Malaysia: Reserve hike on the cards?

Malaysia’s central bank is considering raising the statutory reserve requirement (SRR) to slow the influx of hot money into the economy, but some in the sector fear that the move could impact loan activity and result in economic slowdown.

On January 27, Bank Negara Malaysia’s Monetary Policy Committee announced it was leaving its key overnight policy rate (OPR) unchanged at 2.75%, a level the committee said was accommodative and supportive of economic growth and appropriate given the medium-term inflation prospects.

That said, the bank did warn that there were still risks to stability, most significantly from large and volatile shifts in global monetary flows that were leading to a building up of liquidity in the domestic financial system.

Bank Negara Malaysia said it could take steps other than raising interest rates to stem the shifting tides of liquidity and reduce the flow of hot money into the economy should levels rise further.

“While the liquidity in the financial system has been manageable, going forward, additional policy tools such as statutory reserve requirement and macro-prudential lending measures may be considered to avoid the risks of macroeconomic and financial imbalances,” the bank said in a statement issued to announce its rates decision.

The central bank’s SRR is the amount of money that all Malaysia’s commercial, merchant, investment and Islamic banks must set aside and lodge with Bank Negara Malaysia. Currently, it has been set at 1% of a bank’s eligible liabilities, meaning its deposits and non-deposit liabilities, net of interbank assets and placements with the central bank.

Bank Negara Malaysia uses the SRR to manage liquidity in the market, lowering the percentage that has to be set aside when it deems the economy in need of stimulus and an increase in credit, and raising it when it feels there is too much excess liquidity. Since December 2008, when it stood at 4%, Bank Negara Malaysia has implemented a series of reductions, with the current 1% rate introduced in March 2009.

The policy of freeing up funding to prime the economic pump has been seen as successful, with GDP having expanded by an estimated 6.8% last year and bank lending increasing by 12.8% year-on-year. Loans to businesses were also up by 14.1% and retail lending rose by 11.5%. However, with the property market booming, funds flowing into the capital markets and inflation edging up to a 19-month high of 2.2% in December 2010, Bank Negara Malaysia may well move to tighten the taps.

According to a statement issued by Maybank Investment Bank on January 28, the central bank’s latest monetary policy announcement continued to highlight the risk to macroeconomic and financial stability from international market volatility amid increased global liquidity and hence short-term capital flows into the local economy. This would increase the chances of the Monetary Policy Committee raising the SRR at its next meeting in mid-March by at least 100 basis points, Maybank said.

A 1% increase in the SRR rate could drain some $1.3bn from the banking system, just a fraction of the funds available to the sector for lending purposes. Though only a relatively small amount, an increase in the SRR rate would send a message to the financial sector and could cool the hot money flow.

The direct impact of any such rate hike on domestic lending has divided analysts, with some fearing it could prompt a more conservative approach by banks, thus reducing GDP growth.

According to Bernard Ching, head analyst at ECM Libra Capital, loan activity could be affected if the central bank intervenes, as well as by a forecast slowing of the property market late in the year.

“Loans growth will also be dampened by the impending statutory reserve requirement hike and imposition of macro-prudential lending measures as guided by Bank Negara Malaysia in its latest monetary policy statement on January 27,” Ching told the Borneo Post on February 1.

Others are more optimistic, with Hwang-DBS Research predicting that loan levels will grow by 13% this year, slightly better than the 2010 performance, with economic expansion and high-impact projects generating a multiplier effect that will spur consumer and business spending, with this backed by bank lending.

Of course, there is no guarantee that the central bank will use the SRR as a means to limit the flow of liquidity, and indeed it is possible that it may leave all of its options on the table for now given the potential of another economic slowdown due to a weakened recovery in Europe and the US. Though many analysts are tipping some move by Bank Negara Malaysia in the coming months, either an interest rates rise or an increase in the SRR, whatever action the bank does take, it will be driven by considerations both at home and in broader international markets.

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