BNM Did The Right Thing!

The decision of not raising overnight policy rate (OPR) was a right one!

While the latest CPI inflation of 7.7% yoy seemingly alarming, the impact of rising costs on general prices is definitely not something that Bank Negara is capable of solving it. Interest rate is not the answer to all problems relating to inflation. In my previous posting, I made it clear that there is also the risk of slower growth. Consideration needs to be given to the deflationary impact of fuel price increases on consumption and debt servicing ability. In economies experiencing overheating and strong demand, there is a need for monetary policy to rein in demand, but that is not the current operating environment.

At times, the non-interest rate measure can be more effective. So far, the government has made the following supply-side announcement to deal with inflationary pressures:-

• Banned exports of 10 essential items – sugar, wheat flour, cooking oil, chicken, cements and clinker (except with permits), mild steel bars, petrol, all grades of spirits and gasoline for motors, diesel and LPG.
• RM 4bn for food security policy
• Additional RM500mn for agriculture and agro-based industries
• Higher monthly quota for extra-subsidized diesel to school bus operators and taxis
• Streamlined LPG prices between Sabah-Sarawak with Peninsular
• Abolition of 5% service tax on restaurants (outside hotels)
• One-off cash for vehicle owners plus road-tax cuts
• RM100mn micro-credit scheme for urban low income group

And certainly, there are more supply-side measures that can be adopted to fight rising inflationary pressures in the coming Budget, including adding more products to the list of controlled items, additional allocation for agriculture and agro-based industries, improving public transport services, cut in import duties and cut in personal income tax or greater tax relief/rebates plus cut in EPF contributions.

In the own word from the latest Monetary Policy Committee (MPC) of 25 July 2008, ‘…In the next twelve months, while both the risks to higher inflation and the risks to slower growth have increased, the immediate concern is to avoid a fundamental economic slowdown that would involve higher unemployment. Slowing growth itself will contribute to containing the potential for second round effects on inflation, thereby containing further increases in prices in the second-half of 2009’, I interpret that economic growth has take greater precedence over inflation as key determinant for future direction of interest rates.

The additional enhancement to the latest monetary statement compared to MPC statement in 26 May 2008 is the view that slowing economic in turn will propagate the potential for second-round effects on inflation. Arguably that if the economy to be spared from the second round inflationary impact, slow down in economic momentum must be avoided at all cost, at least not from triggering hike in interest rates. I see as one of the many great ways for authority in explaining why rates hike to be avoided for the foreseeable future.