The Malaysian Insight

MALAYSIANS can expect the overnight policy rate (OPR) to increase further in the second quarter of the year if domestic inflation is not suppressed, economists said.

They said the depreciating ringgit, global commodity prices and other uncertainties may likely push the OPR up further.

However, this may have a positive impact on the Malaysian economy.

Phillip Mutual Bhd chief strategist Phua Lee Kerk said the increase of the OPR by 25 basis points to 2% by Bank Negara yesterday is a positive measure in preparation for the economic recovery in the second half of the year.

While the announcement by Bank Negara was long overdue, many believe that the central bank would increase the OPR in June.

“In any case, we see the hike as a positive sign to help the economy recover in the second half of the year,” Phua told The Malaysian Insight.

He added that another OPR hike cannot be ruled out in the second quarter to help economic recovery.

Phua said the main reason for the OPR hike was because of the US Federal Reserve’s interest hike to curb inflationary pressure.

The US interest hike was due to soaring commodity prices, the Russian-Ukrainian war as well as the weak market.

The Fed’s benchmark interest rate was raised by 0.5 percentage points to a target rate range of between 0.75% and 1%. The hike is the largest since 2000 and follows a 0.25 percentage point increase in March, the first increase since December 2018.

Following the Fed’s interest rate hike, Phua said if Malaysia did not follow suit, funds will flow to other countries with higher interest rates while countries that rely on imports will be badly affected.

“When the currency depreciates, the price of imported goods will soar and the inflationary pressure will increase. If the people’s income does not increase, the economic capacity will be relatively reduced, meaning the country’s economy will slow down or shrink.”

Given that Malaysia is an oil producing country and one of the largest exporters of palm oil, he said this will have a positive impact due to the high prices of the commodity, which is further pushed up due to high cost of fertilisers in the case of palm oil.

However, since Malaysia also imports some of its oil, there is still some inflationary pressure, Phua said.

“The government has been subsidising fuel prices but given the high prices of raw materials, everyone is feeling the pinch.

“If the people’s wages do not increase when the price of food goes up, it will affect consumption and the economy. We will also see other commodities, such as real estate prices increasing further.”

The ongoing war between Russia and Ukraine poses many uncertainties to the market, Phua said.

“We initially predicted that once Covid-19 was brought under control, the borders would reopen and domestic demand will be strong.

“We saw this during the Hari Raya period and it may extend until the end of the year. But because of the war, it is hard to predict how the economy will perform in the second half of the year.”

Phua suggested that Putrajaya consider a national tax exemption in the run up to the 15th general election to avoid an economic downturn.

“If we want to avoid an economic downturn, companies that raise their employees’ wages by 10% to 20% should get additional tax deductions.

“This will assist people to increase their income while rewarding businesses with tax exemptions which will support economic recovery.”

Second OPR hike

Wong Chin Yoong, a professor of economics in University Abdul Rahman (Utar) said Malaysia can expect BNM to raise the OPR again in the second quarter.

He said the sliding ringgit is not caused by domestic inflation, but rather the war and also China’s Covid-19 lockdown which is pushing up prices of commodities.

Wong was against raising the OPR now. Instead, he believes it should have only been raised when the devaluation of the ringgit caused severe domestic problems.

Wong said the 2.2% inflation rate in March showed that it was going down.

Malaysia’s current situation is a departure from the interest rate adjustment to support the ringgit that was implemented in the 1990s.

Wong suggested that it would be more effective for the country to follow the example of 2017, when the cycle of interest rate rises in the US began to cause the ringgit to depreciate, by asking exporters to repatriate 70% of their foreign currency.

Since the BNM estimate for inflation this year is between 2% and 3%, and if the 2.5% mid-point is extrapolated, a 25 basis point rate rise is 20%, Wong said.

“If we predict that the Central Bank’s aim in raising interest rates is to bring them back to a neutral level, then with a 2% overnight policy rate (OPR) and a 25% mid-point inflation comparison, there are likely to be two rate rises.

“To return to the 2.5% level, another 25 basis points are estimated to be needed in the second half of the year.”

The Consumer Price Index showed that the index rose by 2.2% to 125.2 in February compared to 122.5 for the same period last year.

This was mainly due to increase in food prices and an inflation rate of 1.9% between 2011 and February 2022.

Ease fiscal deficits

Lee Heng Guie, the executive director of the Socio Economic Research Centre, said the US interest rates happened due to multitude of shocks from the persistent supply disruptions, inflation pressures, and weak local currencies due to the Russia-Ukraine war.

He said higher interest rates stemming from a hawkish Fed policy or inflationary pressures are much more disruptive.

While the hike will push up the US dollar, Lee said it would make it difficult for emerging markets in terms of borrowings, capital flow and exchange rates.

Lee said there will be an increase in the real value of emerging debts and costs to service debts in the local currency.

“Higher interest rates and tighter liquidity limits will make it costly for governments and companies to borrow or refinance debts under sustainable conditions,” he said.

Higher interest rates in the US could also lead to capital moving away from emerging markets and into the US Treasury securities due to higher investment returns, Lee said.

“In terms of the exchange rate, the higher interest rates will typically support the US dollar by making US-denominated assets more attractive to yield-seeking investors.”

Lee said BNM’s decision to use its international reserves to mitigate the significant withdrawal of foreign currency liquidity and prevent excessive ringgit exchange rate fluctuations would harm the Malaysian economy and businesses.

“The central bank’s international reserves of RM496.2 billion as of April 15 will be able to cover six months of the imports of goods and services and are 1.2 times the total short-term external debt.

“The government should move to alleviate the structural fiscal deficit and reduce debts and liabilities to rebuild a fiscal buffer against future shocks,” he said. – May 13, 2022.