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This article first appeared in The Edge Malaysia Weekly on January 24, 2022 - January 30, 2022

AT its first monetary policy meeting of the year, Bank Negara Malaysia maintained a dovish stance in terms of its overnight policy rate (OPR), despite a more aggressive tone from the US Federal Reserve. Is the Malaysian central bank’s stance justified, in wanting to support the economy rather than tame prices?

In its monetary policy statement released last Thursday, Bank Negara said its current stance on monetary policy is appropriate and accommodative. Fiscal and financial measures will continue to cushion the economic impact on businesses and households, and provide support to economic activity.

The central bank maintained the OPR at 1.75%, which has remained unchanged since July 2020.

Nevertheless, on the price side, Bank Negara expects underlying inflation, as measured by core inflation, to edge upwards as economic activity normalises amid the environment of high input costs. This means core inflation is expected to increase further.

However, inflation is the least of Asian central bankers’ concerns and the region’s economies are expected to better withstand a higher US interest rate environment.

According to Sue Trinh, head of macro strategy for Asia at Manulife Investment Management, emerging Asia’s equities and fixed income will be supported by accommodative monetary policy stances and are in a better position to withstand the Fed’s tapering risks relative to 2013. This is because the region’s economies today have stronger external positions, lower reliance on external funding and better-balanced positioning.

“While inflation will likely pick up further, large output gaps will help keep underlying price pressures in check. In the event global supply bottlenecks worsen upside inflation pressures, Asia is likely to escape the worst of the global inflationary shocks, particularly versus other emerging markets,” she said during the Manulife Investment Management 2022 Asia Investment Outlook media briefing last Thursday.

This was echoed by HSBC’s Asean chief economist Joseph Incalcaterra. In response to The Edge’s questions via email, he says Bank Negara does not face any singular overwhelming challenge, with inflation under control and Malaysia having solid external balances.

“[These] allow the economy to remain resilient in the face of Fed tightening. Bank Negara has the luxury to be preemptive in its next move, tightening policy before inflation or financial stability concerns become a threat. We expect core inflation to rise towards 2% by the end of the year and forecast that Bank Negara will raise the OPR by 50bps in the second half of the year,” he adds.

In the US, at the Fed’s December meeting, every official expected at least one rate increase and half expected three. It would also reduce US$9 trillion worth of assets as another means to tighten monetary policy.

Its Federal Open Market Committee will meet for the first time this year on Tuesday and Wednesday (Jan 25 and 26). Markets are now starting to consider pricing in more than a 25bps increase at the FOMC’s second meeting in March.

Why is inflation not an issue in Asia, including Malaysia?

Inflationary pressure, while increasing in Asia, is much less muted than in Europe and North America. This can be attributed to the fact that Asia is where most of the manufactured goods originate from, and this means the cost of shipping is much lower.

Malaysia’s trade surplus rebounded 36.2% to RM221.53 billion in the first 11 months of 2021, from RM162.64 billion during the same period in 2020.

Exports of manufactured goods grew 25.3% year-on-year (y-o-y) to RM961.89 billion during the period, aided by growing exports of electrical and electronic products, petroleum products, manufactures of metal, rubber products and chemicals and chemical products.

As Malaysia is part of the manufacturing supply chain across Asia, this led to the country’s headline Consumer Price Index still being manageable. In December 2021, Malaysia’s CPI increased 3.2% y-o-y, which was still within the historical trend.

This compares with the inflation in the US, which increased 7% in December, as a result of the spike in energy prices throughout the year. Petrol prices jumped 49.6% last year in the US while natural gas prices increased 24.1%.

“So, why hasn’t inflation emerged as a concern across Asia in the same way as the rest of the emerging world? That’s partly due to fuel price inflation in Asia being much lower, but also because the region has experienced much less disruption from the pandemic relative to other emerging markets,” says Trinh.

At the same time, the surge in demand for goods that is being experienced in other parts of the world did not manifest as strongly in Asia. This led to consumer price pressures being manageable and within trend.

