This article first appeared in The Edge Malaysia Weekly on May 16, 2022 - May 22, 2022

MALAYSIA surprised the majority in a good way twice last week, starting with an earlier-than-expected 25 basis point hike in the overnight policy rate (OPR) from its all-time low of 1.75% on Wednesday (May 11), followed by a stronger-than-expected first quarter GDP growth reading of 5% year-on-year and 3.9% quarter-on-quarter on May 13. Consensus was 2.3% y-o-y and 1.1% q-o-q, Bloomberg data shows.

That is not all. Bank Negara Malaysia governor Tan Sri Nor Shamsiah Mohd Yunus told reporters she was “confident [GDP] growth will be within the forecast range of 5.3% to 6.3% this year”, when asked just how confident the central bank was that the growth trajectory was on a firm enough footing to lift the OPR for the first time since January 2018, after keeping it at 1.75% for 10 straight meetings.

“We do not see any risk of recession in Malaysia. Growth will be driven mainly by domestic demand as we transition to the endemic phase. The performance of our economy in 1Q2022 does reflect that our recovery is on track,” Shamsiah told reporters at the bank’s first physical GDP press briefing in two years.

Whether that is enough to give the market a dose of confidence should unfold in the coming weeks. It does help that economic indicators had turned positive even before Malaysia transitioned to the endemic phase on April 1. In particular, private consumption grew 5.5% y-o-y in 1Q2022 compared with 3.7% y-o-y in 4Q2021. Unemployment had also eased to 4.1% in March from as high as 5.1% during the pandemic, though still above the longer-term average of 3.5%.

For the record, only five of 24 analysts polled by Bloomberg had expected the first move towards policy normalisation to happen in March: Barclays plc, Goldman Sachs, IHS Global, Nomura and UOB Bank. Four of the five (as well as Standard Chartered Bank) had expected another 25bps rate hike to happen by Sept 8 (or as early as the next meeting on July 6), while IHS reckons Bank Negara would pause for two meetings before making another 25bps hike to 2.25% on Nov 3. Goldman Sachs, along with Bank of America, expects the OPR to reach 3% by mid-2023 while the most bearish of forecasters see rates at 2.25%.

It remains to be seen whether the stronger-than-expected 1Q GDP reading and the dose of confidence from Bank Negara will change consensus estimates, which had yet to be updated to reflect the latest policy decision at the time of writing.

The US Federal Reserve, which hiked rates by 25bps in March (the first time since December 2018) and made another hike — of 50bps — in early May to push rates to a range of 0.75% to 1%, is expected to hike rates by 50bps at each of the coming two meetings in June and July, and hike rates further in the remaining three scheduled meetings, to bring rates closer to 3% by December.

While Shamsiah told reporters that the decision by Bank Negara’s Monetary Policy Committee (MPC) to lift rates from its all-time low was to “remove excess monetary policy accommodation” that is no longer necessary, given improved economic conditions, she also said it was “very important that we recalibrate our monetary policy carefully now to avoid having to be aggressive down the road, which is the case for some central banks that are coming out from very low policy rates”.

Asked whether 3% would be the so-called “terminal rate”, or the level that OPR is expected to reach by end-2023 as Bank Negara begins to normalise interest rates, Shamsiah replied: “Let’s not get fixated on any one number because the environment we are in is highly uncertain and still evolving. Because of this, arriving at one neutral rate may not be helpful because this neutral rate may change over time, depending on the environment.”

Noting that, unlike the US, there is still “spare capacity” in the Malaysian economy, Shamsiah said, “that is why monetary policy will continue to remain accommodative”.

“I can already say the extent and pace of the rate increase will depend on how strong the economy will continue to grow and the impact it will have on inflation. For example, any acceleration of economic momentum that is driven by excessive demand would likely necessitate [rate] action.”

She also took care to assure that “any adjustments [in the OPR] would be measured and gradual to support sustainable economic growth, while ensuring price stability”, adding that targeted aid was still available to individuals and smaller businesses that still required capital assistance.

While debt becomes more costly for borrowers, Shamsiah said better deposit rates would help and encourage savers to rebuild savings depleted during the pandemic. Improvements in wages would also help with a higher cost of living, she added. Bank Negara expects headline inflation to range between 2.2% and 3.2% and core inflation to range from 2% to 3%.

A damper to the stellar 1Q2022 GDP reading is the ringgit’s weakness against the US dollar.

Asked whether there are other factors affecting the ringgit’s performance, given that, historically, the ringgit gains strength when oil prices are high, Bank Negara assistant governor Adnan Zaylani Mohamad Zahid said: “Factors affecting the ringgit will change over time. In the past, oil was a strong factor [but] may not be as strong a factor at the moment compared to other factors that are at play.” He added that the dominant factor right now was a rate adjustment in several markets, including the US.

The ringgit depreciation against the US dollar is “in line” with the movements of regional currencies amid broad US dollar strength, Shamsiah said, noting that the ringgit’s 4.7% year-to-date decline (as at May 11) was comparable to the Australian dollar’s 4% decline. “It is not peculiar to Malaysia. Australia is also a commodity-producing [exporting] country.”

At the time of writing, the ringgit was at RM4.3987 against the US dollar, down 5.6% from the 4.1665 at which it ended 2021. That is weaker than median forecasts of RM4.35 for 2Q2022, with forecasts ranging between 4.15 and 4.43 and forward trade at 4.40, Bloomberg data shows at the time of writing.

Shamsiah says Bank Negara “does not target any level of exchange rate” for the ringgit but is “in the market to ensure there is no excessive volatility in the exchange rate and the conditions in the financial markets continue to be orderly”.

What is certain is that the central bank will maintain a flexible exchange rate. While pegging the ringgit to the US dollar had proven successful for Malaysia during the 1997/98 Asian financial crisis, Shamsiah pointed out as a reminder that it came at a cost.

“Pegging the ringgit will not be in the best interest of Malaysia today. It will have substantial risk, we would have to mirror the monetary policy of the currency we are pegged against. For example, if the US raises rates by 3%, we would have to follow suit to maintain the peg … Malaysians, in this case, would have to bear the higher borrowing costs even though the economy is weaker than the US. We would have to resort to capital controls, as that would be necessary to ward off speculative pressures.”

However hawkish the Fed may be, the ringgit would benefit if consensus turned more confident on Malaysia’s growth trajectory. While it was unfortunate that Malaysia has had to revise lower its official GDP growth forecast two years in a row in 2020 and 2021, owing largely to tough measures to protect lives and livelihoods amid the Covid-19 pandemic, the strong first quarter showing is a good start to regaining ground lost in those years. More than ever, Malaysia needs to get policy execution right. 

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