[COLUMNIST] Maintaining interest rate stability would have provided the necessary monetary policy space

The MPC, whilst cognisant of the Fed’s predisposition and exhibiting a pattern of policy behaviour which gives the impression of some kind of coordinated and synchronised action in concert with global counterparts (i.e., fellow central banks), nonetheless remains fundamentally cautious.

The need for the resumption of the OPR hike is partly based on the scenario that although our latest Consumer Price Index (CPI) has eased to 3.4% (March 2023 figures), overall core inflation remains stubbornly elevated at nearly 4% (3.8% from the February 2023 figure of 3.9%) even as the distance or gap (i.e., between the CPI and core inflation) is small.

Cost of living as measured by the bulk of consumption (spending) of the B40 and lower M40, i.e., the food & non-alcoholic beverages group was at 6.9% (representing only a mere 0.1% decrease from the February 2023 figure).

All sub-groups (in the food & non-alcoholic beverages group) recorded an increase of between 0.1% to (a high of) 9.2%.

It’s possible that the CPI could remain “range-bound” – confined to e.g., between 3.3% and 3.5% for a period – driven by the “sticky” levels of fresh food produce alongside processed food products, especially.

The MPC might consider the possibility – that the desired lower CPI (e.g., 3%) might not materialise soon or steadily into account – when deciding to further increase the OPR.

The policy thinking/rationale could be that if demand isn’t “adequately” dampened, this could push the inflation rate up again on the assumption that prices are reflective of current supply conditions relative to demand (in particular, effective demand which portends higher future demand capacity outstripping supply).

Furthermore, the unemployment rate in Malaysia dipped to 3.5% in February 2023, with 591,900 unemployed people compared to 596,100 recorded in January 2023, according to the Department of Statistics Malaysia (DOSM). This implies that (unlike a deflationary momentum), we’re mostly on track to achieving loose full employment.

Whilst our economy isn’t exactly overheating at all, the MPC probably considered that lower unemployment would inject greater spending into the economy on the back of higher aggregate demand which in turn could push up wages even if ever so moderately.

Bank Negara expects the economy to continue to be driven by robust domestic consumption as supported by resilient trade (current account) position and, not least, “a stronger-than-expected rebound of China’s economy” (MPC Statement, May 3, 2023).

So, in their thinking, the position of the sectoral balances means that the economy is able to absorb any increases in the OPR.

Even as “… exports are expected to moderate, growth in 2023 will be driven by domestic demand. Household spending remains resilient, underpinned by better labour market conditions as unemployment continues to decline to pre-pandemic levels”.

This can be seen in the figure for Q1 2023 whereby the GDP posted a 5.6% growth – better than last year’s corresponding quarter at 5%.

On the other hand, should the MPC have chosen to continue the pause indefinitely, it’d be perhaps in “anticipation” of a slowdown. This is where it’d then decide to cut the OPR consequently.

GDP-wise, Bank Negara projects the economy to ease to between 4% or 5%. So, this represents a slowdown from the 8.7 growth in 2022 (which actually stems from the low-base effect of the Covid-19 impact of the economy in 2020).

Thus, a pause would give “room” for rate cuts later on (i.e., progressively).

A too drastic a cut, e.g., in the form of 75 basis points (0.75) might expose the central bank’s credibility to criticisms and undermine confidence in its hitherto reputation for being cautious.

Some are already predicting a full-blown recession in the second half (2H) of 2023.

Currently, oil prices are expected to remain stable, notwithstanding the recent cuts in production/output initiated by OPEC (Organization of the Petroleum Exporting Countries) as the cartel wouldn’t risk accelerating the global economic slowdown with further cuts.

The cuts were made in order to precisely “stabilise” the global oil prices to ensure that they don’t fall further in the face of an anticipated decrease in demand due to (fears of) recession.

Also, the cartel was responding to speculative activities in futures contracts (where the bet is that prices will go down further).

This means that the cartel is trying to counter the decrease in open positions (i.e., active futures contracts – as opposed to closed or settled for the underlying asset) as traders adopt a bearish attitude in the form of backwardation (i.e., expecting long-term prices to reduce further).

In other words, profit gouging or price markups by oil and gas cartels through the wholesale network of the supply chain via both spot delivery and futures (i.e., near-term) contracts which contributed to the inflationary pressure as the costs are transmitted or channelled to the wider downstream economy (e.g., retail) was only transitory.

There won’t, therefore, be inflationary pressure emanating from such a supply-side move (which wasn’t expected, to be sure) that will then be passed through the rest of the supply-chain.

In other words, we have a scenario where one group already profiting from inflation (profit-inflation – see e.g., “How tit-for-tat inflation can make everyone poorer”, The European Central Bank/ECB blog, March 30, 2023), i.e., the cartel (mainly petroleum/oil) fending off another, i.e., the speculators in an effort to maintain their profit margins (trading off volume for profit share).

