Keeping interest rates unchanged sensible, priority is growth

THE decision to keep interest rates unchanged last Thursday makes sense after looking at the big decline in industrial production.

The economy has lost quite a bit of momentum and with economists now expecting growth in the second quarter to come in at around 4%, the focus on keeping growth up at the expense of inflation is now the priority of the authorities.

A hint of such intent was spoken of by Bank Negara's monetary policy committee (MPC) when it issued its statement on Thursday.

“The MPC will assess carefully the evolving economic conditions and to the extent that the growth momentum is sustained, further normalisation of monetary conditions will be considered to safeguard price stability,” it said.

The reasoning behind it was, although inflation remained on the upside, the committee felt that while the outlook for growth remained positive, there were heightened uncertainties to economic growth arising from global developments that had created higher downside risks to growth.

Troubles in Greece, the sluggishness of the US economy and the supply chain disruption cause by the earthquake and tsunami in Japan have shaken the external environment growth prospects.

“The OECD composite leading indicators (CLIs) fell 0.23 point to 102.54 points in May (0.14 point drop to 102.78 points in April), marking the second consecutive month-on-month decline and pointing to a possible slowdown in most major economies,” said CIMB Research head of economics Lee Heng Guie in a note.

“The divergent growth rates between advanced and emerging economies remain but are converging.”

Lee noted that a similar slowdown in leading indicators was also seen in Asia where China's CLI declined in May for the fifth month in a row as the monetary tightening measures bit.

The CLI for India, too, was down in May, pointing to a further moderation in economic activity, he said.

While growth is now firmly in Bank Negara's crosshairs, it's not to say tackling inflation has taken a back seat. Bank Negara upped the statutory reserve requirement to 4% to mop up excess liquidity, and possibly relieve inflationary pressure, from the economy.

A higher interest rate would apply more brakes on the economy and even though economists were divided whether the central bank would raise borrowing costs last week, many felt the pause towards normalisation was the right thing to do right now.

The reason for their consternation was the dip in industrial production in May which showed activity at factories, mines and plantation had contracted by 5.1% year-on-year. April's figure was also revised to a contraction of 1.7%.

The culprit for the drop in May was the steep contraction in mining, in particular production of oil and gas which fell by 20.1% year-on-year.

Manufacturing was up marginally but apparently the sector is still feeling the effects of Japan's supply chain disruption.

“The disruption to Japan's industrial activities and global manufacturing supply chain from the natural disaster and nuclear power crisis was short-lived as indicated by the rebound in Japan's PMI (Purchasing Managers Index) to above-50 in May and June after the plunge in March and April,” said Maybank Investment Bank in a note.

“This should lead to improvement in manufacturing activities especially via re-stocking in the E&E (electronics and electrical) and automotive sector. At the same time, for Malaysia, the disruption to the oil and gas activities should be temporary and the consequent rebound in mining activities will add to the expected improvement in manufacturing activities to lift industrial production in the coming months.”

CIMB, too, was positive over the outlook in the second half of the year.

“In our view, growth will sustain but remain uneven given lingering headwinds. The slow and uneven growth in the US, sovereign debt risks in EU and supply chain disruptions in Japan are unlikely to halt global momentum. In particular, Japan's supply chain disruptions will be short-lived,” Lee in the note.

“Although we expect the growth of the global economy to slow somewhat in the first half, it should rebound in the second half.”

With the outlook right now for the economy to rebound in the second half, also aided by a lower base effect from the same period last year, economists expect a rate hike to take place this year over the remaining two meetings once the current growth bumps have been smoothened.