PETALING JAYA: The biggest risk to Malaysia’s economic growth this year is high inflation, which may dampen the potential upside to the country’s economic recovery, according to RAM Ratings.

RAM senior economist and co-head of economic research Woon Khai Jhek noted that downside risks have become more prominent as all-time high inflation puts brakes on global growth.

“RAM is currently projecting (Malaysia’s) overall inflation to climb further to 3% this year from 2.5% last year, with much of the increase largely driven by higher food prices. And given that food constitutes around 30% of household expenditure, higher food prices will definitely hurt household budgets quite prominently.

“Price control measures and subsidy will somewhat help to mitigate it, but consumers will likely still face higher prices this year regardless. The resulting erosion of purchasing power is expected to hurt consumption, demand momentum, and weigh on recovery momentum in the second half of this year,” he said at RAM’s Insight Series webinar on “Banking Sector: Gearing Up for the Next Challenge” today.

However, he affirmed that economic recovery will tread a firmer path this year as the country transitions into the Covid-19 endemic phase. The firm momentum in H1’22 is anticipated to propel full-year growth to 5.8% from 3.1% in 2021.

Domestic demand will be the key driver, supported by the resilient labour market and ongoing policy support measures. Exports will also stay strong with sustained demand for electrical and electronic goods.

Meanwhile, RAM banking sector specialist Amy Lo reiterated its stable outlook for the local banking industry.

“Malaysian banks should continue to deliver resilient performances in the coming year although global and domestic conditions have become more uncertain. Sturdy capitalisation and strong provisioning buffers have put banks in a good position,” Lo said.

The rating agency expects loan growth this year to come in at 4.5-5% (2021: +4.5%), driven by both household and business loans.

“Loan applications began to pick up in Q4’21 underpinned by pent-up demand and the reopening of the economy. Bank Negara Malaysia’s two recent 25-bps Overnight Policy Rate hikes and another 25-bps increase expected in H2’22 may dampen credit demand somewhat but should not derail the loan growth momentum from our relatively conservative projection,” she said.

As debt forbearance plans expire, banks’ exposure to assisted loans dropped sharply to around 8% as at end-April to mid-May 2022 from 28% as at end-December 2021. Impaired loans will creep up as relief measures are rolled off, alongside rising inflation and interest rates.

“That said, we have seen early encouraging repayment trends for expired relief loans. At the same time, banks remain accommodative in extending additional support to distressed borrowers on a case-by-case basis, which could limit the uptick in impaired loans this year,” observed RAM’s co-head of financial institution ratings, Wong Yin Ching.

RAM does not foresee provisions rising in tandem with impaired loans in view of the large provisioning buffers built up since the onset of the pandemic. RAM projects the average credit cost ratio of the eight banks to recede to 35 bps in 2022 (2021: 49 bps), although still above pre-pandemic levels. Banks are likely to tread carefully with provision reserve releases until a clearer picture of post-relief repayment trends emerges.

Financial institution ratings co-head Sophia Lee said funding and liquidity profiles of banks is expected to stay healthy.

“As interest rates trend up, deposit competition will be keener and banks’ funding profiles will normalise more quickly. Current and savings account deposits will continue to decelerate after expanding at double digits in the last two years. Fixed deposits, on the other hand, have started to inch up, reversing the contractionary trend,” she added.

The lower cost of risk and broader margins from rate hikes will provide moderate upside to banks’ profitability. However, subdued trading and investment income amid upward pressure on bond yields as well as the one-off Cukai Makmur (prosperity tax) may erode some of these benefits. Capitalisation remains a key credit positive for the sector. A handful of banks had opted for transitional arrangements during the pandemic – an optional central bank forbearance measure which lifted banks’ capital ratios. Even after stripping out the effect of the temporary capital benefit and continued unrealised losses on bond valuations, RAM expects banks’ capital buffers to stay robust.