Asia

Malaysia – the economy cruises along

Bank Negara Malaysia (BNM) left rates unchanged at 3% as expected. This was despite higher inflation driven by the fuel price hikes. BNM was willing to look beyond this. It seems content on keeping monetary policy accommodative with a bias to support growth. We expect a 4.7% growth this year driven by domestic demand and firmer exports. Inflation should moderate in the second half of the year but still average around 3.8% this year. For USD-MYR, stability is the new buzzword particularly given rising expectations of a general election in the not too distant future.

BNM kept its policy rate unchanged at 3% as widely expected. The last cut was a year ago in July 2016 with the stated aim to shore up growth (see Chart 1).

Chart 1: BNM has stayed on hold since July 2016
Chart 1: BNM has stayed on hold since July 2016
Source: Bank Negara Malaysia, Bloomberg, Commerzbank Research

Since then, growth has performed rather well, led by strong domestic demand and augmented of late by the stronger export performance. BNM acknowledged this in a statement, noting that: ‘The global economy continuesto strengthen with growth becoming more synchronized across countries. Growth was lifted by stronger domestic demand with additional impetus from exports. Going forward, the more favourable global growth prospects will lead to sustained export performance and generate positive spillovers to the domestic economy. Private consumption will be underpinned by higher wages and employment.’

The economy expanded 5.6% year-on-year. This is unsustainable and expected to moderate for the rest of the year. Nevertheless, we still expect 4.7% growth this year, following the 4.2% in 2016. This is at the upper end of the government’s projection of 4.3 to 4.8%. BNM sees the main risk factors as political with policy uncertainties in the major economies, financial market developments, and volatility in commodity prices. At first glance, inflation may appear to be a problem, the elephant in the room for the central bank. Headline inflation has picked up steadily since the beginning of the year from just 2.1% in 2016. It has averaged 4.3% year-on-year in the first five months of the year. BNM does not have an explicit inflation target for 2017, but it is projecting 3 to 4%. The spike in inflation was largely driven by higher retail fuel prices following a shift in the price setting mechanism. It is expected to moderate in the second half of this year but it is still expected to come in at the upper end of BNM’s projection, at 3.8%. However, underlying price pressures remain in check with core inflation seen holding around the mid-2% area. As such, we suspect BNM is content with the current growth-inflation mix. We expect BNM to stay on hold at 3% till year-end.

If growth remains firm and core inflation begin to climb towards the 3% level, e.g. due to firmer wage pressures, we could see BNM turn less accommodative. The initial response may not necessarily be from higher rates but a stable to stronger ringgit.

On the currency, the ringgit began to appreciate from April this year after holding above the 4.40 level in the first quarter of 2017. It has gained 4.5% versus the US dollar year-to-date versus the average for Asian currencies of just under 4% (Chart 2).

Chart 2: The ringgit remains extremely competitive

Difference of NEER and spot versus 5-year average

Chart 2: The ringgit remains extremely competitive
Source: Bloomberg, Commerzbank Research

It seems BNM’s focus of latest has shifted to ensuring the ringgit’s stability and even allowing some appreciation, to help curtail import inflation, given the improved investor sentiment towards Malaysia. For example, the ringgit collapsed over 18% in 2015 and was down another 4% in 2016 due to political risks linked to the quasi-sovereign wealth fund, 1MDB.

The stabilisation in foreign exchange (FX) reserves over the past year should also help to shore up sentiment. In June 2017, FX reserves stood at USD 98.9 billion after hitting a low of USD 93 billion in September 2015. This is still some distance from the peak of USD 140 billion in May 2013. One risk is that the ringgit remains vulnerable to net portfolio outflows, given that it has a relatively high foreign ownership of government bonds at around 41% as of June 2017. Sound economic management and continued solid economic performance along with a continued supportive risk backdrop will mitigate these risks. Talk of an early general election, possibly around October this year, could also see official support for the ringgit. The next general election is not due until August 2018.

To anchor ringgit stability, we see BNM taking a proactive approach on two fronts:

1) Deepening onshore markets: Between December 2016 and April 2017, BNM introduced a multitude of measures to promote onshore liquidity and deepen the domestic financial markets. This includes the mandatory repatriation of export proceeds, allowing more onshore hedging and clamping down on offshore non-deliverable forward (NDF) trading (please refer to EM Briefing: ‘NDF volatility sparks ban for onshore players’). Overall, the measures are aimed at tapering ringgit volatility by ensuring continuous FX supply on the onshore market and curbing speculative activities in the offshore markets.

2) Rebuilding reserves and strengthening its external buffers: Although Malaysia’s economic fundamentals are sound, investor confidence was shaken in recent years due to the political uncertainties and the relatively low level of reserve adequacy. Our estimates show that Malaysia’s reserve adequacy ranks the lowest among its regional peers when measured in terms of imports cover and short-term debt coverage metrics (see Chart 3 and 4). The return of positive net inflows since the beginning of the year has provided BNM the opportunity to rebuild its reserves. In the first six months of this year, FX reserves have risen by USD 4.3 billion versus a fall of USD 300 million in 2016 (see Chart 5).

Chart 3: Import cover the lowest among Asian peers

FX reserves / 12-month moving average imports

Chart 3: Import cover the lowest among Asian peers
Source: Bloomberg, Commerzbank Research
Chart 4: Short-term debt coverage lowest among Asian peers

FX reserves to short-term debt

Chart 4: Short-term debt coverage lowest among Asian peers
Source: Bloomberg, Commerzbank Research
Chart 5: Reserves are up this year

FX reserves

Chart 5: Reserves are up this year
Source: Bank Negara Malaysia, Bloomberg, Commerzbank Research