Malaysia precariously balanced after rate cuts

Malaysia precariously balanced after rate cuts

By Jalil Hamid

KUALA LUMPUR (Reuters): Malaysia has taken a high stakes gamble over the economy, pushing down interest rates in line with Prime Minister Mahathir Mohamad's strategy for spurring growth, but risking a still weaker currency.

In a major policy reversal that marked a blow to Mahathir's deputy Anwar Ibrahim, Malaysia's central bank last Friday eased its tight monetary policy by lowering a key interest rate.

Analysts said while lower rates could provide some breathing space to businesses, they were unlikely to halt an economic slowdown and could put the ringgit currency under pressure.

The central Bank Negara said late last Friday that it would cut the benchmark three-month intervention rate to 10.5 percent from 11 percent effective Aug. 3. The rate cut was expected to feed through into lower bank lending rates.

With inflation contained and the current account swinging into surplus, the "fundamental trends provide Malaysia with the room for a cautious easing of monetary policy to minimize the severity of the downturn in (the) domestic economy".

"I think there's room for maneuver now," said a senior banking industry official familiar with Bank Negara's deliberations. "The pressure on inflation is tapering off."

Until now, Bank Negara had steadfastly stood by tight money as the best way to defend the ringgit and pave the way for economic recovery. But that orthodox approach has all but fallen by the wayside because of lackluster growth, weak corporate earnings and a sagging stock market.

Mahathir and Special Functions Minister Daim Zainuddin have campaigned for lower rates to help businesses survive the recession.

Like the International Monetary Fund, Anwar, who is also the finance minister, has shared the central bank's worries that a reduction in interest rates would undercut the ringgit.

"In a way, Anwar has been accused by some of following IMF guidelines on tight interest rate regime," said political commentator Rustam Sani. "It seems that decision-making on the economy has now shifted from Anwar's side to Daim's."

The once-vibrant economy is officially forecast to contract by one to two percent in 1998 amid Asia's financial crisis. But analysts reckoned that it could shrink as much as four percent. They said the rate cut was unlikely to spur an upward revision.

Malaysia's depressed stock market could gain on the rate cut news but analysts said it could be bad news for the already weak ringgit. The ringgit, now at some 4.14 to the U.S. dollar, has lost over 30 percent of its value against the dollar since the Asian financial crisis erupted in mid-1997.

"The ringgit may come under pressure as a result of the move, though this may be mitigated by the fact that other Asian countries such as Thailand and South Korea had cut rates before," said markets consultant firm S&P's MMS International.

Banking industry officials said the climate was now ripe for an easier stance. "In this kind of environment, there's room for cautious easing of monetary policy," said a senior banker.

Officials said recent foreign investment commitments could support the ringgit. They cited the sale of a big stake in telecoms firm Binariang to British Telecom [BT.L] and new investment commitments by Shell [RD.AS] [SHEL.L] in Malaysia.

The rate cut came days after Malaysia, hit by twin rating downgrades, shelved plans to raise $2 billion from the international bond market to help fund banks' sour loans.

Analysts said Malaysia could not afford to bring interest rates down too far or risk pricing itself out of the Eurobond market.

Some analysts expected Bank Negara now to cut banks' statutory reserve requirement (SRR), or funds required to be kept interest- free with the central bank. A one percentage point cut in the SRR would release four billion ringgit ($1 billion) into the banking system.

The SRR was cut to eight percent from 10 on July 1. Analysts said the international standard for SRR is three percent. The additional liquidity from an SRR cut could be used for banks' recapitalisation, analysts said.