KUALA LUMPUR: Bank Negara Malaysia (BNM) yesterday raised the key interest rate by 25 basis points (bps) to 2.25% after keeping it at 2% for seven consecutive monetary policy committee (MPC) meetings since April 2009.

This makes Malaysia the second Asian country, after Vietnam, to raise lending rates. BNM’s decision came just hours after Indonesia maintained its already high benchmark lending rate at 6.5%.

In a statement, BNM said a significant improvement in the domestic economy and a moderate rise in inflation amid an improving global landscape had prompted the hike in the overnight policy rate (OPR). This is the first time in almost four years that the rate has been increased.

The central bank said the OPR was reduced to historic lows in early 2009 as a key measure to avert a severe and fundamental economic downturn. However, these conditions no longer prevailed.

“Given the better economic outlook, the MPC decided to adjust the OPR towards normalising monetary conditions and preventing the risk of financial imbalances that could undermine the economic recovery process.

“At the new level of the OPR, the stance of monetary policy continues to remain accommodative and supportive of economic growth,” BNM said.

In line with the rate hike, the floor and ceiling rates of the OPR were correspondingly raised to 2% and 2.5%, respectively.

According to BNM, the recovery in the global economy is progressing against the backdrop of continued policy support and improvements in financial conditions. The central bank said advanced economies had improved although the growth rate was expected to remain modest.

“Emerging economies, however, are recording a stronger recovery. In particular, regional economies expanded strongly in the fourth quarter of 2009 and the growth momentum is expected to be sustained.

“In the domestic economy, the stronger growth performance in the fourth quarter of 2009 affirms that the economic recovery is firmly established. Going forward, growth is expected to strengthen further, supported by domestic demand and continued improvement in external demand, particularly from the regional economies,” the statement said.

The central bank expects Malaysia’s inflation to remain moderate this year despite rising global commodity and  food prices. Prices are expected to gradually increase during the year, reflecting prevailing economic conditions and taking into account possible adjustments in administered prices.
Capital outflow concerns

Economists said the decision to raise the OPR could be prompted by the need to stem the outflow of capital from the country.

“If policymakers are concerned about growth, they would not have raised interest rates,” Kenanga Investment Bank Bhd economist Wan Suhaimie Saidie told The Edge Financial Daily over the phone yesterday.

Ahead of the BNM announcement, the ringgit was already trading at its firmest in a month versus the US dollar at 3.3715 as at 4.59pm. The ringgit had earlier strengthened to 3.3640 in the morning.

TA Securities Holdings Bhd economist Patricia Oh said the ringgit was expected to strengthen to 3.25 this year, assuming that Malaysia’s trade with the US remained sizeable.

“Ringgit strengthened despite the rising inflation,” Oh wrote in a note ahead of the release of BNM’s monetary policy statement.

Investors usually park their money in countries with higher interest rates to generate better returns for their funds. They pick a country deemed to have positive long-term fundamentals, but foreign funds can also come in due to the potential of quick gains which denote speculative elements in the local  market.

For example, anticipation that the ringgit will strengthen will spur overseas investors to acquire local assets such as stocks and bonds, hence the appreciation of the ringgit due to demand for the currency.

This essentially translates into a potential double gain for foreign investors when they sell their assets as they will be able to reap both the currency exchange gains, and capital appreciation of their assets.


Rates to rise 100bps this year?
HSBC’s senior Asian economist Robert Prior-Wandesforde foresees a 100bps rate hike in Malaysia this year.

In a note, he said BNM’s move to raise the OPR by 25bps “was sensible” considering that the economy had bounced back sharply.

Although there is no immediate underlying inflation problem in Malaysia and across Asia, the economist said central banks in the region should take into account the long lags with which monetary policy worked.

“The Asian economies can’t continue to grow at anything like current rates without price pressures intensifying,” Prior-Wandesforde wrote.

