Conventional economic management during times of depressed gross domestic product (GDP) growth and weak business sentiment demands for coordinated monetary and fiscal stimuli to keep the economy going, said Manokaran Mottain, chief economist at Alliance Bank Malaysia Bhd.
“Unfortunately, since the Global Financial Crisis, many governments and central banks, especially those in developed economies, have been finding it difficult to heal the damages brought upon by the crisis,” he said.
Central bankers in major advanced economies like the United States, eurozone and Japan have been pushed to the frontline to support their economies, while the governments focus on bringing public debt and fiscal deficits to more manageable levels.
While the US economy seems to have recovered since the 2008-2009 episode, the fact that the US Federal Reserve remains highly cautious at raising the interest rate to its preferred ideal long-term target of 3.25 percent (currently between 0.25 percent and 0.50 percent since December 2015) indicates an uncomfortable reality.
In Malaysia, Bank Negara unexpectedly cut the overnight policy rate (OPR) by 25 basis points to 3.0 percent this month.
He noted that subdued economic growth outlook coupled with weak inflation are textbook case studies that warrant monetary easing.
Over the last 15 months, the International Monetary Fund revised its 2016 global GDP growth target five times. Currently, it expects a 3.1 percent expansion compared with the 3.6 percent projected last October.
With global crude oil prices plunging since 2H 2014, lowering energy costs and subsequently overall headline inflation, it should not come as a surprise that many central banks are slashing cost of borrowing in a bid to stimulate domestic demand and credit growth.
“For Malaysia, the narrative leading to the latest OPR cut is similar,” he said.
“Bank Negara sees a lower inflation outlook moving forward as crude oil prices could remain depressed and cost-push inflationary pressures since 2015 would eventually subside. Its headline consumer price index forecast this year was revised to 2.0 percent to 3.0 percent, down from 2.5 percent to 3.5 percent expected at the start of the year.”
As an open economy with exports of goods and services, over 70 percent of Malaysia’s GDP is subjected to diminishing interest of foreign investments inflows and negative spillover effects of weak global trade.
As such the decision to reduce the OPR without much prior forward guidance is deemed as a “pre-emptive move to ensure domestic consumption remains supportive of overall GDP growth this year.”
However, he cautioned that over-dependence on monetary easing for economic growth could go out of hand.
Once the central bank interest rate reached its nominal rock bottom level of 0 percent, yet “economic conditions remain very weak, it seems that desperate times call for desperate actions.”
Following in the footsteps of Denmark, Japan, Switzerland and Sweden, the European Central Bank (ECB) charged negative interest rates on deposit facilities in June 2014 – essentially penalising banks depositing money with the central bank.
However, the negative benchmark interest rate failed to revive the economy.
In fact, the ECB main deposit rate is now at -0.4 percent since March, a further negative than the -0.1 percent when it first ventured into uncharted monetary policy territory.
In March 2015, the ECB finally decided to pursue quantitative easing (currently purchasing selected public and private securities up to 80 billion Euro a month until March 2017) to push down long-term interest rates.
“Consequently, the negative spillover effects from quantitative easing and prolonged low-interest rates are seen in the form of negative sovereign bond yields in economies such as the eurozone and Japan,” he said.
In recent months, there were more than US$10 trillion outstanding negative-yielding global sovereigns bonds while 28 percent of total value of JP Morgan’s global government bond index has negative interest rate, said Forbes.
“Essentially, investors holding on to negative bond yield until maturity would be making a sure loss in the investment. This situation could go on precisely because the ECB and Bank of Japan continue to pursue their respective quantitative easing, which seeks to buy up sovereign bonds – even those already in negative yield territory.”
Since sovereign bond yields are benchmark references to price financial market assets, it should be taken seriously that negative sovereign bond yields may cause asset bubble mispricing in some parts of the global markets.
With this, he underscored that monetary easing is only effective from the supply-side perspective.
“Even with ultra-low costs of borrowing and if there is inadequate demand for loans to invest in capital expansion, there is only so much central banks can do,” he said.
“Realistically, the conversation on the current state of slow global growth should turn away from how low central banks can go to what economic reforms can be delivered – before growth moderation becomes the “norm”.”
Moreover, domestic private consumption should be taken care of in order to ensure baseline GDP growth performance.
While the macro conditions of Malaysia are nowhere near the dreadful complications of those major central banks, an expected slowdown in the country’s GDP in the coming quarters “remains a downside risk”.
Fortunately, the Malaysian government pursued timely intervention in the form of the Budget 2016 revision measures to boost household disposable income.
“The special income tax relief for the middle-income class group and voluntary cut in the Employees Provident Fund employees’ contribution rate to 8.0 percent is estimated to contribute up to 0.4 percent to GDP this year.”
He believes that the strategy will be effective considering the private consumption account for almost 55 percent of Malaysia’s total GDP.
“Even with our Government currently committed to balancing its fiscal deficit from 3.1 percent of GDP expected this year to a balance budget by 2020, there is still scope for Bank Negara in its monetary policy to navigate our economy.”
“Therefore, with a dynamic labour force, manageable inflation environment and sound economic fundamentals, Malaysia is confronting external headwinds from a position of strength.”
Mangalesri Chandrasekaran, Editor at PropertyGuru, edited this story. To contact her about this or other stories email mangales@propertyguru.com.my
