This article first appeared in The Edge Malaysia Weekly on August 10, 2020 - August 16, 2020

AT 1.75%, the current overnight policy rate (OPR) is at its lowest level since it was introduced as the financial system’s interest rate framework in 2004. Within a span of seven months, the OPR has been reduced by a total of 125 basis points (bps).

While it appears to be a steep cut over the span of half a year, it is worth noting that the OPR was slashed at a speedier pace during the 2008 global financial crisis (GFC), when it shed 150bps over four months. The OPR was reduced from 3.5% in October 2008 to 3.25% in November. By January 2009, it was reduced by another 75bps to 2.5%, before being lowered again to 2% in February.

That said, the lowest the OPR fell to during the financial crisis was 2%. As Bank Negara Malaysia reduced interest rates, the government utilised fiscal stimulus to help revive the economy.

The impact of the GFC was actually felt in the country by late 2008, when exports plummeted 7.4% as a result of a contraction in manufactured exports. World trade was reeling from the recession in advanced economies. At that point, Malaysia’s economy had not slipped into a contraction yet as it had private consumption to thank for providing the needed life support.

Bank Negara highlighted in its 2009 annual report that the sharp decline in world trade had affected exports, including those from Malaysia. This resulted in a reduction in production, especially in the manufacturing sector.

The spillover effect from this was a freeze in hiring, pay cuts, reduction in overtime work and even layoffs, the central bank said in the report. The unemployment rate rose to 4% in 1Q2009 from 3.1% in the previous quarter.

Needless to say, consumer sentiment was impacted as a result of the overall weak economic conditions and uncertainties about future employment. In 1Q2009, private consumption declined 0.7% while total investments contracted 10.8%, stemming from steep declines in private investment spending.

As history tells us, the Malaysian economy bounced back quickly from the GFC. After the economy contracted 6.2% in 1Q2009, the subsequent quarters saw milder contractions, and the economy finally saw growth by 4Q2009. The low interest rates and ample liquidity in the system from the 300bps cut in the statutory reserve requirement (SRR) ratio had allowed financing activity to continue expanding.

Bank Negara highlighted in its 2009 annual report that lower interest rates gave households an opportunity to refinance earlier loans taken at higher rates while the demand for new housing loans was spurred by stimulus measures provided by the government to promote home ownership. Meanwhile, banks offered attractive packages for the refinancing of housing loans and transfer of credit card balances while also lowering rates on newly approved personal loans to an average of 6.31% per annum.

While economic activity moderated, total outstanding loans grew 7.8% in 2009, with the lift coming from households as outstanding loans for this segment grew 9.8% in 2009. More loans were extended for personal use for the purchase of residential and non-residential properties, passenger cars and securities.

Looking at the loan numbers, outstanding residential property loans — the largest chunk of total outstanding loans — grew from RM192.17 billion at end-2008 to RM210.7 billion by end-2009. As a percentage of total banking system loans, residential property loans climbed from 26.4% in 2008 to 26.8% in 2009. The number continued to grow rapidly and reached 30% of total outstanding loans in 2015.

As loans grew, so did debt levels. Almost half of household debts in 2009 constituted home loans. Household debt levels increased from 63.6% of GDP at end-2007 to 76.6% of GDP at end-2009. By end-2015, household debt-to-GDP reached a peak of 89.1%.

Easy monetary conditions, coupled with inflows of capital, pushed property prices up in the years after the crisis. House prices increased at an average 9.5% per year from 2010 to 2015, outpacing the increase in average household income.

The property sector was overheating and the government took measures to tame it by reintroducing the Real Property Gains Tax (RPGT) in 2010 while Bank Negara introduced responsible lending guidelines to banks. In 2014, the central bank introduced several other cooling measures for the property market.

Many say these measures were timely and helped curb the speculation that was pushing property prices above what the average Malaysian household could afford. As for businesses, the non-financial corporate debt-to-GDP actually dipped in 2009 to 83.4%, from 92% the year before. Nevertheless, subsequent to 2009, corporate debt-to-GDP trended back to above 90% and hit 106.7% in 2015.

In the most recent Financial Stability Review for 2H2019, Bank Negara reported that non-financial corporate debt-to-GDP had fallen to 99.4% in 2019 as external debt declined and domestic borrowings were subdued due to cautious sentiment.

Following the GFC, Malaysia’s economy did recover and it came out of the crisis with higher leverage than before. It wasn’t just the domestic low interest rate environment that caused the higher debt levels, especially among households, as interest rates had started to increase in March 2010. A large part of it was attributed to the substantial foreign capital inflow due to the low interest rate environment outside the region, which helped push indebtedness higher.

Will history repeat itself this time? That remains to be seen as the current pandemic continues to ravage economies around the world.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's App Store and Android's Google Play.