR by 25 basis points to 3.25% in the first half of this year against the backdrop of rising inflation due to the 20-sen hike in RON95 petrol and diesel prices in early September, the abolishment of the sugar subsidy in late-October and the hike in electricity tariffs from Jan 1 this year.
Outside these domestic issues, the key external concerns are the significant economic slack and the impact of fiscal consolidation on the pace of recovery of the advanced economies while emerging economies face the challenge of managing external risks.
CIMB Investment Bank Bhd economic research head Lee Heng Guie says in a report that the central bank is walking a fine line between supporting domestic demand and mitigating the possible negative effects arising from inflation and financial imbalances. “A monetary policy response would be appropriate if there are signs that inflation is becoming more pervasive and persistent. We expect Bank Negara to raise its OPR by 25 basis points in the second half if gross domestic product (GDP) growth remains steady. We maintain our end-2014 OPR target of 3%-3.25%,” he says.
Alliance Research chief economist Manokaran Mottain maintains that there is a 50/50 chance of a 25-basis point rate hike in the second half of the year after taking into consideration the economic growth outlook, the downside risks to growth, inflation and domestic demand’s moderating trend.
Bank Negara’s monetary policy committee has met twice this year, on Jan 29 and March 6, but have not raised the OPR despite the fact that headline inflation in December has surpassed the average three-month fixed deposit rate of 2.97%. When queried during the recent media briefing, governor Tan Sri Dr Zeti Akhtar Aziz pointed out that several conditions for a rate hike had not been met.
One of these conditions is a persistent rise in cost-push inflation via the transmission of second-round effects. Zeti said while headline inflation would trend higher this year at between 3% and 4% (compared to 2.1% last year), more moderate domestic demand conditions and modest commodity price increases arising from external conditions would contain inflationary pressure.
Besides inflation, she said economic growth conditions and the build-up of destabilising financial imbalances would also be monitored. “That has not yet been seen,” Zeti added.
As usual, she has kept her cards close to her chest where a rate hike is concerned despite the best efforts of the media to weedle out more information.
“Our central bank does not practise forward guidance and we believe that our system is less complex than that of the United States or Britain where forward guidance is important. For us, when we make the assessments, our policy is forward looking, so we don’t look at current conditions but future conditions to see what the prospects for inflation is,” Zeti said.
Above all, Zeti stressed that domestic demand considerations would remain key to any change in the OPR. “The primary aim of monetary policy is to address risks to monetary stability in an environment of sustainable growth,” she says, adding that recent hikes in benchmark rates have been due to such considerations.
One of these domestic considerations is the fear of excessive risk-taking in an environment of relatively low international and domestic interest rates over a prolonged period. In Malaysia, the concerns over high household debt, now at 86.8% of GDP as at end-2013, driven by loans for properties and vehicles, has given policymakers pause for thought.
“The consequent build-up of excessive leverage and asset price misalignment could undermine macroeconomic and financial stability should these imbalances unwind in a disorderly manner. To the extent that such excessive risk-taking behaviour or asset price escalations occur within specific segments of the economy, other targeted policy instruments such as macro-prudential measures would be deployed to address the risks. Such measures are, however, complementary in nature and not a substitute for interest rate policy,” Bank Negara says in the annual report.
There is a sense that the central bank is leaving the revision of the OPR only when conditions merit it. Zeti says that the OPR is not the only policy tool in the hands of the central bank where managing the domestic economy is concerned. “While we take into account what has happened around us, we don’t just rely on monetary policy. It’s not the only policy tool available with respect to household indebtedness, this is one area where macro-prudential matters are very effective. They’ve already shown results, after being implemented gradually and incrementally,” she says.
An over-adjustment or tightening of the benchmark rate may precipitate a collapse of the property sector.
Zeti says that the sector is already undergoing an adjustment. However, despite these macroprudential measures including the responsible lending guidelines introduced on Jan 1, 2012 as well as further measures at avoiding household indebtedness introduced last July, those who are eligible will still be able to get loans.
“I want to emphasise that people with a steady income, with jobs and want to purchase a car or a house will still be able to do so,” Zeti says, adding that a young population with a growing middle class should see the rise in demand for housing and vehicles over time.
But she remains firm on the measures, saying that the banks have to strengthen their assessments of those who are eligible for loans.
“Right now, we believe that the macro-prudential measures are beginning to take effect. In fact we’re seeing the moderation taking place for a number of years so we’ll just monitor the quality of the loans. The impairment ratio is less than 2%, so it’s very low. There are very few household loans going bad,” Zeti says.
Although the central bank has downplayed the rising household debt, economists believe further action may be needed as the debt levels are expected to remain elevated in the medium-term.
“While the Government’s effort to increase the supply of affordable homes and the development of the public transportation system could lead to a decline in household debt, further macro-prudential measures are expected to be introduced,” Manokaran noted.
Meanwhile, Lee says the debt levels warrant close surveillance to avoid risks from financial imbalances and excessive leverage. “Since 2010, Bank Negara has introduced a series of macro-prudential measures in stages to prevent the household balance sheets from becoming a source of systemic risk.”
According to Bank Negara’s assessment, the level of indebtedness is expected to remain elevated over the next few years as the demographic profile of households, broader access to financing and increasing urbanisation will continue to generate strong demand for asset and wealth accumulation,” Lee says.
Given that household debt is only expected to begin moderating as the effects of structural measures to increase the supply of affordable housing and to improve the public transportation system become more entrenched, and despite the risks being contained for now, Lee says the central bank is ready to take pre-emptive action to mitigate the build-up of imbalances where appropriate.