THURSDAY was the first glimpse into what Bank Negara might be thinking over interest rates when it came out with its Monetary Policy Committee (MPC) statement.
It considers monetary policy to be appropriate and accommodative, indicating that fiscal and financial measures will continue to cushion the economic impact on businesses and households and provide support to economic activity.
“The stance of monetary policy will continue to be determined by new data and their implications on the overall outlook for inflation and domestic growth,” the MPC says in its latest statement.
Its decision to keep interest rates at a record low is guided by the data in front of it. Malaysia’s interest rate policy seems to be more targetted at growth rather than a counter-inflation measure. And while the statement by the MPC does refer to pressure points for inflation, the central bank reminded everyone that growth prospects are tilted towards the downside.
That, however, has not stopped economists and economy watchers from saying what is being repeated throughout the world – that interest rates are expected to rise in the second half of the year.
The normalisation of interest rates has always been a priority for the central bank in the past. It has spoken on delivering real returns to depositors, but that is nearly impossible to do with inflation punching upwards at multi-decade highs in many of the developed countries.
Yet, despite the seeming hesitancy, an interest rate hike may be imminent in the second half of the year, more so out of concern for global norms with inflation peaking in many of the trading partners of Malaysia.
According to Sunway University economics professor Dr Yeah Kim Leng, (pic below) inflationary pressures appear to be by and large still under control in Malaysia.
He tells StarBizWeek that inflationary pressures as they stand are more cost-push. Higher prices of commodities that go into making the finished product are sending prices of goods higher.
There is a fundamental difference between cost and demand-led inflation, with the latter more difficult to tame.
“As long as it is not reinforced by a demand-pull (pressure), there is less of a risk of runaway inflation that is most feared by the central banks,” says Yeah.
There are also some expectations for inflation to keep piling on the pressure in the near future.
“We expect it to surge further in the months ahead, driven by double-digit increases in the Producer Price Index or PPI that was seen in November 2021. Given that it is a politically sensitive issue, however, we expect the government to resort to subsidies and price control mechanisms to keep inflation at bay,” Malaysian Rating Corp Bhd (MARC) Ratings notes.
Any reason for interest rates not to rise was further weakened when inflation data for December was released. For the month, the Consumer Price Index (CPI) rose 3.2% and the Statistics Department says that rate of inflation surpassed the average inflation rate over the past decade of 1.9%.
Much of that is a result of the higher price of goods. The higher food prices and even petrol prices have had an effect in pushing up prices in the basket of goods.
Food and non-alcoholic beverages were up 3.2% and transport, which captures higher energy prices, was higher by 9.5%.
The weak economy and the embers of demand are, luckily, not putting any demand-lead pressure on inflation.
“Unless it (demand) overshoots –depending on how strong the surge is – then interest rates may need to be raised. This may be needed to dampen demand-pull pressures that would lead to high inflationary pressures,” says Yeah.
“With these developments (threats of new Covid-19 variants and a gradual improvement in the economy), a normalisation in interest rates may take a while, with it being more gradual than expected,” says Yeah.
MARC Ratings in its note on Wednesday says that there is a slight chance Malaysia could face a monetary policy decision dilemma this year.
“Suppose the Omicron or other Covid-19 iterations rage on in 2022 as much as Delta did in 2021, or even more. And suppose global supply chain shocks cause inflation to surge even higher while hampering domestic recovery, if worst comes to worst, we expect Bank Negara to clamp down on inflation to maintain price stability and risk choking off growth,” MARC Ratings says.
It adds that it expects Bank Negara to start normalising monetary policy in the second half against the backdrop of a gradually recovering economy by raising the overnight policy rate (OPR) by 25 basis points. Most economists expect a similar rise in the OPR in the second half of the year.
The chief executive officer of the Center for Market Education, Malaysia, Carmelo Ferlito tells StarBizWeek that the chances are high that the OPR would be raised by Bank Negara should there be no further lockdowns implemented.
“Due to inflationary pressures and economic recovery, I do expect Bank Negara to raise the OPR,” Ferlito says.
He maintains that the current inflationary trends worldwide are due to governments overspending to provide a huge stimulus to counter the crunching impacts of the pandemic and monetary mismanagement, not supply side shocks.
Bank Islam Malaysia Bhd’s chief economist Dr Mohd Afzanizam Abdul Rashid is more sanguine of the situation.
He says that any potential rise in interest rates is a strong indication that the economy is recovering and central banks are removing policy accommodation since there are signs of improving economic activities.
“For instance, in the United States, the unemployment rate has trended down significantly from as high as 14.7% in April 2020 to 3.9% as of December 2021. Similarly for Malaysia, the jobless rate fell from 5.3% in May 2020 to 4.3% in November 2021,” Afzanizam says.
