Monday, July 28, 2008

BNM Maintain OPR At 3.5%: Right or Wrong?

Does Bank Negara Malaysia (BNM) made the right decision by maintaining base rate at 3.5%?

Yes, (should not increase)

1. Prevent economy slowdown & higher unemployment. Higher interest rates would deter both capital investment & consumer spending. Fall in these two would possibly send Malaysian economy into recession given that we are already slowing down. Besides, in the environment of high interest rates, employers may opt to cut jobs on the basis of cost management

2. Demand pull vs. cost push inflation. Interest rates are normally raised to combat demand pull inflation resulting from excessive spending into the economy by households & private sectors. However, we are facing cost push inflation due to high oil prices & fundamentally it is not right to raise base rates. If we insist, inflation may be lowered at the expense of economy running into a recession

3. Cushion the impact of global economy slowdown. If the present situation prevails, borrowings can be increased to finance productive growth domestically. In current capacity, it’s difficult to export ourselves out given that slowing economy is inevitable in US & Western Europe

4. Unavoidable trade off. While it is true that spiraling inflation rate erode savings from fixed deposits, but this is the social cost the nation has to pay to battle tough times

5. Healthy fundamentals. Interest rates need not be adjusted downwards too given that our current account was in surplus to the tune of 16% of GNP last year (The Edge, 28th July 08). Others like Malaysia’s total debt to GDP is only 40% & federal government deficit is 3.2% which is far from the 5% which indicates that the economy is in trouble

No, (should increase)

1. Stronger ringgit is a must. By raising the interest rates, it will help Malaysia a lot since this will lead to appreciation of ringgit, which means relatively cheaper imports. Bear in mind that many food & general items in shops are imported. What’s more now they are even pricier due to global stagflation (imported inflation)

2. Inflation is hurting growth not now, but future. If interest rate is not raised, it may temporarily boost economic growth when there is increase spending into the economy by both households & firms. With the ambitious government expenditure under 9th Malaysia Plan (9MP), spending has increased from RM30 billion to RM 230 billion. Hence it’s just a matter of time before inflation is ballooning. That’s not all. There is already table talk to increase wages & introduce minimum wages in Malaysia. The combination of these may send inflation level to another record high

3. Enforce efficiencies. While it is true that increase in base rates may deter firms from expanding their business, it must be looked positively from another angle. Higher costs of doing business, may force those firms to be more cost efficient. As such, this means shifting aggregate supply to the right resulting in economic growth & yet lowers inflation

4. Ringgit will depreciate. If Malaysia interest rate is lower than global rates, investors will flee ringgit assets & place their money in higher yielding assets elsewhere, which will pressure ringgit to depreciate. In the period of imported inflation & stagflation, depreciating currency is the last thing we want

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