The real interest rate becomes negative

This article first appeared in The Edge Financial Dailyon March 22, 2017.

KUALA LUMPUR: If you put your money in a national savings account, your purchasing power may be depleted. Indeed, the real interest rate in the country has turned negative, with the consumer price index (CPI) rising 3.2% in January from a year earlier, its highest level since February. 2016.

The CPI is an indicator of the rate of inflation in the country and the latest rate is higher than the 2.8% growth predicted in a Reuters poll. It is also higher than the 1.8% growth of December 2016.

Vincent Loo Yeong Hong, an economist at RHB Research Institute, said that despite the institute’s target of a 3% inflation rate for 2017, there is upside risk to the target due to the rise in raw material prices.

Loo added that the negative real interest rate may widen as Bank Negara Malaysia (BNM) is unlikely to raise the interest rate as the economic growth is still not very strong and impressive.

“What we are facing now is quite a challenge,” Loo told Edge Financial Daily. “Economic growth is not very strong as inflationary pressures continue to weigh on consumers’ wallets. I don’t think there is much room for the BNM to tighten monetary policy despite a possible rise in the inflation rate.

“Currently, if you put your money in a savings account, you will see a drop in purchasing power, but if you put your money in FD (fixed deposit), you will still see a little gain because it is higher than the OPR (overnight deposit rate) rate of 3%,” Loo said.

He shared that the weakness of the ringgit remains, hurting the purchasing power of Malaysians. However, he said, the weakening of the local currency has helped ease the exchange rate, boosting Malaysian exports.

“The economic environment remains gloomy. We are not yet out of the bottom, but there are outward signs indicating the start of a recovery,” added Loo.

Another economist, Julia Goh of United Overseas Bank (M) Bhd, is also of the view that BNM is unlikely to raise RPO in the current environment.

“I see negative interest rates persisting. The jump in inflation is largely driven by the costs of rising energy and commodity prices as well as the pass-through from a weaker currency.

“However, this is likely to be temporary assuming global oil prices do not move significantly above USD 60 (RM265.20). [a barrel].

“While we see some upside to growth from improving export prospects, overall GDP (gross domestic product) growth will still remain below potential growth levels, meaning the economy is still functioning. below its full potential, which does not justify any rate hike.

“Rising rates could also lead to increased NPLs (non-performing loans) and credit quality issues. As such, we believe BNM is more likely to keep rates unchanged,” Goh said in an email exchange with The Edge Financial Daily.

Affin Hwang Investment Bank Bhd economist Alan Tan was slightly more positive as he expects current inflationary pressures to normalize to below 3% in the second half of the year.

“Inflationary pressure comes from the cost push factor and is not demand driven, so it is unlikely to persist. We expect inflation to reach around 3.5% in the first quarter of 2017 before normalizing to below 3% in the second half of the year Malaysia’s full-year inflation rate is expected to remain below 3%,” Tan said.

He added that the level of growth has shown a positive trend in recent months globally.

“If there is a sustained pick-up in demand-driven inflation, it is likely that the BNM will review monetary policy,” he said.

Earlier this month, The Edge Financial Daily reported that economists expected the RPO to remain at 3% as the current economic situation did not warrant the central bank raising the rate. Furthermore, the BNM said that at the current level of the OPR, the monetary policy stance is accommodative and supportive of economic activity.

However, at the current TPO of 3%, Malaysia is already in a negative real interest rate environment and with inflationary pressures resulting from rising commodity prices, it is likely that the real interest rate falls further into the negative range.

The weakness of the ringgit is another factor that contributes to the decline in the purchasing power of Malaysians. Compared to most of its peers, the ringgit continues to be the weakest currency in 2017, outperforming only the rupee, Philippine peso, yuan and Hong Kong dollar. This is despite the price of oil hovering above the US$50 level.

Tan, however, expects the ringgit to gradually recover against the US dollar in the second half of the year, with some of the uncertainties surrounding US President Trump’s policy expected to ease by then.

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