Policy Matters - BNM governor steps ahead of the curve

DATUK Muhammad Ibrahim, the new governor of Bank Negara Malaysia (BNM), in an unexpected move cut the overnight policy rate by 25 basis points. With this surprise slash, Muhammad has established his stamp on the role that BNM can be expected to play under his leadership.

Most analysts thought that there would be a rate cut towards the end of the year. But Muhammad has responded proactively, diverging from the more passive and tentative style that marked Tan Sri Dr Zeti Akhtar Aziz's timing of policy action.

By way of illustration, Zeti introduced a slew of measures (including the famous property gains tax) to curb rising property measures at a point when some analysts thought that the gates were being shut after most of the horses had run out of the stable. Not so, it seems, with Muhammad.

There are two reasons why Muhammad has acted the way he did.

First, it was an open acknowledgement of the fact that the global economy is taking a downward turn and that Malaysia has to be prepared.

The impact of Brexit may bode poorly for global markets and by default affect us negatively. How this will turn out is not clear at this moment. China's economic picture is not too rosy. As an indicator, one should turn to China's imports, which have contracted by 6.2% year-on-year. The World Bank has revised its global growth forecast to 2.4% from its forecast of 2.9% in January. Malaysia's export figures (year-on-year) have slipped down, while imports have increased.

Second, the domestic scenario supports Muhammad's decision. Household debt is high, the cost of living is high and inflation is tapering down. The brunt of the GST has waned, so there is no need to raise interest rates to curb inflationary tendencies now. Lowering interest rates may give some respite to households and encourage household expenditure.

With externally generated demand softening, Malaysia's growth has to turn to domestic sources to whip up the demand. A lower interest rate may help boost household consumption and prod companies into borrowing for investment purposes. One should not miss the fact that the rate cut decision was made without forewarning. Analysts were surprised because they had thought that if a change was coming up there would have been some hint of it in the previous Monetary Policy Committee meeting.

There are two possible explanations for this. First, this was, after all, Muhammad's second meeting. He might not have had enough time to size up the situation and premeditate on his actions before the first meeting. There could be a more significant reason for announcing the decision without preceding it with hints. The governor probably sees merit in intervening without giving markets time to warm up and adjust to policies. In other words, that is how he wants to handle expectations – firmly and decisively, so that policy has bite.

But there are limits on what the decision could achieve. A lower interest rate, in theory, would spur investment and consumer spending.

In practice the story could be different. Banks will not slacken in their lending policies, exercising due care in evaluating loans. Consumers could act perversely: the lower interest rates may encourage more household borrowing, rather than act as an incentive to settle outstanding loans. As for firms, if the global market is depressed, the lower borrowing costs may not translate into more investment expansion.

However, one cannot take it for granted that this will be the start of a series of rate cuts, as some analysts have opined. To do so, unless there is strong data to prompt such action, may not be productive.

With the figures as they are, and as events present themselves at this moment, it seems to make sense to lower interest rates. It is undoubtedly a confidence-boosting measure.

Shankaran Nambiar is author of The Malaysian Economy: Rethinking ­Policies and Perspectives. The views expressed in this article are his own.