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Economics: Malaysia
Economics – Markets – Strategy
Bank Negara to
hike the policy rate
50bps in 3Q08, to
4.0%
Policy action needed
Higher inflation will push real interest rates towards negative territory, if they
are not already there (Chart 3). Adjusted for inflation, real deposit rates were at
-1.63% in Apr08. Real policy rates and lending rates will most likely fall further
if inflation spikes to 5.8% in June on the fuel price hike. A negative real interest
rate scenario favours borrowers, and risks fuelling asset inflation. As general
prices rise, so could inflation expectations, resulting in even higher inflation
going forward. For example, if workers demand higher wages in anticipation
of further price increases, it will inevitably set off a second round of price increase.
Thus, policy action is needed now to anchor inflation expectations, and to prevent
second-round inflationary effects. We expect Bank Negara to hike the policy
rate by 50bps at the next policy meeting in July (Chart 2), taking the Overnight
Policy Rate to 4%. In fact, while no policy meeting is planned for June, we do
not discount the possibility of an inter-meeting hike. In addition, while the
inflationary effects of the fuel price hikes are expected to be transient and will
likely wear off after 12 months, the government has hinted that this may just
be the first of a string of subsidy cuts. Overall, inflationary pressure will remain
high amid risks of higher global commodity prices and further hikes in subsidized
fuel prices. The central bank sounded hawkish in its most recent policy statement,
and we believe the rhetoric will remain so in the next few quarters given the
outlook on inflation.
Chart 3: Real interest rates heading south
%, % pa
6
5
4
Real policy rate
Real deposit rate
Real lending rate
3
2
1
0
-1
-2
-3
-4
Latest: Apr08
Jan-05 Aug-05 Mar-06 Oct-06 May-07 Dec-07
Chart 4: Growth likely to moderate
%-pt contribution
20
15
10
5
0
-5
-10
Net exports
Investment
Govt expenditure
Pvt consumption
GDP growth
Latest: 1Q08
Mar-05 Mar-06 Mar-07 Mar-08
Growth will be affected
The impact on growth will be mixed. Although savings from the subsidies can
be used to stimulate growth, we think that this is more likely to happen in the
longer term than in the near term. In fact, the government has not publicly
explained how the savings from the subsidy cuts will be used. While we assume
that effort will be put into upgrading the existing transport network, work will
probably start at a later stage and benefits will only be reaped in the longer
term.
In the near term, domestic demand will be most affected by the fuel price hike.
In particular, private consumption, which registered robust growth of 11.6%
YoY and contributed 3.6%-pts to overall GDP growth, is expected to moderate
to an average of 7.3% for the full year (Charts 4 and 5). Government expenditure,
which grew by a robust 10.5% YoY in 1Q08 (making a 0.7%-pt contribution to
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