Bank Negara Malaysia (BNM) made a surprise cut to the Statutory Reserve Requirement (SRR) by 50 basis points (bps) to 3.50% while maintaining its monetary policy stance leaving the Overnight Policy Rate (OPR) unchanged at 3.25% at the first of six Monetary Policy Committee (MPC) meetings scheduled for this year. BNM said the SRR cut is to raise liquidity in the banking system. In its monetary policy statement, BNM said its current policy stance remains accommodative and supportive of economic activity. Though the SRR cut increases the likelihood of a shift to a looser monetary policy stance, we expect BNM to maintain the OPR at 3.50% for this year. We expect more SRR cuts in the offing if the need arises.

• BNM made a surprise announcement by reducing the SRR by 50 bps to 3.50%. This is the first change to the ratio of reserves banks are required to maintain since 2011. The 0.5 percentage point (ppt) cut is a welcome decision by BNM which would work to reduce the high loan-to-deposit ratios in the banking system and reduce funding costs for banks. BNM stated that the SRR cut was not a signal on the stance of monetary policy.
• This is the ninth MPC meeting in a row with the OPR left unchanged since a one-off increase of 25 bps to 3.25% in July 2014. The decision by the MPC is in line with market polls which unanimously predicted no change to the OPR.
• Following the 0.5 percentage point (ppt) SRR cut we estimate it will release about RM6.3b in liquidity. This will add to the total of about RM40.0b which BNM said it has added into the system since early 2015 via its regular monetary operations to offset the impact of net external outflows.
• The last time the SRR was cut by 0.5 ppt was at the height of the global Financial Crisis in Nov 2008 from 4.0%. Subsequently it slashed the SRR by 1.5 ppt to 2.0% in February of 2009 followed by another 1.0 ppt cut in March to reach its lowest point of 1.0%.
• Depending on the domestic liquidity condition and the impact of another Fed rate hike, we do not rule out the possibility of more SRR cuts in the upcoming meetings.
• Since the last MPC meeting on November 5, 2015, foreign exchange reserves have gradually increased and the USDMYR cross rate remained relatively stable within the 4.20 – 4.40 range. Crude oil prices have fallen further below expectations and now average below US$30 a barrel, posing a risk to fiscal sustainability.
• In December 2015, the US Federal Reserve made a historic move to raise the Federal Funds Rate above the zero bound. Calmer financial markets resulting from this move could spur BNM to look into making refinements to its monetary policy, which was not possible a few months ago when the ringgit exchange rate was fluctuating wildly.
• Despite the increased downside risks to growth for the Malaysian and regional economies, BNM assured that the current OPR remains accommodative and supportive of economic activity. While its monetary policy stance remains unchanged, BNM acknowledged that close monitoring of macroeconomic conditions is necessary.
• We maintain the view that the current monetary stance will remain unchanged and further expect no change to the OPR in the near-term, barring any unforeseen risk to growth. We however view that the bias for looser monetary policy has increased.
• BNM’s outlook for the Malaysian economy is that of lower growth in 2015 compared to 2015. Domestic demand will however continue to be a significant support to the economy.
• Our assessment of historical movements in the OPR in relation to global manufacturing PMI is that current BNM’s policy stance is about right. A proxy for worldwide aggregate economic growth shows that manufacturing activity is well under the 54 global PMI reading that would trigger a rate hike bias and above the 40 point mark that would beckon a rate cut.
• Since the last MPC meeting on November 5, 2015, the central banks of Taiwan and Indonesia moved to further cut their policy rates.
• Focus has not turned to the upcoming Federal Open Market Committee (FOMC) meeting on January 28. A rate hike is unlikely at this meeting but Federal Reserve chair Janet Yellen could provide guidance on the pace of rate hikes subsequent to the first one made on December 2015. Market is expecting the Fed to at least hike rates three more times this year.

Source: Kenanga Research - 22 Jan 2016