The fact that Asia is the manufacturing hub of the world also plays out as a favour to many central bankers in the region, as intra-Asia shipping cost did not surge as much as the cost to ship manufactured products from Asia to other parts of the world.

“We are expecting policy normalisation in Asia as a whole and it has started in earnest in the likes of South Korea and Singapore to a degree, but we do expect any kind of normalisation seen in the region to be at a much slower pace and at a lower magnitude relative to previous cycles and other emerging markets,” says Trinh.

What about pressure on the ringgit as the interest rate differential narrows?

While consumer and producer price pressures are not expected to be very high in Asia, including Malaysia, as the Fed increases its key policy rate, there is a concern that funds, especially hot money, will flow out of local assets.

If funds flow out of Malaysian assets in a big way, it would put pressure on the ringgit, and that could become a headache for manufacturers that rely on imported raw materials and unfinished goods. Prices of imported consumer products too could be more expensive if the ringgit weakens as a result of the outflow.

However, according to MIDF Amanah Investment Bank Bhd head of research Imran Yusof, while the interest rate differential will narrow and may lead to a weaker ringgit, it is just one factor out of many that influence the movement of the ringgit.

“The high commodity prices may help support the ringgit and our expected economic growth as well. In fact, in the early part of this year, we saw an inflow of funds despite the Fed’s announcement of a more aggressive timetable [of a reduction in asset purchases and normalisation of funds rate],” he tells The Edge.

The narrowing interest rate differential between Bank Negara and the Fed may not be the main reason for the weakening ringgit and outflow. This can be seen empirically as the ringgit strengthened when the US central bank raised its key policy rate between 2016 and 2018.

Between Dec 15, 2016, and June 14, 2018, the Fed raised its funds rate by a total of 100bps to 1.75%. During this period, the ringgit strengthened 10.5% to 3.995 against the US dollar. The interest rate differential between Bank Negara and the Fed narrowed to 150bps from 225bps.

“Looking at the policy formulation by Bank Negara, we do not expect the FOMC’s decision to hike rates will be a major determinant that will directly influence the Malaysian central bank to raise the OPR. We believe the consideration for monetary policy decisions will take into account a series of indicators to gauge and assess the situation in Malaysia’s economy and overall stability in the domestic financial system,” says Imran.

He adds that Bank Negara may act by containing strong underlying price pressures from recovery in demand and cushioning any destabilising effects from changes in the global financial markets such as large fund outflows. These policy interventions, however, will not necessarily require changing the OPR, he points out.

Imran suggests that there is a higher probability that the Malaysian equity market will see a net inflow from foreign funds, premised on an improving economic outlook and strong commodity prices.

“In fact, we have seen a net inflow of RM265.7 million year to date, as at Jan 17. In addition, out of 11 trading days, only three days registered as net outflow. This was after the Fed announced earlier tapering and rate hikes,” he says.

Apart from the narrowing interest rate differential, economists believe there are other factors at play that would compel Bank Negara to keep its monetary policy accommodative to growth.

OCBC Bank economist Wellian Wiranto tells The Edge that the resurgence of Covid-19 infections last year dented the country’s growth momentum considerably. And although there are now budding signs of recovery, it remains under threat, not least from a potential spike in Covid-19 cases.

“The flood situation at the turn of the year served as a reminder of unexpected challenges that might pop up to threaten the recovery. On top of that, the fact that the structural issue of high household debt has been worsened by the pandemic will be a consideration too,” says Wellian in an email.

In the Ministry of Finance’s Economic Outlook 2022 report released in late October last year, the household debt-to-GDP ratio had increased to 89.6% at end-June 2021 from 87.5% as at end-June 2020.

Recall that due to the pandemic, RM101 billion worth of retirement funds have been withdrawn by Malaysians to support their livelihoods, as a result of the economy shutting down several times. The quantum of withdrawals shows that many Malaysians have been in a dire situation economically over the past two years.

Now that the economy is recovering, while there are pressures in terms of prices and the possibility of a weaker ringgit, Bank Negara and other policymakers will have to take into account every aspect before deciding on the monetary and fiscal policy.


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