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Divided views on rate hike

PETALING JAYA: As interest rates are rising globally, local economists are divided in their views whether Malaysia should follow the same route.

Economists who want rates to go up are concerned that continued low interest rates would fuel asset price inflation. Those who view that rates should be maintained, point to the benign inflation in the country and that inflationary pressures are mostly cost-pushed rather than demand driven.

http://biz.thestar.com.my/archives/2011/2/12/business/b_11mano.jpgManokaran Mottain ... ‘Malaysia’s inflation is cost-pushed.’

“Malaysia cannot stay in an environment of low interest rates for too long as this may fuel excessive demand as well as exacerbate credit and asset price cycles,” said CIMB Investment Bank chief economist Lee Heng Guie.

Globally, many central banks have been normalising interest rates, and Bank Negara is no exception. In fact, it has been in the forefront of this trend. Between March 10 and July 10 last year, Bank Negara had raised the overnight policy rate by 75 basis points to 2.75%.

The general consensus is that the central bank will continue to normalise interest rates, contingent on factors such as capital flows and excess liquidity in the system.

The need to control inflation is another impetus for the rise in interest rates. While Malaysia's current inflation rate is relatively tame at 2.2%, higher food prices will impact consumer's purchasing power.

Economists are forecasting the consumer price index to average 3% this year.

AmResearch senior economist Manokaran Mottain said there was no urgent need for a rate hike in the short term, given that inflation was relatively low compared with that of other countries in the region.

“Malaysia's inflation is also cost-push. Thus, setting higher interest rates will not counter the problem. Bank Negara has also voiced its concern on the excess liquidity in the system, not so much inflation,” said Manokaran.

With economic growth projected to cool to around 5-6% this year compared with a projected 7% last year, there is also a case against raising interest rates.

Nevertheless, asset inflation is one area that needs to be controlled either through a combination of interest rate hikes or other measures.

“Our view is that there is pressure for interest rates to go higher in the fast-growing economies, and this emanates from domestic and external sources. Domestically, many economies in Asia and other emerging markets are growing strongly and output gaps have narrowed or closed over the last year,” said ECM Libra's economist Michelle Chia.

Externally, the run-up in commodity prices was a concern, especially in lower-income economies, where food and energy components accounted for a higher percentage of a person's take-home pay.

The argument is that the run-up in commodity prices was partly driven by speculation, and the huge amounts of liquidity generated needed to be controlled. In this case, higher interest rates could be used to cool demand, and hopefully, in the process, lower prices.

“Economies that fail to rein in inflationary pressures, either through conventional monetary policy or other administrative and macro prudential measures, face the risk of a hard landing,” said Chia.

Against concerns that higher interest rates will attract more hot money, economists pointed out that this was not the main reason for foreign money to enter Malaysia or other emerging markets.

“Post the global financial crisis in 2008, most policymakers in the emerging markets have been normalising interest rates. This has widened interest rate differentials with the advanced economies and hence, attracted favourable to short-term flows into the emerging markets in the pursuit of higher yields,” Lee said.

“However, flows into a country cannot just be attributed to the level of interest rates. There are other structural factors, such as prospects for growth, economic conditions and investors' perception of the country's policies,” he added.

In the past, Bank Negara had mentioned that the large and volatile shifts in global liquidity were leading to a build-up of liquidity in the domestic financial system. This warrants continued surveillance to avoid the risk of macroeconomic and financial imbalances.

To safeguard against potential systemic risks from excess liquidity, Bank Negara signalled that it would consider other policy tools, such as the statutory reserve requirement (SRR) and macroprudential lending measures, to ensure domestic macroeconomic and financial stability. The SRR is currently at a historic low of 1% compared with 3.5% in 2008.

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