At an OPR of 2.25% and in anticipation of the Malaysian economy expanding at an annual pace of at least 11% in the first quarter, he said it was hard to argue that Malaysian interest rates had been normalised.

Considering that BNM had slashed the OPR by 150bps during the economic downturn, he believes that a 3.5% OPR would be regarded as a normal monetary stance for the country.

“Overall, we expect BNM to lift the OPR by another 75bps this year, but the risks to this are probably slightly on the upside,” he said.

Maybank Investment Bank Bhd chief economist Suhaimi Ilias has a similar view, saying that a 25bps hike was not enough to normalise monetary conditions, considering the 150bps reduction  earlier.

“Normalisation of monetary conditions would require a hike of at least 50-75bps,” Suhaimi said. A total of 18 out of 29 economists polled by Bloomberg earlier had expected the central bank, at yesterday’s meeting, to raise the OPR by 25bps or request financial institutions to earmark more money as reserves.

A Reuters poll last week showed nine out of 12 economists expecting a 25bps rate hike by May this year, with four saying it would come yesterday.

At its first MPC meeting for the year in January, BNM had maintained the OPR at a record low of  2% for the seventh consecutive time.

The central bank had slashed the OPR by a total of 150bps since November 2008. Prior to that, it had kept the OPR steady at 3.5% since May 2006.

The statutory reserve requirement (SRR), the reserve capital financial institutions place with the central bank, was reduced from 2% to 1% in February 2009. A reduction in the SRR means banks have more money in hand to lend.

In November 2008, BNM reduced the SRR to 3.5% after maintaining it at 4% for 10 years since 1998, subsequently trimming it to 2% in January 2009.


Malaysia’s economic rebound
The Malaysian economy rebounded from a recession in the  fourth quarter of  2009, expanding by an annual rate of 4.5% following three consecutive quarters of contraction.

The fourth-quarter GDP numbers translated into a full-year GDP contraction of 1.7% in 2009. In quarterly terms, fourth-quarter numbers expanded 2.2% from the preceding third quarter. Policymakers are targeting a GDP growth of 5%-6% for 2010.

The country’s GDP contracted by an annual rate of 1.2% in 3Q of 2009 although the economy grew 5.7% in quarterly terms.

In 2Q, GDP contracted by 3.9% year-on-year (y-o-y) but registered a 4.8% expansion quarter-on-quarter (q-o-q), while 1Q GDP declined 6.2% y-o-y and shrank 7.7% q-o-q. The economy expanded by 4.6% in 2008.

The country’s inflation rose by an annual quantum of 1.3% in January 2010, mainly due to costlier food and non-alcoholic beverages, besides more expensive housing, water, power and fuel. Transport cost also increased during the period.

The CPI turned positive after rising by an annual pace of 1.1% in December last year, the first time following six consecutive months of negative consumer price numbers. Full-year inflation rate grew 0.6% in 2009.


Tightening measures in region
Policymakers in the region, including Vietnam, China and Australia, have begun initiating tighter monetary measures to curb inflation and asset bubbles.

In November 2009, Vietnam raised its benchmark interest rate to 8% from 7%, and reset its currency’s exchange rate which devalued the dong by over 5%.
In January 2010, China policymakers increased the reserve requirement ratio for banks by 0.5%.

Last Tuesday, Australia’s central bank raised the benchmark cash rate by 25bps to 4%, the fourth increase in five policy meetings, with indications of further hikes ahead.

Indonesian policymakers yesterday maintained the key lending rate at 6.5% against a backdrop of lower-than-expected inflation in the country.

Across the globe, the Bank of England yesterday maintained its benchmark interest rate at 0.5% for the 12th consecutive month as the country’s recovery is still deemed weak.

In the US, a still-high unemployment rate and tame inflation are expected to see the key interest rate held near zero for the time being. Policymakers in the world’s largest economy had however raised the rate charged to banks for emergency loans, also known as the discount rate, from 0.5% to 0.75%.


This article appeared in The Edge Financial Daily, March 5, 2010.