Is country’s surprise interest rate hike the right move?
WITH the economy just recovering from the Covid-19 lockdowns, is it the right move for Malaysia to nudge up its interest rate even by just 25 basis points (bps) to 2%?
Those who have been struggling in the past two years would probably feel it is too fast to contend with higher rates. Among the arguments are:
> People talk about ringgit weakness but the ringgit has actually strengthened against the yen, euro, pound and yuan.
> Bank Negara’s inflation forecast was below 3%; why be the first in Asean to raise? Why not let the economy improve further?
> Higher rates are going to affect consumers’ loan monthly repayments on financing with variable rates.
Concerns on domestic and imported inflation, excessive borrowings as well as the need for pre-emptive measures to prepare for future shocks, are some reasons cited by those who support the move to raise rates.
The reality of higher inflation is something that Bank Negara has to face; underlying inflation, as measured by core inflation, is expected to trend higher between 2% to 3% in 2022, due to economic momentum and lingering cost pressures.
Rather than hide behind the tame inflation numbers in March, Bank Negara has decided to be pre-emptive; its decision is aided by the fact that the economy is on a firmer footing with strengthening domestic demand amid sustained export growth, said OCBC Bank (M) Bhd economist Wellian Wiranto in his report.
While the current price inflation is largely due to supply disruptions rather than higher-than-expected demand, the lifting of restrictions will lead to further recovery in demand.
Bank Negara’s earlier-than-expected hike in the overnight policy rate (OPR) may well be justified on this premise and signals its recognition that economic recovery is clearly evident, said Fortress Capital Asset Management Sdn Bhd CEO Thomas Yong.
The surprise hike in the OPR indicates that Bank Negara is responding to recent market developments – the downward pressure on the ringgit and dollar exchange rate; rise in 10-year Malaysian Government Securities (MGS) yields and narrowing of the Mgsunited States Treasury 10-year yield spread.
Rising bond yields indicate expectations of higher inflation and interest rate hikes; when interest rates rise, bond prices fall as investors no longer want the lower fixed rate paid by the bond.
At higher rates, Malaysian bonds are attractive as they currently enjoy high commodity prices, while investors seek safety from heightened risks posed by, among other things, the Russia-ukraine war.
Bond yields of the 10-year US Treasuries and MGS had trended sharply upwards and it was a concern that the narrowing yield differentials may dampen foreign appetite for MGS in the near term, if Malaysian interest rates remained unchanged.
Maybank Investment Bank Bhd has revised its OPR outlook to hikes of 50 bps to 2.25% in 2022 and 75 bps to 3% in 2023.
This is against its previous forecast of plus 25 bps to 2% in the fourth quarter, and plus 100 bps to 3% in 2023. Total OPR hikes in 2022-2023 remain at 125 bps to restore OPR to the immediate pre-covid-19 level of 3% next year.
Over the course of the Covid-19 pandemic, the OPR was reduced by a cumulative 125 bps to a historic low of 1.75%, but the unprecedented conditions that had necessitated such actions have since abated.
Interest rates are expected to be raised in a measured and gradual manner, ensuring that monetary policy remains supportive to growth in an environment of price stability, said Maybank Investment Bank in its report.
Some regard Malaysia as having little choice but to raise rates as it may be already behind the curve in terms of rate hikes.
The ringgit has weakened sharply to RM4.40 to the dollar and this will result in more imported inflation.
Malaysia may be hoping ringgit weakness will give it a shot in the arm via export growth, but if every major economic region is experiencing a recession, who will buy more of our exports?
No matter how much the ringgit weakens, the volume of exports is not going to spike up because of supply chain bottlenecks and also the looming global recession, said former Inter-pacific Securities head of research Pong Teng Siew.
It is a choice between depreciating the ringgit without any gain in exports or raising rates and forcing the economy to slow down.
After a long spell of very low rates, many industries cannot earn their keep if rates merely normalise. While keeping rates low to allow zombie companies (companies that need bailouts in order to operate) to survive seems an attractive idea, they already have little spirit or energy left after fighting rearguard financial fires; they cannot contribute to fresh investments and growth.
It is actually a lose-lose situation when we try to support employment by avoiding layoffs associated with zombie companies, at the expense of savers, added Pong.
Savers would come from households, businesses and institutional investors while deposits can be an asset class that carries lower risks. House, personal and business financing based on variable rates may now carry higher monthly repayments; some banks may extend their financing to ensure that monthly instalments remain the same.
But the latest first quarter gross domestic product growth of 5% and the decline in the unemployment rate from 5.3% in May, 2020, to 4.1% in March, 2022, suggests that rates have to be revised higher.
Otherwise, it could lead to excessive borrowing among households and businesses.
OPR hikes can also be deemed as building further monetary policy space as Bank Negara has to prepare in order to respond to future shocks, said Bank Islam Malaysia Bhd chief economist Dr Mohamed Afzanizam Mohamed Rashid.
Seen in the context of gradual rate normalisation with economic recovery, Bank Negara’s move to raise rates will also help curb inflation.
Acting as a pre-emptive measure, it will give room for Bank Negara to act in case of future shocks, especially with so much talk of a possible global recession.
Hopefully, the pace can be gradual.