Interest rates hike inevitable, says economist ….(Worst yet to come)

Yeah Kim Leng, group chief economist of RAM Holdings believes that a hike in interest rates is inevitable and necessary to cool off rising inflation in the country.

Yeah Kim Leng

“I believe Bank Negara Malaysia (BNM) will raise interest rates by 25 basis points to 3.25 per cent in the second half of 2014. I expect inflation to hover between 3%-3.5%,” said Yeah to KiniBiz while predicting that the government would also be forced to increase petrol prices again to reduce subsidies.

According to data from the Statistics Department Malaysia’s annual inflation rate rose to 3.2% in December, the highest in more than two years as the effects of the government’s fuel subsidy cut ripples through the economy.

“In the long term we need to increase interest rates. That should help rebalance things. Our economy has been fuelled by cheap money for far too long,” said Yeah.

On the other hand, RAM’s chief economist doesn’t expect the recent US tapering of its quantitative easing (QE) monetary policy to have any significant impact on the Malaysian economy. Last December, the US announced that it was cutting down on its bond-buying by US$10 billion a month. That has since caused panic especially in the emerging markets that have been relying heavily on foreign funds.

“The tapering in the US won’t affect our economy so much. After the signal (by the US) last year to taper its QE, investors have priced in the tapering because of the forward guidance and the gradual pace of tapering off. Investors nowadays are also able to differentiate between the different countries in emerging markets and not lump them all together. For example, they can separate the stronger Asian countries from the fragile ones. Even so, some of these countries such as Thailand are troubled by political turmoil, not weak economic fundamentals,” said Yeah.

He also feels that although the tapering could cause capital outflows, Malaysia’s fundamentals should remain strong enough to withstand withdrawals of foreign funds.

“Capital outflows will happen naturally as a result of the tapering but as foreign investors check out, big local institutions such as the EPF (Employees Provident Fund) would also move in quickly to snap up cheaper assets. As long as we have active institutional investors, we should be able to offset any sharp capital correction,” said Yeah.

However, Yeah is more concerned about how the expected interest rates hike could impact the property market and the issue of affordable housing.

“What we’re hoping for is a gradual easing of property prices. We have seen double-digit price increases in recent years that are simply not sustainable. We need income levels to catch up with all the hikes in property prices,” said Yeah.

He also adds that currently 55% of the total number of households in Malaysia earn between RM4,000-RM5,000 and could only afford to buy houses at a maximum estimated price of RM360,000.

Household debts could also be a major problem due to an interest rates hike.

“Skyrocketing house prices have resulted in households maximising their borrowings to finance home purchases. When you borrow to the limit, you’re always exposed to any sharp rise in interest rates. The income groups that are most vulnerable are the lower and middle class.

Asset value will be affected if there are price corrections in the property market. The fear is of knock-on effects on NPL (non-performing loans) because borrowers who simply can’t afford to pay will just walk away from servicing their loans. This is what triggered the sub-prime crisis in the US,” said Yeah.