Monetary policy is pre-emptive, not premature

 

From Nor Shamsiah Yunus

Monetary policy decisions affect many facets of a nation’s economy. As such, it is often the case that such decisions are closely watched and debated not just by financial markets, but also by the general public.

The lively conversations around the BNM Monetary Policy Committee’s (MPC) decision to raise the overnight policy rate (OPR) by 25 basis points on May 3 exemplify this fact.

Deciding on the OPR isn’t something we take lightly. There are many factors that the MPC considers. Our analysis is based on a broad range of forward-looking data and engagement with various industries and consumers.

In addition to the monetary policy statement itself, we have also put out other explainers (for example, a simplified snapshot of our monetary policy statement, FAQs) on our website and on social media.

In this letter, I hope to provide further context and colour to the MPC’s actions and clarify some points that have been made in the public discourse that we have been observing.

1. “OPR hike will affect economic growth”

BNM’s mandate is to maintain price stability that is conducive to the sustainable growth of the Malaysian economy. In doing so, the bank pursues a monetary policy that serves the interests of the country with this objective in mind.

This means not just considering the immediate impact of our action, but also taking a long-term view of our policy measures, including OPR decisions. All central banks work under the same premise.

The past and recent decisions on the OPR are based on this principle. At every meeting, the MPC walks the policy tightrope carefully – balancing between the risks to economic growth and inflation.

Meeting over the course of two to three days, we examine and discuss a range of indicators and macroeconomic models to assess the health of the economy and inflation.

We also review feedback and observations shared with us from households, businesses and market players, allowing us to get a better understanding of developments and economic conditions on the ground, across all segments of the economy, up and down our country.

It is important that the MPC be prudent and forward-looking. BNM was one of the first central banks in the region to have started normalising interest rates last year, and this can be seen by our inflation rate being lower than the regional average.

We also want growth to continue steadily, and not engineer a slowdown in growth or even a recession to bring down inflation. This is a spectre facing quite a few countries which we want to avoid.

In normalising the OPR, we made sure to do so in a way that works for our economy. Hence, our increases were measured and gradual.

In fact, they were smaller and slower than rate adjustments made around the region in the past year. We even paused twice to assess the cumulative impact of our OPR increases last year. This is because monetary policy actions take time to transmit through the economy, and it was important to observe if there were signs that might suggest an over-tightening of monetary conditions.

The picture that we’ve gleaned at the MPC meeting on May 3 and other recent meetings is this: Our economy continues to show strength.

The 5.6% GDP growth for 1Q 2023 was stronger than the pre-pandemic period. Hiring is also up. We see various indicators highlighting the continued strength in domestic demand: retail spending, passenger car sales, tourist arrivals, and more.

Looking ahead, we expect our growth prospects to remain resilient based on many forward-looking indicators, including loan growth, and insights from businesses across all sectors, such as backlog orders, export orders and business outlook, to name a few.

The MPC looks at a broad suite of indicators to form a view on the outlook for growth and inflation. The MPC has to consider all relevant information, both global and domestic, holistically; it cannot consider data in isolation.

This is crucial for the MPC to make an informed judgment on the state of the economy. The Purchasing Managers’ Index (PMI), along with other indicators, are tracked but individual indicators on their own cannot be the sole basis of determining an appropriate policy stance.

2. “There is no reason to hike after the earlier pause and with inflation moderating”

On inflation, the picture is more nuanced. Indeed, as some have observed, cost pressures have been easing.

Headline inflation was lower, averaging at 3.6% in the first quarter compared to 3.9% for the previous quarter.

Much of this downtrend was driven by lower RON97 prices, which contributed around two-thirds of the decline during the first quarter.

However, despite some moderation, prices are expected to remain elevated compared to what Malaysians are used to. This is because demand remains strong, driven by the economic recovery.

Core inflation, which is a proxy of demand-driven inflation remains high, averaging 3.9% in the first quarter compared to the long-term average of 2.1%.

In sum, from a macroeconomic perspective, economic conditions have even surpassed pre-pandemic levels. So it is only right that macroeconomic policies are recalibrated to reflect this and in general, return to pre-pandemic levels.

It is against this backdrop that the MPC decided that it was the right time to normalise the OPR. While some have claimed that our policy normalisation is “premature”, we aim to be pre-emptive as this is less costly to the economy than waiting until it is too late to act.

It will take much bigger and faster OPR increases to bring inflation down once it has taken root – as we can see in other countries.

There are also the perils of having a “too low for too long” interest rate environment, with damaging effects on the economy. The devastation of the global financial crisis, rooted in the US housing market, is a sobering reminder of this.

In the run-up to the decision in May, a further OPR hike was widely anticipated by financial market observers in line with the bank’s communication of a “gradual and measured” normalisation path, although there were differing views on the precise timing of the increase.

Many expected us to do it in the second half of the year but some noted that it was timely to do so in May to prevent inflation from becoming entrenched, given the resilient economic growth. We are not out of the woods yet and need to be on our guard.

3. “OPR hikes have caused financial hardship for borrowers”

We recognise that some people may be more affected than others by the OPR hikes.

The OPR is by design a blunt tool to deliver price stability. It does not distinguish between those who have loans and those without in its transmission to the economy.

Having said that, any borrowers – B40, or M40, any individual or businesses – who may be facing difficulties servicing their loans can reach out to their banks or its counselling unit (AKPK) to work out an alternative repayment arrangement that works for them.

Help is available for borrowers that need it, and such customised arrangements would benefit both the borrowers and the banks.

That said, over 50% of loans from B40 and vulnerable groups are in fixed-rate instruments. So their monthly repayments from these fixed-rate loans will not be impacted by the OPR increases.

However, if we do not manage excessive price pressures like we are seeing in some other economies, this will affect everyone.

The B40 and vulnerable groups are the ones who will be the most affected if we let inflation get out of hand, and we will not be able to preserve sustainable growth over the longer term. We cannot and must not let that happen.

4. “OPR has not helped the ringgit”

The value of the ringgit against other currencies is determined by the market. It reflects ongoing developments, domestically and abroad. At present, the movement of the US dollar continues to be the major factor that affects other currencies, including the ringgit.

In particular, the higher demand for the US dollar has been partly due to uncertainty over the US government’s debt ceiling and disappointing economic data for the month of April from China.

Sentiment on the ringgit was further weighed down by views on the importance of trade linkages between Malaysia and China.

Furthermore, OPR hikes were done at a more gradual pace compared to major and regional peers, making the OPR the lowest in the region.

Under a flexible exchange rate regime, it is reasonable to expect the ringgit to fluctuate from time to time. These adjustments are necessary to allow the domestic economy to adjust to global economic and financial shocks.

In 2022, at one point, the ringgit swung as much as 11.5% between end-March to early November, before appreciating towards the year-end.

Yet the real economy grew by 8.7% during the year. This is how the exchange rate and the deeper financial market buffer us from adverse external shocks.

Malaysia remains an open economy and BNM’s role is to ensure that in the short-term, excessive volatility to the ringgit is contained.

The policy priority now is to sustain economic growth in an environment of price stability and to further strengthen domestic economic fundamentals through structural reforms.

BNM has been steadfast in our calls and advocacy for structural reforms. This, rather than short-term measures or monetary policy decisions, will provide more enduring support for the ringgit. - FMT

Nor Shamsiah Yunus is Bank Negara Malaysia governor.

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