Bank Negara's Monetary Policy

After cutting rates by 1.5% during November 2008-March 2009, Bank Negara has kept interest rates unchanged starting Q2 2009. Since cutting rates too low has its risks , the central bank has focused more on improving "credit access" in the economy. Deflationary pressures, large output gap, low resource utilization and a sluggish recovery will help the central bank to remain on hold until sometime in 2010. But deflationary pressures might ease in H2 2009 due to commodity prices and fading base effects of 2008, preventing further rate cuts.

Will Bank Negara Remain on Hold for Now?

• October 28, 2009: Bank Negara maintained the interest rate unchanged for the fifth consecutive month at 2.0% to support economic recovery since price pressure are still low.
• BNM October Monetary Policy Statement: The current monetary policy is “appropriate” and will “support” economic activity as domestic economic conditions are improving with policy support, and inflation and inflation expectations are expected to remain “contained” in the coming months. BNM sees strong improvement in the labor market, domestic demand, financing activity and external trade, and these developments are expected to continue into 2010. Without any unexpected external impact, inflation in 2010 will turn positive, but remain “subdued”.
  
• BNM sees limited impact of low interest rates and the risk of fueling asset bubbles. It is rather focusing on credit measures to improve liquidity in the financial system. Fiscal stimulus, past interest rate cuts and government and central bank credit measures are improving credit flow in the economy (especially for smaller firms) and slowing the pace of job losses.
• The contraction in manufacturing activity and exports has eased since June 2009. The pace of economic contraction has eased since Q2 2009.
  
• The recovery is expected to be very sluggish due to slow recovery of exports and foreign investment inflows. Excess capacity and large output gap will persist through 2009 and most of 2010. This might lead the central bank to keep interest rates on hold for a long time and be one of the last central banks in Emerging Asia to raise rates.
• But BNM would remain vigilant about rising oil and commodity prices during the global recovery, especially as the base effects of 2008 food and oil prices start fading in Q3 2009. Going forward, improvement in private demand, lag impact of fiscal stimulus and liquidity impact of portfolio inflows might reduce deflationary pressures.
  
• However, further rate cuts are not expected. Low rates pose risk of capital outflows and downward pressure on currency amid declining interest rate differential with other Asian countries and the U.S.. This is exacerbated by risks to the debt ratings. Currency has showed some gains from April 2009 since when the rates have to kept on hold.
• Analyst Wei Zheng Kit, Citigroup: The central bank will not increase interest rates until H1 2010. BNM might be the last central bank to tighten the monetary policy in Asia.
  
• Economist Vishnu Varathan, Forecast Singapore: Since economic recovery in Southeast Asian countries is weaker than India and South Korea, Malaysia will not hike interest rates earlier than these two countries.
• Analyst Tetsuji Sano, Nomura: If global oil prices continue to increase, the government may hike domestic gasoline prices. On a year-on-year basis, the CPI will continue to remain in negative territory. The central bank is expected to keep current key rate unchanged at least until Q1 2010 as economic recovery is still "nascent". Even after the central bank begins to increase interest rate, the real interest rate will stay below zero if the CPI remains around 2.3% in 2010 and 3.3% in 2011.
• EIU: Malaysia is in a mild and short-lived deflation owing to falling global oil and non-oil commodity prices and base effects of 2008. However, the central bank will keep interest rates at around 2% for the rest of 2009 and probably until H1 2010.
• Morgan Stanley: Deflation will continue until the end of 2009. The central bank will start raising interest rates in H2 2010.

Are Deflationary Pressures in Malaysia Fading?

• The Consumer Price Index (CPI) declined 2% y/y in September 2009 for the fourth straight month of deflation after falling 2.4% in August 2009 and 2.4% in July 2009 due to relatively lower petrol and diesel prices. Yet, the pace of deflation has been slower led by the moderation of the decline in transport and food, clothing and food wear prices. On a month-on-month basis, CPI increased to 0.3% m/m in September 2009 after rising 0.2% m/m in August 2009. (Department of Statistics Malaysia, 10/23/09)
• Deflationary pressures are due to high base effects of Q2 2008, decline in food and oil prices relative to 2008, government subsidies for flour, sugar and bread.
• Deflation will persist due to output gap, excess capacity in manufacturing and rising unemployment. Sluggish recovery in 2010 implies that inflation will remain low until early 2010.
• A risk is that the base effects of 2008 will start fading by Q3 2009 and might raise inflationary pressures due to recent increase in oil and commodity prices.
• Inflation peaked in Q3 2008 at 8.4% y/y on high food and fuel prices and electricity tariffs.
• BNM: Inflation and inflation expectations are expected to remain “contained”. Without any unexpected external impact, inflation in 2010 will turn positive, but remain “subdued”.
  
• Analyst Wei Zheng Kit, Citigroup: Deflation has bottomed in August 2009 and positive momentum will continue to increase CPI. A year-on-year CPI may enter positive territory in 2009, but the central bank will hold interest rate unchanged in October 2009.
• Economist Intelligent Unit: Inflation will stay in slightly negative territory in H2 2009 due to the decline in global oil and non-oil commodity prices and base effects from 2008. However, lower global commodity prices are positive for growth, which could strengthen domestic demand. Inflation will pick up in 2010 as global commodity prices increase.

p/s photos: Li Xiao Lu