Interesting Case of Malaysia

Malaysia will report July CPI figures and Q2 GDP data on Wednesday. The data is expected to show that inflation pressures remain near 2-year highs of around 3.5% year-over-year. With the o/n policy rate at 3.0%, Bank Negara has been under pressure to raise rates. It has hiked rates once this year after three hikes last year.

However, what blunts this pressure is the global economic uncertainty and the fact that domestic economy likely slowed markedly in Q2 to 3.6% year-over-year from 4.6% in Q1. This will be the slowest pace since the recovery began in Q4 09. Each quarter has seen the pace of growth moderate since Q1 last year.

Although Malaysia is a small country (GDP=~$235 bln), these challenges appear broadly representative of many countries in the region. Concern about the near stagnation of Europe and the US coupled with elevated price pressures. Commodity prices have come off the boil as WTI is well below $90 and the CRB index is off about 11.5% from its early May high. Hence the interest in unconventional (macro prudential) policies and the reluctance to hike interest rates.

Again this applies not only to Malaysia, but a number of other countries. A common response, including in China, seems to be to allow the currency appreciation to do more of the work of curbing price pressures. The Malaysian ringgit has appreciated in the Asian session for six days running. Through yesterday, during this run, it has been the strongest currency in the region, but today, the strong foreign demand for Korean shares (the first time in a couple of weeks ) helped the won rise faster.

Malaysia has in the recent past sought to stem the ringgit's appreciation. In doing so, it has amassed a significant war chest of currency reserves. At about $121 bln, its reserves are a little more than 50% of GDP and are up more than 40% year-over-year. The ringgit reached a 14-year high against the dollar last month and shed almost 4% earlier this month amid the market turmoil. However, it has recovered more than 2/3 of those loses during this advancing streak.

Although the local market is off 1.3% this year, it is among the better performers in the region, with only Indonesia, Thailand and the Philippines doing better by posting modest advances. The uncertain economic outlook and the relative low volatility of the MYR may encourage fixed income investors to look at Malaysia as a bit of a carry trade.

At the same time that some Asian countries appear more willing to allow their currencies to appreciate to stem inflation, it implies less pressure to intervene. The possibility of less intervention coincides with the drop in US Treasury yields, which might dishearten if not discourage central bank Treasury purchases. This in turn may help explain why the Fed's custody account for foreign officials, which has been fairly flat in recent months, may not accelerate soon.