The Business Times

Bank Negara's delicate balancing act

Published Thu, Feb 6, 2014 · 10:00 PM
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MALAYSIA'S central bank, Bank Negara, has a tricky balancing act on its hands. It has now maintained its overnight policy rate at 3 per cent for over 10 straight quarters, sticking to its accommodative stance to keep the country's growth engine ticking.

Among other reasons, the cheap credit has unfurled an unprecedented borrowing binge that's resulted in one of the highest household debt to gross domestic product ratios (85 per cent) in Asia, second only to South Korea. That's a potential, although admittedly limited, risk to the financial system, so 2014 could be the time when the central bank takes the punch bowl away from the party. Inflation is only expected to rise given the government's subsidy rationalisation measures and the imposition of a goods and service tax in April 2015. Real interest rates are now negative. As rates rise in the United States with its gradual recovery as well as the tapering of quantitative easing, Malaysian yield spreads will narrow, tempting investors to cut and run. That's seriously not a good idea. Since 2008, when US interest rates dropped sharply, foreign holdings of Malaysian government securities have increased sharply - almost 50 per cent at its peak in May last year. A sell-off would be pretty damaging to the ringgit, which is why the central bank will probably raise rates sometime this year.

The local currency hasn't been faring too well either. It has already depreciated 2 per cent against the greenback since the beginning of the year, making it the second worst performing currency in Asia in 2014. The sliding ringgit, in turn, exacerbates imported inflation. A hike in interest rates can, and probably should, stem the slide.

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