(Aug 27): Malaysia must keep the door open for further monetary policy tightening to tamp down any price pressures as the government winds down subsidies, according to the Organisation for Economic Cooperation and Development (OECD).

“The current monetary policy stance seems adequate and provides room to accommodate a temporary increase in inflation,” the OECD said in its Economic Survey on Malaysia published Tuesday. “At the same time, monetary authorities should stand ready to raise rates to counter possible second-round effects from higher energy prices,” it said.

While Malaysia’s inflation has stabilised around 2%, there are “significant risks” around the price growth trajectory that warrants caution, according to the OECD. The report comes as easing price pressures in countries including the US have given central banks the scope to start pivoting to rate cuts. The Philippines reduced borrowing costs from a 17-year high earlier this month while Indonesia and Thailand have signalled openness to loosen monetary settings.

The inflation trend in Malaysia depends a lot on the pace of subsidy removal, which explains why it faces the risk of further monetary tightening unlike its peers. This too, as the inflation effects of the subsidy withdrawal are highly uncertain, according to the OECD.

Prime Minister Datuk Seri Anwar Ibrahim allowed diesel prices to float in June in order to strengthen government finances. He intends to do the same with the more heavily subsidised and most widely used fuel RON95. The move could potentially increase inflation by 3.05 percentage points, according to calculations by RHB Bank Bhd analyst Chin Yee Sian, who expects the government to push the RON95 subsidy removal to end-2024 at the earliest.

Malaysia increased its key rate by 125 basis points over a one-year tightening cycle that started in May 2022, taking the overnight policy rate to 3% from a record low 1.75% during the pandemic. The statutory reserve requirement that was also cut during the height of Covid-19 has remained well below pre-pandemic levels.

In the best case scenario, removing energy subsidies could increase inflation temporarily, said the OECD. But there could also be more enduring second-round effects and more widespread upward pressures, it said.

“Against this background, it is important to avoid a premature easing of the monetary stance and to respond quickly to any inflationary pressures that could result from the planned reform of subsidies,” the OECD report said.

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