Interest & the Beast


Economic News

22 Jul 2010
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Stories of a giant, hairy ape-like creature roaming the southern state of Johor are perhaps not the only thing that is being inflated in Malaysia these days. Inflation has shown up elsewhere too - but its presence is not a cause for concern, according to Bank Negara Malaysian (BNM) Governor Zeti Akhtar Aziz.

"Our tool for managing inflation is the interest rate and that will reflect the underlying fundamentals," she told OBG recently. "Whilst inflation has risen above 3%, which we consider high, we will monitor the situation and make an assessment of the inflation outlook. That will determine the interest rate policy."

It was early in the second quarter of 2005 that inflation turned upwards, largely as a result of a cost-push from higher oil prices. Although Malaysia is an oil-producing nation, it exports sweet crude and imports sour for refining, leaving net exports at around 5% of production, by some estimates, and increasing exposure to higher prices.

Growth also slowed from 5.8% in the first quarter to 4.4% in the second - a cause for caution at the BNM when deciding on a course of action. Acting too soon with interest rates could have had negative effects on growth and expectations.

Yet growth turned back onto an upward trajectory in the third quarter, sustained by a recovery in consumer demand and an up tick in the electronics and electrical goods market - largely driven by US consumers. With the growth outlook stable in November, the decision came to raise interest rates for the first time since 1998.

The expectation is that inflationary pressure will dissipate over this year, but Zeti assures that the BNM will monitor the situation and may raise interest rates if necessary.

"Unlike what is happening in the US, this does not represent a series of interest rate increases," she told OBG.

Even though inflationary pressure may be reduced over the year, analysts expect rates to increase through 2006. Not least among the factors is a negative interest rate differential, which has meant low deposit rates and driven high liquidity levels.

"Eventually, deposit rates will at least match inflation," explained Baljeet Kaur Grewal, chief economist at Aseambankers, when speaking to OBG recently. "Even then, Malaysia will have some of the lowest interest rates in the region."

Expectations vary between analysts, but most agree on an increase of between 50 and 70 basis points over the year. Intuitively the effect of increasing the cost of borrowing money should stem the demand for loans, a possible concern, as it may choke growth.

A further concern in Malaysia had been the numbers of non-performing loans (NPLs) on the books of local commercial banks. Years of very low interest rates had allowed many Malaysians to take mortgages and invest in the property market, driving property prices up. In 2005, the alarm was raised that there were still concerns over loans dating back to the 1997 financial crisis.

The estimated RM46bn ($12.3bn) in gross NPLs has by all accounts been more of a drag on earnings and new credit than a serious threat to bank stability. However, recent moves from Bank Negara have seen the NPLs become saleable to locally incorporated foreign entities as well as domestic banks.

Analysts expect that as much as 30% of NPLs could be sold in this way over the next two years, mostly to foreign investors. The impact of such a move will likely be the ability to extend fresh credit from the locals, possibly mitigating the effects of increasing interest rates.

Nonetheless, concerns endure, in particularly with regard to Malaysia's currency, which was taken off a dollar peg in June 2005. If interest rates increase, then demand for the ringgit could increase and drive demand for the currency, putting upward pressure on its value and harming exports.

Zeti claims the bank does not defend any particular level or value-band for the currency. She adds that the exchange rate would be managed to prevent excessive volatility in the face of capital inflows.

January saw the ringgit reach its highest level since the de-peg, which set off concerns that the currency was on an upward trend. But it has since fallen, with many attributing the brief rise to outflows of "hot money" which had been lingering since the de-pegging. Reserves dipped commensurately over the same period.

Many agree, and others hope, that the central bank will strive to accommodate exporters since Malaysia is largely an export-focused economy. While the belief that the currency is undervalued by as much a 6% endures in some quarters, most accept that the currency is not going to reach that level any time soon.

Stability is the name of the game for the BNM. While inflation may affect some, the BNM will have to strive to see inflation does not effect growth over 2006.

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