By P. Gunasegaram
Tomorrow Bank Negara Malaysia’s committee meets again to decide whether or not to raise interest rates. Tiger thinks the last interest rate rise in July was unwarranted and therefore surmises the interest rate should be left well alone this time around.
Most analysts this time around feel interest rates should be left where they are, which is quite a bit higher than most other countries around the world. And it looks like that’s what central bank, Bank Negara Malaysia, will do.
As this Tiger said ahead of the last rise in the benchmark overnight policy rate (OPR) by 0.25 percentage points or 25 basis points to 3.25% in July, Bank Negara was perhaps a tad too early in hiking the interest rates.
This has been borne out in the interest rate movements since July when not one of the countries surveyed raised their key interest rate in the last two months (see chart). While most kept their interest rates unchanged, two actually lowered them, Singapore by four basis points and Europe by 10 basis points.
By far and away, Malaysia’s interest rates are still the highest at 3.25% while the next closest, Australia, has an interest rate 100 basis points lower at just 2.5%. The European Union, Japan and the US have hardly any interest rate at all at 0.25% for the US, 0.1% for Japan and 0.05% for Europe. That’s nearly the whole world.
What does that mean in practical terms? Simply that most of the world simply does not think that the time has come to raise interest rates because economic recovery has not been particularly strong.
Yes, we have heard the other arguments — that soon the US will stop monetary easing and funds will flow back to the US as interest rates rise. But really, we have a 300 basis points difference already with US interest rates. What more do we need?
Bank Negara is at least two months early in raising interest rates and there definitely is no reason to try and anticipate further increases in interest rates when the earlier anticipated ones are yet to materialise.
Thus, Tiger surmises, Bank Negara is not likely to raise interest rates until there is a firm sign that world interest rates are going up first. The most likely scenario is that the central bank will leave interest rates unchanged tomorrow as it is hardly likely to lower interest rates after having raised it two months ago.
If you take another look at the chart, Malaysia’s real interest rate, after taking out inflation is negative but it is the least negative of all the countries surveyed. So even after taking into account inflation, Malaysia’s interest rate is the highest.
In economic terms, there are two main reasons for raising interest rates. The first is to provide a real rate of return to savers so as to ensure liquidity within the country. The second is to dampen economic activity if it is being fuelled by rampant demand.
Let’s look at how valid the first reason is in Malaysia’s context. Yes, savers have a negative rate of return now but these are difficult circumstances with the world suffering from the lingering effects of the world financial crisis and the Eurozone crisis. Even if our savers took the money out, no one else pays better rates for the same amount of risk.
One can argue that much of excess liquidity therefore goes into other assets instead of savings such as property. But really that is better addressed by sector specific measures such as doing away with 5/95 system which encourages rampant speculation by requiring just a 5% down payment and nothing else for two to three years.
That’s actually the right way to check property speculation together with other measures such as higher down payments for second house purchases. That ensures more stringent loan conditions for property, where there may be excessive speculation, while keeping credit flowing to productive sectors of the economy.
Let’s look at the second reason now. A broad-based interest rate increase is something that has a tendency to slow the entire economy down and should only be used when there are signs of economic overheating stoked by rampant demand caused by excessive money in the system. That’s surely not the case now.
Meantime, the central bank must surely be aware that large differences in domestic interest rates compared to those of the US will attract large amounts of hot money to flow in to take advantage of abnormally high rates of return here. In fact that’s already been happening – for years.
The gradual normalisation of US interest rates should be taken as an opportunity to gradually reduce these interest rate differentials to bring about a more orderly funds flow in and out of our markets.
As the world stabilises so must we move towards stability in our markets and do away with artificially high differentials which encouraged the inflow of hot money.
GRRRRR!!!
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