“Keeping the interest rate for too low for too long a time when the recovery has become more tangible would risk putting the economy into severe imbalance, such as excessive risk taking and asset price bubbles,” he adds.
Yeah says that the public and markets in general need not fear a gradual adjustment or normalisation in interest rates eventually and their impact would be manageable if done properly.
“A gradual normalisation is welcomed and will provide the economy with greater resilience in facing future price shocks. It takes us to a level that will help the country cope with supply and demand shocks,” Yeah says.
He says there is not much to be concerned about especially with regards to demand for big-ticket items such as vehicles and property which are usually bought using a bank loan.
“They will be impacted (initially) but if the increase in interest rates is gradual it will not derail the anticipated demand. As long people have jobs and incomes remain sufficient, they would still be able to afford and borrow, moving forward,” Yeah says.
He says that as long as the interest rate increase is gradual, it should not jeopardise the ability of people to repay their loans.
Yeah notes that other factors of a smooth running economy are also important such as job prospects and income growth which are the other main factors that will offset any interest rate increase.
The impact on the people
Contributing to the surge in inflation is the food people eat. The price of chicken, the staple source of protein for Malaysians, was up 13.6% in December. Eggs too were 13.5% higher, and the price increases of both are putting pressure on people’s incomes.
The Statistics Department says that inflation for people earning below RM3,000 increased 3.2% in December 2021 from the same month a year ago.
“We expect the government to continue assisting vulnerable households, which will help support consumer spending to some extent,” says MARC Ratings.
The impact of higher interest rates will also have to be balanced against crimping on people’s spending ability, especially so as incomes are slowly rebuilding from the debilitating economic crunch over the past two years. And there is a benefit for those who want to lock in the record-low borrowing rates before interest rates start to climb.
Afzanizam says demand for cars could be impacted, but notes also that automotive loans are usually based on a fixed borrowing rate.
“Perhaps, buying a car now would be a wise decision. Of course, this will be subject to their affordability and the main reasons for purchasing a new car. Similarly, potential house buyers would opt for a fixed rate whenever they decide to purchase a residential property should they want to avoid risks of a fluctuation in the interest rate,” Afzanizam says.
Meanwhile, Yeah says a rising rate environment would benefit net savers of the economy and will give people more incentive to increase their savings.
“During the pandemic-induced recession, interest rates were brought down to a historical low. And this move meant that the savers are actually shouldering the burden since they are getting very little risk-free returns from their savings,” Yeah says.
Shifting the balance
He says any rate rise will be helpful to net savers and shift the balance of the equation towards this group of people.
“It will strike a more sustainable interest rate that would not overly penalise savers,” he says.
On the flip side, Afzanizam says if interest rates are maintained despite rising inflationary pressures, a depositor’s savings in the bank would be eroded by the high inflation rate.
“This would disincentivise them to keep their money in the bank, leading to unhealthy competition for deposits and perhaps, scarcity in liquidity conditions in the financial system,” Afzanizam adds.
At the other end of the equation, the people who are over-leveraged may need to face the higher borrowing costs – such as for variable rate property loans for example.
“The over-leveraged people, or those at the borderline who do not experience any income increases, will be constrained in their ability to borrow, especially from the banks. This would dampen demand (such as for properties), but at the same time, it would reduce the chances for the economy to be overly indebted,” Yeah says.
He also points out that the country’s current level of household debt is high even though it has tapered off recently.
“Another concern is to what extent would a rate rise pose a shock to borrowers – especially to the households and businesses.
“We may see some negative spillovers in this area, but so far the banking system is well provisioned and capitalised to cope with any increase in delinquencies,” Yeah adds. Banks normally benefit from higher interest rates.
Despite these slight concerns, economists are confident that any change to the interest rate would be done gradually as it had been done before.
Interest rates in the country would also be in line with global trends and developments such as the interest rate in other countries and inflation globally.
“The decision to raise the OPR will not be done hastily. It will be carefully calibrated at the MPC meeting whereby two external members would be providing their inputs from the private sector.
“Further, the frequency to change the OPR has been very gradual based on past history,” Afzanizam says.
“The highest level of OPR (in recent history) thus far was 3.50% during 2005 and 2006. And the lowest is the prevailing level which is at 1.75%,” he adds.
Yeah says that so long as the interest rate increase is not too sharp or too sudden, businesses and consumers would be able to adjust gradually and absorb its impact.
“It should not be too huge of a jump. If this happens then it would be very disruptive – and it is also reflective of a very volatile economic environment,” Yeah says.