BNM: Setting the right framework for Malaysia’s future economy

The state of the economy affects both the conventional and the Islamic financial institutions. Here's are views of a senior Malaysian central banker on the state of the economy. It's taken from THE MALAYSIAN RESERVE, a daily business/finance newspaper. 

By Tanu Pandey

At a time when the advanced economies are back on the path of recovery after the financial crisis, the period ahead will be one of transition for the economy, and consequently for macroeconomic policy.

This changing environment carries with it some risks. Bank Negara Malaysia (BNM) has been monitoring developments in the domestic economy and financial system to ensure that risks are dealt with preemptively.

“The advantage of addressing them (risks) early is that they never evolve to become vulnerabilities, especially when circumstances turn adverse,” said BNM deputy governor Dr Sukhdave Singh in a recent discussion on the country’s economy organised by Persatuan Ekonomi Malaysia on the day after the central bank released its annual report.

Here are excerpts from Sukhdave’s comments on the issues.

Dealing with a Financial Crisis

We do not know if there is going to be a crisis in the future, and if there is one, where it would happen. But as an open economy, any crisis that affects the major economies will eventually reach our shores. There isn’t much we can do about that. But we can make our economy as resilient as possible in facing such an external shock.

That includes addressing any vulnerabilities that may be present in our economy. That is why we have acted preemptively to address the issue of household indebtedness. That is why we ensure that our financial system is sound and able to withstand shocks. It is why the government is undertaking the fiscal reforms.

High Household Debt Levels

We expect that the ratio of household debt to gross domestic product will continue increasing because of demographic factors, urbanisation and other factors. We have undertaken measures to ensure that the banks are being prudent in the extension of loans to the household sector.

For example, following the issuance of our responsible lending guidelines, the overall quality of bank lending has increased. Therefore, while the level of household indebtedness may continue to grow, the overall quality of the borrowers is improving due to the more rigorous vetting process for the new borrowers. Our supervision teams are also ensuring that the financial institutions have the appropriate standards of credit assessment and that they have adequate buffers.

Subsidy Rationalisation and its Impact on Prices

We have incorporated some assumptions on price adjustments in our inflation forecast, but frankly, we do not have any advance information of when and by how much the government will reduce subsidies.

These subsidies have grown very large and removing them too rapidly will have a significant negative effect on the economy and economic welfare. Therefore, these subsidies will have to be removed gradually.

From a macroeconomic perspective, the objective is to minimise the potential negative impact on economic growth and inflation. Unfortunately, there will be spillovers to the economy from the reduction in subsidies i n the form of higher prices for goods and services.

For example, higher fuel prices will have to work themselves through the economy. However, this should not be taken by some quarters as an opportunity to indulge in profiteering by increasing prices unreasonably using the pretext of the subsidy reductions. Such behaviour can best be countered through enforcement under legislations such as the Price Control and Anti-Profiteering Act 2011 and the Competition Act 2010.

The government is also undertaking mitigating measures to protect the welfare of the lower income groups, as for example through the fiscal transfers and the exclusion of many essential goods from the Goods and Services Tax that would be introduced in 2015.

The Need to Maintain Foreign Reserves

The ringgit is not a reserve currency and we do not conduct our international transactions in the ringgit. Our international payments and receipts are done using the major foreign currencies. As an open economy that has significant financial and trade flows with the rest of the world, we therefore need to hold adequate foreign exchange reserves to ensure that we are able to meet our international obligations and also to safeguard our economy against shocks such as those created by volatile financial flows.

A component of our reserves is solid in the sense that it is built from past current account surpluses. But there is also a volatile component which relates mainly to short-term capital flows. For long-term resilience, we need to ensure that we have adequate solid reserves to meet our real and financial obligations to the rest of the world over a period of time.

With the growing presence of non-resident funds in our financial markets, having adequate reserves is important to ensure that if there is a sudden outflow of these funds, it would not lead to sharp and disruptive changes in the exchange rate.

Therefore, the foreign exchange reserves meet the needs of the economy and also act as an insurance policy for the country. We are comfortable with the current level of these reserves.

Monetary Policy Action to Arrest Inflation

At this stage, it is cost related factors that are driving the increase in the inflation rate. There are no signs that secondary price increases are occurring and we do not yet see signs that the inflation is becoming more persistent. Therefore, at this stage we do not see a role for monetary policy.

However, we are being vigilant with our surveillance. We do not want inflation to become high before acting. Given that monetary policy has a 12 to 18 months lag before changes in it have the desired impact on macroeconomic variables, we would need to act preemptively if we see that the inflationary pressures are becoming more persistent.

[THE MALAYSIAN RESERVE, 24 March 2014]