In view of the current economic challenges and headwinds, an SRR cut could potentially happen. The last time BNM reduced the SRR was in the January 2016 MPC, cutting it by 50bps to 3.50% with the aim of ensuring sufficient liquidity in the domestic financial system and support the orderly functioning of the domestic financial markets. Our estimates suggest that a 50bps reduction in the SRR should help release about RM7 billion of liquidity into the system. Assuming the SRR is set at 1%, this would release an estimated RM35 billion of liquidity back into the system.

The risk in cutting the SRR is that the funds released could find their way flowing more into the financial markets and lesser into the real economy through lending. This happened in 2016. The SRR cut in January failed to support lending and instead favoured the bond market with loans continuing to head south while bonds benefitted. Savings picked up. Such trend could to take place this time around with the overall business and consumer sentiments softening and savings on the uptrend. Such a setting, if it continues, is expected to reduce the effectiveness of the “monetary multiplier”.

Nonetheless, a reduction in the SRR could still take place. Our fiscal space is currently limited as the government is determined to ensure the fiscal consolidation effort is not jeopardized by the current slowdown. In addition, fiscal policy works with a lag and is normally effective in the medium and long term. Thus, monetary policy has to lend support although it cannot shoulder the entire burden of supporting the economy. Easing monetary conditions appears to be based on the “orthodox policy”, especially when our growth momentum wheels lower with the counter-cyclical fiscal policy being constrained.

A further adjustment to the OPR over and above an SRR cut could also take place. If this happens, it implies the need to ensure the degree of monetary accommodativeness remains consistent with the policy stance to support the domestic economy on a steady growth path amid stable inflation.

A. In view of the current economic challenges and headwinds, an SRR cut could potentially happen.

• The SRR essentially is the amount of funds that commercial banks are required to keep with the central bank, interest-free. It is an instrument to manage liquidity and not a signal on the monetary policy stance as this would come under the OPR, the rate at which banks lend.

• The last time BNM reduced the SRR was in the January 2016 MPC by 50bps to 3.50% with the aim of ensuring sufficient liquidity in the domestic financial system and support the orderly functioning of domestic financial markets. It was the first time since July 2011 that BNM had adjusted the SRR. BNM has not revised the SRR since the 2016 cut to 3.50%. Chart 1 presents the SRR movement.

• An SRR cut could potentially happen if liquidity is being further tightened from net external outflows driven by external headwinds and uncertainties, added with domestic challenges. At the moment, foreign investors are net sellers in the equities market. The net outflow stands at RM4.9 billion YTD as presented in Chart 2. Foreign holdings in the bond market saw an outflow of RM3.5 billion in April 37.1% of the MGS holdings in April as shown in Chart 3.

• Selling pressure on the bond market remains. It is expected to stem from the outcome of the likelihood of the Norwegian sovereign wealth fund with its US$1.96 billion or 5.4% of foreign holdings, pulling out from 10 emerging market countries in which Malaysia is also included. Besides, there is the potential risk of FTSE Russell downgrading us to Tier 1 from Tier 2, where our estimated exposure is around US$8 billion which translates to about 21.8% of foreign MGS holdings as shown in Chart 4.

B. But there is some risk of reducing effectiveness of ‘monetary multiplier’

• A cut in the SRR will provide liquidity in the market. Our estimates show that a 50bps reduction in the SRR should release about RM7 billion of liquidity into the system. Assuming the SRR is set at 1%, it would release an estimated RM35 billion of liquidity back into the system.

• The risk in an SRR cut is that the funds released could find its way flowing more into the financial markets and lesser into the real economy through lending. This happened in 2016. The SRR cut in January failed to support lending and instead favoured the bond market as shown in Charts 5 and 6. And in July 2016, the OPR was also reduced by 25bps. Still, the loans continued to point south while bonds benefitted and savings rose as shown in Chart 6 and Chart 7.

• Such trend could to take place this time around with the overall business and consumer sentiments softening and savings on the uptrend. Such a setting, if it continues, is expected to reduce the effectiveness of the “monetary multiplier”.

• Nonetheless, a reduction in the SRR could still take place. Our fiscal space is currently limited as the government is determined to ensure the fiscal consolidation effort is not jeopardized by the current slowdown. In addition, fiscal policy works with a lag and is normally effective in the medium and long term. Thus, monetary policy has to lend support although it cannot shoulder the entire burden of supporting the economy. Easing monetary conditions appears to be based on the “orthodox policy”, especially when our growth momentum wheels lower with the counter-cyclical fiscal policy being constrained.

• A further adjustment to the OPR over and above an SRR cut could also take place. If this happens, it implies the need to ensure the degree of monetary accommodativeness remains consistent with the policy stance to support the domestic economy on a steady growth path amid stable inflation.

Source: AmInvest Research - 29 May 2019