KUALA LUMPUR (March 24): Malaysia may face heightened and recurring supply shocks going forward, the central bank warned, but argued that any monetary policy response is only needed if the risks worsen or intensify.

Supply shocks — disruptions that raises production costs or constrain output — are likely to increase in scale, frequency, and persistence from geopolitical tensions, deglobalisation, demographic shifts, and climate change, among others, Bank Negara Malaysia (BNM) flagged in its 2024 Economic and Monetary Review released on Monday.

“Monetary policy cannot work in isolation from other policies, particularly in responding to policy-induced supply shocks,” BNM said. “Close coordination between fiscal and monetary policies is crucial for a more coherent and effective response.”

Fiscal measures, such as cash transfers, can help ease the financial burden on the most affected households, though it is important to ensure the aid “is not overly generous and is carefully targeted” to limit undue pressures on demand, the central bank said.

BNM’s framework outlined in the report sheds more light on how it assesses and manages supply shocks. The framework comes at a time when the government is poised to rationalise subsidies on the widely used RON95 petrol by the middle of this year.

The central bank has largely shrugged off some of the past supply shocks as one-off events whose impact on inflation and growth would be immaterial or fade away with time, such as sharp spike in domestic energy prices during fuel subsidy rationalisation in 2008. 

In that particular instance, BNM judged that the spike in fuel prices, shortly before the onset of the Global Financial Crisis, would be temporary and self-correcting as the sharp increase in domestic energy prices as well as the unfolding global crisis would significantly dampen demand and ease underlying inflationary pressures in the medium term.

A higher overnight policy rate is only necessary to prevent the initial inflation impulse from supply shocks becoming entrenched, BNM said. Left unchecked, second-round effects could emerge, especially if amplified by strong demand, leading to more persistent and pervasive inflation, it noted.

“Even in the absence of second-round effects, salient price shocks can destabilise inflation expectations”, and attempts by firms passing on costs to their customers could amplify the initial pressures, BNM said.

A policy response then becomes necessary to anchor expectations and prevent inflation from becoming more persistent and widespread, the central bank said.

Click here to read more stories on BNM Annual Report 2024.