The central bank in Malaysia is keeping an eye on macroeconomic stability at a time when a cooling external environment is putting pressure on growth. While international factors are starting to affect overall economic performance, domestic demand remains relatively robust, supported by consumer spending and public investments.

On July 11, the Bank Negara Malaysia (BNM), the central bank, announced it would be maintaining its key policy rate on hold for the 13th consecutive month. The bank kept its benchmark overnight rate at 3%, as analysts surveyed by Bloomberg had expected.

The BNM decision balanced concerns of both a slowdown in the economy and rising personal debt. Malaysia's year-on-year GDP growth has dropped below 5% for the first time in seven quarters, while household borrowing has been increasing at an annual average 12% for five years.

In a statement, the bank noted that slow global growth had begun to act as a drag on the Malaysian economy, as in other emerging markets, despite healthy domestic demand. Domestic consumption has helped Malaysia and many of its neighbours weather the economic turbulence of recent years, with the rebalancing of the economy helping reduce dependence on exports, which have proved susceptible to slowdowns in Europe and the US.

"For the Malaysian economy, domestic demand has continued to support growth amid the continued moderation in external demand," the bank said. "The sustained weakness in the external sector may, however, affect the overall growth momentum."

Even so, the bank retains a positive outlook. It expects private consumption to stay steady, led by income growth and a stable labour market, and capital investment both from domestic-oriented industries and government infrastructure projects to help maintain economic momentum. Malaysia is in the process of rolling out the government's Economic Transformation Programme (ETP), a wide-ranging package of projects, including infrastructure schemes, designed to boost productivity and increase the private sector's ability to drive growth.

The BNM is also comfortable with Malaysia's inflation outlook. Inflation averaged 1.6% in the first five months of the year -low given the rate of economic growth. And while the central bank expects the rate to pick up in the second half of the year, it does not foresee inflation becoming a serious risk factor.

Despite low inflation and slowing growth, the BNM avoided cutting rates, keeping a wary eye on rising debt in an economic climate that has become more volatile in recent months. Malaysia's experience in the 1997 Asian financial crisis makes policy-makers particularly aware of the need for financial and macroeconomic stability.

In early July, the BNM tightened regulations on lending, cutting the maximum repayment terms on personal loans to 10 years and property loans to 35 years, down from 25 year and 45 years, respectively. Some analysts quoted in the international press suggest that the bank may become more hawkish on interest rates as well towards the end of the year, if growth remains resilient.

Following a period of strong capital flows to emerging markets, there has been a cooling off recently in the wake of signs from the US Federal Reserve that it would not push forward its quantitative easing (QE) policy. QE, a strategy of stimulating the economy through expansion of the monetary base, had boosted inflows to emerging markets as investors sought higher returns than those available in developed economies. Malaysia, with its macroeconomic and political stability and stable growth rate, proved particularly attractive: by February, foreigners held almost half the country's outstanding sovereign debt.

With QE now likely to be phased out and signs of a slowdown in major emerging markets such as China (a key export market for Malaysia), investor appetite for Malaysian assets are expected to abate. However compared to advanced economies Malaysia along with the rest of South East Asia will continue to enjoy a higher rate of growth thanks to relatively stable domestic demand and investment.

By oxfordbusinessgroup.com

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