The same scenario applies to the US too – where the bullwhip effect, i.e., small changes in the downstream is magnified or amplified in the midstream and, by extension, the upstream in the supply chain – is being cushioned by near-shoring, i.e., the process of relocating operations to a nearby/nearer country/base – shortening the supply-chain (“Nearshoring ‘about service & products, not just costs’”, Supply Chain, April 18, 2023 and “US reshoring is supply chain success - Kearney report”, Supply Chain, April 14, 2023).

Meanwhile, according to Freightos (a leading global container freight index), global container freight costs have fallen by more than 85% from their peak in 2021. Freight costs are today at the same level as in January 2020, i.e., pre-pandemic.

Again, this points to the transitory nature of the supply-side inflationary pressure.

Domestically, there’s no spectre of high inflation on the horizons emanating from “excessive”:

• fiscal stimulus – whereby direct fiscal injection — from the unconditional cash transfers/UCTs and wage subsidies are estimated to total just RM83 billion or 16% of the total packages of RM530 billion of the eight government packages (the rest being EPF withdrawals, loan moratoriums, loan guarantees, etc.); or

• monetary stimulus – with businesses still having to pay a minimum of 2% above the then OPR rate of 1.75% given the net interest margin (NIM) compression faced by banks at the time.

On the other hand, core inflation is a result of the lagged impact of previous supply-chain disruptions (e.g., fertilisers) and consecutive OPR (for domestic supply) and external interest rate hikes (imports), and is highly concentrated in urban areas (at 3.6%) as opposed to rural (at 2.8%).

This means that the cost of manufacturing food – as part of the cascading costs of the entire supply chain – may remain elevated for a while longer. This is unlike fresh food produce where the supply chain is shorter.

Wage growth is very limited in terms of sectors and workers (albeit encompassing highly skilled, semi- and low-) and no prospects of a spiral due to the weak state of organised labour in Malaysia.

Hence, a pause would have represented the proper balance between normalisation and accommodation.

It’d have been advisable, then, for Bank Negara not to wait for the lag effect of the OPR transmission – which is estimated be between 12 to 18 months – as a rationale/basis for pursuing the normalisation agenda, i.e., 3.25% as the ultimate/end goal (“All eyes on BNM’s Monetary Policy Committee’s meeting in early May, The Sun Daily, April 17, 2023).

To do so would be counter-productive because as OPR hikes only add to the inflationary pressure. Higher interest rates increase the cost of business (COB) and, by extension, cost of living (COL). This is in turn self-feeds into a COB-COL spiral in line with the consecutive hikes.

Notwithstanding, it could also be argued that a pause, even as it’s the “lesser of the two evils” in relation to an increase, would also position us to be behind the monetary policy curve as we would still need to cut rate(s) later – if by which time we are already in recession.

We should be taking a pre-emptive strike rather than reacting because by then Bank Negara could be compelled to cut the OPR drastically (especially should the OPR go beyond 3.25%).

Going by this logic, wouldn’t this reflect “poorly” on our central bank’s credibility and reputation?

Ideally, what we should be doing now is to immediately cut the OPR and leave it at 1.75% until we’re sure the global headwinds have gone away and that we’re out of the woods.

In the final analysis, there’re two major policy concerns.

Short-Term: 1. The counter-balancing impact of consecutive OPR hikes on dis-inflation.

Disinflation (i.e., including in relation to core inflation) should be taking place given the easing of the supply-side inflationary pressures as transitory.

Medium-Term 2. That is, a possible or even looming downturn in the second half of the year (2H 2023) especially given that we’re most likely in a technical recession (see, “Monetary policy in the ‘Great Transition”, Paolo Casadio and Geoffrey Williams, Malay Mail, March 10, 2023).

Worst still, so to speak, is the elevated levels of inflation at the same time, i.e., stagflation (or otherwise in the context of recession).

This is something that central bankers, especially as embodied by the Fed, haven’t “considered” in their calculus.

That is, the need to reduce interest rates during recession but with inflation (CPI and core) remaining elevated (or even going higher if inflationary pressures from the supply-side disruptions in turn resulting from fresh outbreaks of geopolitical conflicts returns).

To recapitulate, a pause would have provided the necessary monetary policy space by cushioning the impact of an imminent slowdown whilst simultaneously allowing for a pace of cuts later (i.e., when the slowdown moves towards recession) that doesn’t affect central bank credibility.

At the same time, such a move (i.e., maintaining the pause to be followed by consecutive cuts) would help to stabilise capital inflows and outflows (since, e.g., pre-existing bonds would be more attractive than newly issued bonds at the secondary markets).

By extension, it’d indirectly support our RM.

Lastly, Malaysia should be seen as a more attractive haven relative to the US now given the banking crisis by way of prospective higher capital inflows which in turn should also strengthen our currency.

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* Jason Loh Seong Wei is Head of Social, Law & Human Rights at EMIR Research, an independent think tank focused on strategic policy recommendations based on rigorous research.