Fitch: Expect Another Round of Policy Rate Cut By Bank Negara To Save Economy

Fitch Solutions maintains its forecast for the central bank to cut its policy rate by 25bps to 1.50% in 2021 in order
to support the economy against the impact of the third wave of Covid-19 infections and the lockdown measures taken
to contain it.

Indeed, rising fiscal constraints will mean that Bank Negara Malaysia (BNM) will have to use its policy space to
aid the recovery. Given that inflation is likely to remain low due to the economic disruption, BNM will be able to reduce
interest rates without stoking price pressures. However the agency added that its forecast is still subject to downside risks and will depend on the full extent of the fallout from the lockdown over the coming months, BNM could cut interest rates more.

On March 4, BNM decided after its monetary policy committee meeting to hold its benchmark Overnight Policy Rate
(OPR) at 1.75%, which was itself the result of 125bps worth of cuts in 2020 in order to support the economy against the pandemic’s impact. In the statement accompanying the decision, BNM struck an optimistic tone despite acknowledging the risks arising from the third wave and the lockdown measures, saying that ‘while the re-imposition of containment measures will affect growth in the first quarter, the impact is expected to be less severe than that experienced in the second quarter of 2020’. Significantly, BNM expects the economy to begin recovering from the second quarter onwards. Fitch on the other hand does not hold such an optimistic view as to the speed at which the outbreak can be brought under control and greater degrees of normalcy restored.

We continue to see a softer inflation outlook in 2021 due to the disruption and resulting spare capacity caused by the
lockdown, although the extent of this softening will be mitigated somewhat by likely rising oil prices in 2021. However, in
light of a slow start to inflation in 2021, we have revised our average inflation forecast to 1.3% y-o-y from 1.8% y-o-y
previously. This benign inflationary environment will allow BNM to cut interest rates to support the economy. Indeed,
2021 has begun with 0.2% y-o-y deflation in January and as data from the rest of Q121 comes in, we expect to see a
deepening of this trend.

Another key factor solidifying the conviction for a rate cut is the lack of fiscal resources to enact stimulus to support the economy. Government debt levels at 61% of GDP as of Q320, are already above the legal debt limit of 60% that it has set for itself. Furthermore, even if the government raises the debt limit for the second time since August 2020 to 65% of GDP, it is still left with little room for further spending, while raising the debt limit further to 70% of GDP could have an outsized impact on investor confidence and is unlikely to be considered

Its noted that the rate forecast remains subject to downside risks, and depends largely on the shape of the recovery
once Malaysia lifts lockdown measures over the coming months. And furthermore, the country faces significant political uncertainty in H221, when another general election could be called, leaving a coordinated fiscal and monetary response to any shocks even less likely.

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