Baseline estimate is for a slight improvement in global growth in 2017

Bank Negara Malaysia (BNM) kept its overnight policy rate (OPR) at 3.0% in the final Monetary Policy Committee (MPC) of 2016, unchanged for the second straight meeting after a surprise 25bps cut in July 2016. We believe this was partly attributed to the central bank’s baseline assumption of only a slight improvement in global growth in 2017. BNM acknowledged that “the prospect of a shift towards progressive use of fiscal policy in the developed economies could lead to a more balanced policy environment that would support growth going forward.” We believe the statement may be in reference to the proposed infrastructure spending plan by President-elect Trump in the US as well as similar measures in UK and Japan to stimulate their economies from 2017 onwards.

On the domestic front, BNM continued to expect Malaysia’s economy to expand, as reflected in 3Q16 GDP growth of 4.3% yoy, with private sector activity as the key driver of growth. Going into 2017, BNM noted that “private consumption is expected to be sustained by continued wage and employment growth, with additional support from Government measures to increase disposable income. Investment activity, although moderating, will be supported by on-going infrastructure investments and capital expenditure in the manufacturing and services sectors.” In tandem with the official forecast, we believe BNM is looking at the underlying real GDP growth to be at a range of 4.0-5.0% in 2017, an improvement from 4.0-4.5% in 2016. On the inflation front, BNM expects headline inflation to be at the lower end of 2.0-2.5% for 2016, with inflation remaining relatively stable in 2017 in view of low global energy and commodity prices, as well as subdued global inflation.

However, in the latest MPC statement, BNM also cautioned that “there is uncertainty arising from risks of protectionism and financial market volatility.” We believe the statement may again be in reference to the unexpected outcome of the US presidential election, which have led to the recent sharp depreciation of Ringgit against US$. In our view, this was attributed by concerns of the uncertainty surrounding risks associated with protectionist policies, that Trump may use the threat of tariffs against Asian countries (especially China) to correct US trade imbalances with the region, which may put downward pressure on Malaysia’s exports and economic growth.

Similarly, BNM also cautioned that “heightened financial market volatility in recent weeks has had an adverse effect on various asset classes, exchange rates and yields across many emerging economies.” This concern may be referring to current weakness of ASEAN currencies (including Ringgit) and yields possibly over fear of inflation and interest rate hikes in the US. Trump in his campaign has proposed a huge US$1trn infrastructure spending over 10 years as well as lowering corporate and personal income taxes to stimulate private investment and accelerate economic growth in the US. Putting aside the uncertainty on whether the stimulus will be approved as well as the impact on US federal government debt level, market observers expect that higher inflation may lead to more aggressive rate hikes in the US. As such, sharp improvement in yields of the US$ denominated assets may risk some capital outflow from Asia back to the US, as investors also expect a sharper appreciation of the US$ against regional currencies.

This has already been reflected in the steeper US Treasury yield curve, where 10-year UST has risen by close to 50bps since the Presidential Election day. Going forward, Trump’s unpredictability on trade policies and possible aggressive rate hikes in the US are potential risks on further financial market volatility. However, we believe Malaysia’s economic fundamentals continue to remain sound, and be in a better position to deal with volatile capital flows, supported by sustainable current account surpluses, healthy foreign exchange reserves as well as manageable inflationary pressure. BNM also gave the assurance “to provide liquidity to ensure the orderly functioning of the domestic foreign exchange market. The capital market remains accessible, deep and liquid. Banking system liquidity is ample. Financial institutions continue to operate with strong capital and liquidity buffers and the growth of financing to the private sector is consistent with the pace of economic activity.”

US Fed unlikely to hike fed funds rate aggressively in 2017

Judging from the dot plots of fed funds rate (FFR) expectations, the FOMC members are still guiding that any increase in the FFR is likely to be gradual. US Fed has guided one rate hike for 2016 (in December), and possibly a gradual two hikes in 2017. As such, the interest rate differential between the US FFR and Malaysia’s OPR remains positive. Overall, as BNM’s monetary policy is forward-looking, despite noting that the risk of destabilising financial imbalances has been contained, we believe BNM will likely maintain its policy rate at 3.0% throughout 2017.

Bank Negara Malaysia (BNM) had earlier highlighted in a press release that “the ringgit is a non-internationalised currency, where prices should be fully determined by onshore financial market transactions that are be driven only by the fundamentals and genuine trade and investment activities in Malaysia.” As such, despite some downside risks to the country’s reserves, we believe the short term negative volatility, particularly on the capital and foreign exchange markets, will likely be manageable.

Source: Affin Hwang Research - 24 Nov 2016