In a rather surprising move, Bank Negara, through its monetary policy committee (MPC) meeting which was held recently, slashed the overnight policy rate (OPR) by 25 basis points.
This is the first rate cut since 2009, and the first significant move by the newly appointed governor, Datuk Muhammad Ibrahim, since he took office in May.
In 2009, when the global economy was experiencing a crisis, Bank Negara had cut the rate from 3.5 per cent to two per cent, that is, by a whopping 150 basis points.
The Malaysian economy at that time plunged into a recession and had recorded a contraction of 1.5 per cent of gross domestic product (GDP) for 2009.
The last time Bank Negara changed its monetary policy stance was in July 2014, where it had increased the rate by 25 basis points to 3.25 per cent from three per cent.
The rate was unchanged at three per cent since 2011.
The fact is that in 2014, there was a slew of positive data sipping into the Malaysian economic outlook, such as an improvement in the industrial production index (IPI) data, buoyant private sector-led initiatives, and also improvements in the overall trade data especially on exports.
On the global front, in 2014, there were uncertainties in the world financial market as the concern was on possible massive capital reversal back to the developed countries, especially to the United States economy as the US Federal reserves was in the midst of an attempt to taper its bond-buying programme, namely the third round of the quantitative easing, or QE3, as a result of a better than expected US economic data at that time.
Seeing a potential risk coming out of this, Bank Negara had acted ahead of the curve by raising the OPR rate.
Eventually, in 2014, the Malay- sian economy grew at an encouraging rate of six per cent.
Now, in 2016, how should we interpret the move by Bank Negara in easing the monetary policy and also the somewhat dovish tone of Muhammad in his statement?
To begin with, this clearly goes against consensus market expectation, which predicted for the rate to hold for some time.
While the move for the monetary policy to be more accommodative in the future seems to be on the radar, the timing is clearly unexpected.
Both globally and regionally, the trend appears to be more of a rate cut.
In fact, some developed countries, such as Japan, Denmark, Sweden and Switzerland, and even the European Central Bank (ECB), have ventured into negative interest rates.
Perhaps, the main reason for more rate cuts in many central banks worldwide, including Malaysia’s, is due to the expectation of a protracted slowing down of the global economic growth, especially in the aftermath of the United Kingdom’s referendum to leave the European Union, or Brexit.
It is then apt for Muhammad to term this latest move by Bank Negara as “preemptive”, as it will ensure that the targeted growth rate for this year, which is at the range of four to 4.5 per cent, will be comfortably met, especially for the growth rate in the second half of this year.
It is also to ensure the sustainability of the growth momentum in the future to remain intact.
Another important factor this time around is inflation, where the projection rate for this year has been more stable at two to three per cent, compared with 2.5 to 3.5 per cent from the previous forecast, and is expected to remain steady for next year.
This essentially gives room for Bank Negara to ease the rate further.
As the Malaysian economy is now more driven by domestic demand especially on private consumption, the move to cut the rate is seen as a complementing role to other government measures and initiatives in an attempt to ease the burden of the people who are confronting the issue of rising cost of living.
Under the 2016 Budget, many initiatives have been laid out to stimulate private consumption, such as the increase in minimum wage, hike in pension and the upgrade scheme for civil servants, which will boost the overall purchasing power of the people.
In addition to all these are measures under the 2016 recalibrated budget, whereby the government has decided to cut the Employees Provident Fund (EPF) contribution by three per cent and the tax relief of RM2,000 for the threshold salary of RM8,000 and below.
Special programmes, such as MyFarm outlets and MyBeras, plus the temporary move to liberalise the approved permits (APs) on eight agricultural products, appear to have been very effective in tackling the spike in the cost of living.
While the cut in the interest rate is expected to stimulate Malaysia’s GDP in the third quarter and, to a greater extent, boost the people’s purchasing power, some possible risks to reduce the rate this time around should not be overlooked or downplayed.
One is the household debt level, which is now at 89.9 per cent of GDP, still among the highest in the region for quite some time.
A much cheaper borrowing cost would certainly give incentive to consumers to borrow more.
The other would be on the performance of the ringgit and the possible capital outflow as the result of the OPR trim.
And of course, the other uncertainty moving forward in the international financial market would be on when the US Federal Reserve Bank will resume its rate hike.
A probable hike, especially in the fourth quarter of this year, would pose a potential downward risk in the performance of major currencies in the developing countries.
A day after the MPC meeting, Muhammad signalled that there will be no more rate cut in the foreseeable future.
It is still early to tell whether the market will take heed of his statement, but many analysts are now looking for a possible round of easing this year with perhaps in a smaller quantum or clips than 25 basis points.
Dr Irwan Shah Zainal Abidin is senior lecturer at the School of Economics, Finance and Banking, Universiti Utara Malaysia