The limits of the OPR

 While the overnight policy rate is an important lever in managing the macro side of the economy, it cannot control every economic parameter.

From Mazli Noor

Bank Negara Malaysia (BNM) has held the overnight policy rate (OPR) at 2.75%, following the latest monetary policy committee meeting. However, while the OPR is an important lever in managing the macro side of the economy, it cannot control every economic parameter. The biggest example of this lies in the nation’s producer price index (PPI).

The PPI, which is the leading indicator of inflation for manufacturers, rose 9.2% year-on-year in June 2026, up 0.6% from May. This stands in sharp contrast to headline inflation, which was flat at 1.9% in June, against 2% in May.

This divergence points to a distortion in the Malaysian economy, where producers are facing genuinely rising costs, yet those same increases are not being passed on to consumers.

Ultimately, someone will have to bear them, whether producers who absorb much thinner margins, or taxpayers who continue to fund the subsidies masking the upward pressures.

The main reason is the fiscal support embedded within the Malaysian economy.

To date, subsidies and cash assistance have absorbed the pressures that would have otherwise reached consumers some time ago, which is why the very real production-side inflation has not yet translated into consumer-side inflation. This cannot however continue indefinitely, given the government’s limited fiscal capacity amid increasingly difficult external and internal economic pressures.

The subsidy bill rose to RM35 billion-RM40 billion in 2025, with the increasing costs related to the Middle East crisis requiring a further RM7 billion a month in RON95 petrol and diesel subsidies alone, pushing the estimated total subsidies required for 2026 to RM58.4 billion. On top of this, direct cash assistance promised to the rakyat in 2026 is expected to reach RM15 billion, which will be the largest amount the government has ever committed to.

It is also possible that producers are absorbing the increasingly higher costs directly rather than passing it on to consumers, protecting their customer base to an extent. Realistically, however, this is simply not sustainable, and something will have to give.

A third possibility for inflation being much smaller than the PPI is that producers are still able to draw on older, cheaper raw material secured before prices rose. If so, this too is temporary, since it is only a matter of time until new inventory will eventually be needed at current prices, pushing production costs up regardless.

This very real opposing trend between the PPI and consumer inflation is unhealthy for the economy and must be corrected sooner rather than later, before further distortions that will be more difficult to rectify build up in the system.

Ultimately, only two outcomes resolve it: either the PPI must come down, or inflation must rise to meet it. This is perhaps where the OPR could play a coordinating role in managing inflation. Tactically however, its function as a macroeconomic tool is limited.

While the OPR is effective in keeping the consumer price index (CPI) at optimal levels by tweaking the liquidity that shapes consumption patterns, the PPI is a different beast altogether: it cannot be controlled through the OPR because it is driven by external markets.

Complex supply chains, geopolitical conflict and volatile global oil and mineral prices are critical to the cost of raw materials – and all lie beyond the influence of domestic interest rates.

At best, the OPR has only a limited, indirect effect on production costs, for example, by raising the rate to support the ringgit, which in turn lowers import costs. Any changes such as this must be handled carefully, however, since raising the OPR also risks dampening the domestic economy, making it a lever to be used sparingly.

Within these limits, BNM still needs to monitor the PPI trend closely, to see whether producers eventually pass their higher costs on to consumers which might trigger a second round of inflation. If that happens, the OPR would have a genuine role to play as an adjustment mechanism, protecting consumers and the domestic economy from the effects of inflation.

Beyond monetary policy, however, Malaysia also needs more fundamental reforms to keep the PPI at a more sustainable level. Chief among these is raising productivity consistently and across the economic spectrum.

Higher productivity builds production capacity, strengthening Malaysian manufacturers while also strengthening the country’s demand capacity, which in turn lowers the cost of raw materials and supports both exports and domestic consumption.

The government needs a comprehensive plan to lift national productivity, particularly in key sectors such as construction and manufacturing where the productivity index currently sits at just 1.4%.

A stronger ringgit is equally fundamental. Where higher productivity can raise production that heightens exports ergo demand for the local currency, BNM’s decision to hold the OPR also helps by attracting – and retaining – foreign capital. Together, these support a stronger ringgit, helping moderate the PPI while strengthening the national economy.

None of this is possible, however, without strong investor confidence in the Malaysian markets.

The government must therefore commit to the reforms that investors have come to expect: stamping out corruption, ensuring transparent governance and maintaining high fiscal discipline.

Concerted gains in these areas will invariably help improve the country’s risk profile, raising its international credit rating and lowering its borrowing costs.

The OPR remains the right tool for keeping consumer inflation in check.

But correcting the current distortion between PPI and CPI – and closing that gap sustainably – depends on increasing our productivity, ensuring a stronger ringgit, and boosting investor confidence, not on the interest rate alone. - FMT

Mazli Noor serves on the boards of several public and private companies and is an FMT reader.

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