Interest Rates

Excerpt from The Star, 26th March 2009

Lower interest rates are expected to provide support for domestic demand

As one of the most open economies in the region, Malaysia is already affected by the worsening external environment.

With the risk of inflation abating considerably, the balance of risk has shifted from inflation to growth. Headline inflation decelerated to 3.9% in January 2009 from the peak of 8.5% in July 2008.

There are strong indications that this downtrend is likely to continue this year while wage demands will be muted.

As pre-emptive measures, the Monetary Policy Committee reduced the overnight policy rate (OPR) by 25 basis points in November 2008, followed by further reductions of 75 and 50 basis points in January and February 2009 respectively to provide a more supportive monetary environment for the local economy.

Lower interest rates are expected to provide support for domestic demand through the availability of credit at cheaper costs and by increasing disposable income through lower debt servicing costs.

Reduced interest rates also increase the affordability of loans and the cost of capital.

The cuts in the OPR were accompanied by reductions in the Statutory Reserve Requirement and the floor on deposit rates. The reduction in deposit rates does not detract from the long-standing emphasis on ensuring a positive real rate of return to savers.

With inflation trending down, the real rate of return on 12-month deposits is expected to average above 0.5% this year.

Bank Negara announced the issuance of the Merdeka Savings Bond amounting to RM2bil as an additional savings instrument for Malaysian citizens aged 56 and above.

The Government has also announced the issuance of syariah-compliant Savings Bonds amounting to RM5bil for citizens above 21 years old. With a nominal return of 5% per annum, the real return on these bonds are expected to average above 3% in 2009.

Going forward, Bank Negara will continuously assess the appropriateness of the OPR and its monetary policy stance. As monetary policy works with a lag, the central bank has frontloaded the cumulative 150-basis point OPR reduction in view of the significant moderation in the prospects for growth and inflation.

In the next few months, Bank Negara will continuously assess whether all these measures are having their intended effects in sustaining domestic credit expansion and economic activity.

Globally, while central banks are easing monetary policy, governments are undertaking fiscal stimulus on a scale that is creating large fiscal deficits unseen in recent years and such complementarity of policies is necessary.

Monetary policy, as a demand management tool, has limits on the magnitude of reflation it can achieve in the current environment.

In addition to the RM7bil stimulus package, the Government has announced an additional stimulus package worth RM60bil to mitigate the adverse developments in the external sector.

The collective impact of monetary and fiscal policies should limit the effect of the global economic downturn on domestic economic activity and provide a firm base for the economy to return to its medium-term growth path once global economic and financial conditions normalise.