Strong Growth in Domestic Demand Expected to Continue Into 2018

Bank Negara Malaysia (BNM), in the Monetary Policy Committee (MPC) meeting, raised its Overnight Policy Rate (OPR) by 25bps to 3.25%, after holding the rate steady at 3.0% since July 2016. As the country’s monetary policy statement is “forward-looking”, the hike in OPR was consistent with BNM’s earlier guidance that “the MPC may consider reviewing the current degree of monetary accommodation.”

The latest global economic assessment in the MPC monetary statement was in line with the view expressed by the IMF. In its World Economic Outlook Update report, the IMF raised its global GDP growth forecast for the second time to 3.9% in 2018, from the 3.7% estimated in October last year. The optimism was attributed to the US tax policy changes, with a possible positive macroeconomic impact, in particular from the reduction in corporate tax rates, while economic growth in Europe and Asia will also be sustained this year. However, we believe BNM is also taking pre-emptive action with the latest move from possible sharper-than-expected policy rate hikes by the US Federal Reserve in 2018.

On the domestic economy, BNM expects real GDP growth to remain strong in 2018, likely at the upper end of the official forecast of 5.0-5.5%, with robust domestic demand. Growth in private consumption will be underpinned by favourable income and labour market conditions. On the investment front, BNM is also optimistic that the outlook for investment activity will be supported by new and on-going infrastructure projects and capital spending by both export- and domestic-oriented firms. Despite strong domestic demand, BNM is expecting the country’s headline inflation rate to trend lower in 2018, after the high of 3.7% in 2017, on expectations of a smaller effect from global cost factors, partly attributing this to a stronger ringgit exchange rate mitigating import costs. The ringgit has appreciated by close to 9.8% against the US$ to RM3.90 currently since 2H17. Nevertheless, BNM noted the overall direction of the inflation rate in 2018 will also be highly dependent on global oil prices, as the weighting of fuel prices in the CPI basket remains significant at 7.8%.

In the MPC statement, BNM guided that the decision to normalise the degree of monetary accommodation was to prevent the build-up of risks that could arise from interest rates being lower than necessary for a prolonged period of time. However, at the current level of OPR, BNM also guided that the stance of monetary policy remains accommodative, but it will continue to assess the balance of risks surrounding the outlook for domestic growth and inflation.

Going forward, we believe BNM will likely maintain its policy rate at 3.25% in 1H18. BNM will likely wait until 2H18 to gauge the state of the Malaysian economy, before deciding on whether to raise OPR further by 25bps to 3.5%, especially when the government is targeting domestic demand growth to sustain the country’s real GDP growth. We believe the strengthening ringgit may begin to raise some concerns among domestic manufacturers over export competitiveness. Following the announcement of forex measures, where BNM requires 75% of export proceeds to be converted into ringgit, the country’s net conversion for the period July to November 2017 rose by US$7.7bn, supporting the ringgit. Similarly, the amount of its swap positions by BNM has narrowed and improved from a high of US$19.1bn in April 2017 to US$11.1bn in November 2017, reflecting improving macro fundamentals and rising demand for the ringgit.

Source: Affin Hwang Research - 26 Jan 2018