Malaysia Central bank sees challenging year as inflation climbs

Bloomberg

Malaysia’s central bank said this year will be another challenging one for monetary policy as inflation pressure builds and risks loom over the economy.
Gross domestic product is forecast to expand 4.3 percent to 4.8 percent this year, Bank Negara Malaysia said in its annual report in Kuala Lumpur on Thursday. That compares with the government’s earlier forecast of 4 percent to 5 percent for 2017, and a growth rate of 4.2 percent last year.
“Although growth is expected to improve due to better performance of the external sector, the economy will be challenged by higher inflation, volatile capital flows and lingering uncertainties in the global economic and financial environment,” the central bank said. Inflation is projected to reach 3 percent to 4% in 2017, compared with an average of 2.1% last year, it said.
After a surprise interest-rate cut in July, Bank Negara has left borrowing costs unchanged in the face of a weakening currency and rising prices. While signs of a recovery in exports are growing stronger — reducing pressure on the bank to ease again to support the economy — the global trade outlook is still vulnerable to shocks, including the threat of protectionism in the U.S.
That’s complicating the outlook for monetary policy in Malaysia, with economists surveyed by Bloomberg diverging in their views on whether the central bank will raise, cut or keep interest rates unchanged this year.

Growth Outlook
Domestic demand will continue to be the main driver of GDP growth, particularly from the private sector, the central bank said. Investment growth is projected to remain modest in an “environment of cautious business sentiment and continued uncertainty in the economy,” it said.
A recovery in commodity prices may be a boost to the Malaysian economy and exports. Shipments of crude palm oil will likely rise this year, following the increase in prices and production volumes as yields recover from the effects of El Nino, according to the report.
Malaysia’s current-account surplus is forecast to narrow to 17.4 billion ringgit this year, from a projected 25.2 billion ringgit in 2016, according to the central bank.

Inflation Outlook
Inflation is projected to average higher in 2017, mainly due to the impact of higher oil prices on local fuel costs, the central bank said. The forecast range is higher than the finance ministry’s projection in October and comes after a spike in consumer prices in January. The ringgit, which has dropped 7 percent against the dollar in the past six months, is another contributor to faster inflation.
These cost-push factors aren’t expected to cause significant spillovers to broader price trends and core inflation is forecast to increase only modestly, the central bank said.
Currency Policy
The central bank said its exchange-rate policy remains the same: that the currency should reflect the “economic realities of Malaysia.”
Bank Negara warned foreign banks late last year against using offshore non-deliverable forwards to bet against the ringgit and vowed to limit speculation. It also imposed rules for exporters to hold at least 75 percent of export proceeds in ringgit from no such restrictions previously.
“As exchange rate volatility has become more pronounced and prolonged, it is important for policymakers to manage the trade-off between the benefits of allowing exchange rate flexibility to act as a shock absorber to the economy and the potential costs of allowing sharp adjustments in the exchange rate,” the central bank said.
Fiscal deficit
The government’s fiscal deficit is set to narrow further to 3 percent of GDP this year, from 3.1 percent in 2016, according to the report. Prime Minister Najib Razak removed subsidies on fuel and sugar and diversified revenues away from oil by introducing a 6 percent goods and services tax in 2015. Malaysia has been running a fiscal deficit since the 1998 Asian financial crisis and aims to gradually move to a balanced budget.
The contribution of oil-related revenue in the budget is expected to fall to 13.8 percent in 2017, from 14.6 percent last year, Bank Negara said.