OPR Cut: Was That Necessary?

On January 22, 2020, Bank Negara Malaysia (“BNM”) cut its Overnight Policy Rate (“OPR”) by 25 basis points to 2.75%. Some were caught by surprise!

Was BNM signalling that 4^th quarter GDP (for 2019) will not be great? BNM says it is a “pre-emptive’ measure to contain uncertainty in the global sphere.

Some may argue that global economy may actually strengthen with Phase 1 trade agreement between the U.S. and China. Perhaps, a higher volume of trade will enhance Malaysia’s trade flows?

Central banks resort to lower interest rates in order to boost economic activity and hence GDP. Empirical evidence suggests rate cuts may not stimulate growth, especially if business outlook is cautious and domestic demand is tepid. Yields on Malaysian Government Securities (MGS) shed about 10 bps to 13 bps after the announcement. Exchange rate showed a marginal decline.

What if it had raised rates? What signal would that give? Mortgage rates would increase, savings and deposit rates will increase, credit card rates will increase, auto loans will increase in interest rate and stock market indices may decline. Savers are generally rewarded while borrowers are now negatively impacted. Investors in equities or projects may delay their investment because conditions are not favourable. Exchange rate, however, may appreciate against the U.S. dollar and reduce cost of food imports. (Malaysia imported nearly RM20 billion processed food in 2018 (The Star, June 5, 2019).

Now with the Coronavirus epidemic, tourists coming to Malaysia will drop, retail sales may decline, and investments could be deferred. So the “pre-emptive” move by BNM looks timely in light of recent developments. For China, the outbreak could cost more than 40 billion Yuan (USD 5.8 billion) and shave 1% off China’s 2020 GDP growth. For Australia, GDP may fall by USD2.3 billion and 20,000 full-time jobs could be at risk. This is after the horror of a bushfire season.

A 2004 analysis determined that SARS cost the world economy about USD40 billion, travel, trade and financial flows had direct and knock-on effects. Oil prices fell by 20% during the 2002-2003 SARS season.

What about Malaysia?

SARS in 2002-2003 impacted tourism by a third, hotel occupancy plunged, air travel was decimated, restaurants, cinemas and entertainment outlets struggled to remain in business. Growth was dented by 0.5% for Southeast Asian countries and China suffered 1-2% reduction in its growth rate (Centre for International Development). SARS caused a USD25 billion loss to China alone. Global impact by Australia’s Griffith University puts it at between USD30-100 billion. And now 20 years after SARS, we face another health emergency that will impact lives and the economy.

So what about the OPR cut?

It is a pre-emptive move but can consumption and investment step-up? Not with Coronavirus! People will remain cautious. The only parties likely to step-up are glove manufacturers and those producing N95 masks (or other medical aids). We need fiscal support to assist sectors impacted, stimulus for sectors encouraged and much needed reforms of “sacred” policies.

References:

1. Bank Negara’s puzzling pre-emptive move to cut OPR, Ranjit Singh, Focus Malaysia

2. SARS wiped $40 billion off world markets; what will coronavirus do? Martha C White, NBC News

3. Food security is important, Star Online, 5 June 2019

4. Coronavirus could cost Australia’s struggling economy billions, Daily Mail Online, 27 Jan 2020.