Don’t give in to calls for higher interest rates

 

From Paolo Casadio and Geoffrey Williams

As central banks around the world increase official interest rates in the face of higher inflation, there is a growing chorus of noise from many sources calling for Bank Negara Malaysia to follow suit and raise its overnight policy rate, too. This would be an utter disaster.

There is no inflation in Malaysia. The increase in the consumer price index has been due to price rises in specific components, oil, food and utilities for non-residential business users. There is no general rise in prices, which is how we define inflation.

In fact, the inflation rate measured by the CPI rose to 4.7% in April 2021 due to higher oil prices and fell to 3.2% by December then 2.3% in January 2022 and 2.2% in February and March. In other words, the rate of headline inflation is falling, not rising. Inflation, excluding oil and core inflation, was around 2% in March, so both are also at modest and manageable levels.

An increase in interest rates is only appropriate when there is a general rise in prices. The price of oil, chicken or utilities will not fall because the cost of borrowing rises. Ironically in the current circumstances, the rate of inflation could rise if interest rates rise, especially if companies pass on higher financing costs to consumers.

There is no rebound in growth. Based on recent data, we do not see a clear pattern in private consumption and investment which would be consistent with a positive transition of the economy toward a systematic and sustained recovery.

The current phase of recovery is in a delicate transition and there are still many weaknesses and a risk of a new recessionary phase, although we forecast the risk of recession at only around 25%.

Disposable income and wealth among households are not recovering quickly, due to weak real wages growth, a slow increase in employment and continuing withdrawals of EPF funds to finance current expenditure even among the middle-income population.

In our base scenario we forecast that GDP in the first quarter of 2022 may contract by 1.5% quarter-on-quarter and contract 0.7% year-on-year. The expected contraction in the quarterly figures is likely to be from the huge quarterly growth of 6.6% in the fourth quarter of 2021. The low quality of this growth mainly reflects government spending and EPF withdrawals.

The increasingly negative outlook for global economic growth and trade will also hold back the contribution of net external demand. Among the factors are the conflict in Ukraine, high oil prices, the effects of the zero-Covid lockdowns in China and now the anti-inflation austerity policies in Europe and the United States.

Based on recent economic data from overseas, Malaysia’s main export markets will be weaker not stronger compared to the start of the year. Global central banks are already addressing their inflation problem. Raising Malaysian interest rates will not have any effect on these efforts.

In the domestic economy, consumer debt has increased during the lockdown period of 2020 and 2021 due to higher borrowing and multiple loan moratoria. Not only do consumers have more debt but if interest rates rise they will be paying more, sometimes much more, for the debt they have accumulated.

This borders on usury which is morally repugnant as well as economically and socially damaging.

For consumers, higher interest rates will increase the cost of borrowing on already high debts and the cost of living will increase, reducing consumer purchasing power and holding back consumer demand which is barely recovering already.

Similarly, corporate debt increased during the lockdown periods as businesses, short of revenue from closed shops, raised more debt and leveraged their cash flow to pay bills and wages. BNM has warned in its latest annual report that there is a concerning rise in corporate debt. Private investment has contracted in the last two quarters, a sign of weakness in the business environment.

The need for stability

Raising interest rates will increase company financing costs which will, at best, reduce their profits or be passed on to consumers through higher prices. In the worst case it could cause an increase in zombie companies, who can pay the interest but not pay-down the debt itself.

It could even lead to a rise in non-performing loans or defaults which would affect the overall risk profile of the financial sector.

There is also a technical issue on monetary policy credibility. The role of BNM is to promote monetary and financial stability aimed at providing a conducive environment for sustainable growth.

BNM’s monetary policy stance is to maintain price stability while remaining supportive of growth and financial system stability. Under the current conditions, Malaysia has price stability which is supporting growth and maintaining the stability of the financial system. BNM is therefore fully in line with its mandate.

To raise interest rates when there are no inflationary pressures and only tentative growth coupled with a heavily burdened consumer and corporate debt market could damage its hard-earned reputation for credible, effective monetary policy.

Faced with these risks, BNM should resist the siren voices of those calling for higher interest rates and like Ulysses tie itself to the mast and maintain the course of accommodative interest rate policies.

The government should assist BNM with supportive fiscal policy, price controls and subsidies to cushion the blow of rising prices on specific products. The government should also reverse the utilities hike on non-residential users in the business sector to allow them to reduce costs to customers.

Now is not the time for higher interest rates when Malaysia is at the start of its recovery compared to Western economies which are at a turning point. Instead, we need stable short-term policies and for the long-term, we need to begin a national debate on structural reforms post-Covid-19 to rebuild the foundations of growth and development in Malaysia for the next decade. - FMT

Paolo Casadio and Geoffrey Williams are economists with Help University and Malaysia University of Science and Technology respectively.

The views expressed are those of the writers and do not necessarily reflect those of MMKtT.