This article first appeared in Forum, The Edge Malaysia Weekly on October 18, 2021 - October 24, 2021

The Federal Reserve, which is the most influential central bank in the world, has signalled that it will start tapering its quantitative easing (QE) programme that was rolled out early last year to keep the economy afloat.

The Fed’s move has pushed up bond yields as fixed income investors expect the US to start tightening its monetary policy, something that should have a profound effect on countries such as Malaysia.

For the last 13 years, when interest rates have generally been low and stable, the Malaysian government has had the luxury of expanding its budget and not being penalised for allowing a substantial amount of financial resources to go into unproductive assets.

In normal circumstances, this would have resulted in grave consequences for an emerging economy such as Malaysia. The currency would have depreciated, leading to economic turmoil and causing the stock market to go into a tailspin.

But fortunately, Malaysia and most other emerging economies have not been punished for having weak macroeconomic fundamentals because developed nations have also been taking the same path. Since the 2008 US sub-prime financial crisis, all advanced economies have advocated a loose monetary policy and an ultra-low interest rate environment to overcome a situation of persistently high unemployment and low inflation.

As the pandemic recedes, developed nations are well on their way to correcting the two macroeconomic imbalances of high unemployment and low inflation. In fact, the fear now is of inflation rearing its ugly head.

The unemployment rate in the US continued to decline to 4.8% in September this year while inflation was at a 13-year high of 5.4%. At one stage, US unemployment was more than 8% while inflation was less than 2%.

The situation is similar in almost all developed countries as they come out of a deep recession. In fact, economists are talking about the possibility of stagflation — a period of high inflation and low growth — but this is highly unlikely.

Stagflation is not likely because the current inflation, which is a general rise in prices of goods and services, is due to the supply disruptions caused by the pandemic. It is not because of people having more money to spend.

Nevertheless, in order to counter inflation, monetary policies are being tightened. The US is tapering its quantitative easing programme, which will effectively result in less money going into the system and give rise to higher interest rates eventually.

Several countries such as South Korea, Norway and New Zealand have raised interest rates to prevent excess money from going into unproductive sectors.

The most-watched barometer today is the 10-year US Treasury yields, which is the benchmark used to price the cost of funds globally. The yield on the US 10-year Treasury, which moves inversely to its price, rose to 1.6% last week.

The yields have been rising in recent months, indicating that the market is anticipating that the Fed will start raising rates, which are now between 0% and 0.25%.

Since the pandemic started, the Fed has bought US$120 billion (RM500 billion) of bonds from the market in a move to pump liquidity into the system. Starting next month, it will reduce the purchase by US$15 billion a month, in what is termed as the “tapering exercise”.

The Bank of England is also looking at ending all stimulus programmes that were put in place to help the country overcome the economic lockdown due to the Covid-19 pandemic.

In contrast, Malaysia continues to be on an expansionary path when the world is slamming on the brakes to prevent too much money flowing into the system.

To allow for pump priming, parliament approved a bill tabled by Finance Minister Tengku Datuk Seri Zafrul Tengku Abdul Aziz to raise the federal government’s statutory debt ceiling to 65% of gross domestic product (GDP) from 60%, which was the limit set last year. Prior to the pandemic, the acceptable level was 55% of GDP.

The increase in the debt ceiling will give the federal government an extra RM45 billion to fund its pandemic recovery initiatives. In total, Malaysia’s Covid-19 fund will increase to RM110 billion from RM65 billion.

To battle the pandemic, the government has so far relied on an expansionary fiscal policy. In 2020, the federal government’s fiscal deficit went up to 6.2%. The Budget that was initially projected at RM297 billion with a fiscal deficit of 3.2% went up to RM314 billion.

This year, the fiscal deficit, which was initially projected at 5.4%, is projected to rise to 7% due to the prolonged Covid-19 situation.

On top of expanding its balance sheet to keep the economy afloat, the government has announced eight fiscal and non-fiscal packages worth RM530 billion to assist the people and affected businesses since the pandemic started in March last year. Out of the RM530 billion, the direct cash injection into the system is RM65 billion while the rest is in the form of stimulus packages.

Among the stimulus packages are a blanket moratorium on bank loans for six months, wage subsistence for companies that have seen a drop in business and withdrawal of funds from the Employees Provident Fund (EPF).

In terms of actual cash disbursements, so far, RM60 billion out of the RM65 billion allocated has been given out to the affected people and small and medium-sized enterprises. EPF members have withdrawn RM67.6 billion out of the RM79.6 billion approved under the i-Citra and i-Sinar programmes.

The latest package said to amount to up to RM1 billion is under the Financial Management and Resilience Programme (URUS). It is to be borne by banks and is for B50 households, defined as those with a total income of RM5,880 or less per month. The programme is generally to help fund the cost of interest and restructure the repayments of those seeking a reprieve for the next three months.

URUS would likely be the last assistance package to households affected by the pandemic. Next year, reality will hit borrowers who have yet to restructure their repayments as banks start to face the prospect of writing down loans that have gone bad.

Rating agencies such as S&P Global Ratings anticipate the asset quality of Malaysian banks to deteriorate and non-performing loans to rise next year, up to 4% from 1.5% prior to the pandemic.

Further government intervention in the banking system will not be taken lightly. The era of easy money is over and borrowers have to face the reality.

M Shanmugam is a contributing editor at The Edge

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