MPC Statement: OPR Stays At 2.75%, SRR Up 1%

In a move that took nobody by surprise, the Monetary Policy Committee opted to keep the Official Policy Rate at 2.75% (excerpt; emphasis added):

Monetary Policy Statement

At the Monetary Policy Committee (MPC) meeting today, Bank Negara Malaysia decided to maintain the Overnight Policy Rate (OPR) at 2.75 percent...

...Global inflation is increasing primarily due to the rising energy and commodity prices. For several countries, this has been exacerbated by domestic demand conditions which have prompted policy responses. Meanwhile, most emerging economies, particularly in Asia, continue to be affected by significant shifts in global liquidity, which have increased the risks to macroeconomic and financial stability.

In the domestic economy, latest available indicators suggest continued expansion in private consumption and sustained business spending activity amid more modest growth in external demand. Going forward, economic growth is expected to be moderate in the earlier part of the year and to improve during the course of the year, driven by strong expansion in domestic demand...

...Domestic headline inflation has increased to 2.4% in January 2011. Driven primarily by the significant increases in global commodity and energy prices, domestic prices are expected to continue to rise. There are, however, some incipient signs that domestic demand factors could result in possible upward pressure on prices in the latter part of the year in line with the sustained expansion in economic activity.

Moving forward, while the stance of monetary policy is expected to remain supportive of growth, the degree of monetary accommodation may be reviewed given the sustained growth in the economy and risks to inflation. This is to ensure the sustainability of the growth prospects of the Malaysian economy.

That’s as clear a central bank communique as I’ve ever seen. They’ve as much as said there won’t be a rate hike until the meeting after the next one, on July 7th. Not good news for the Ringgit.

The statement on the SRR (issued separately) was similarly transparent (excerpt):

Increase in the Statutory Reserve Requirement (SRR) Ratio

Bank Negara Malaysia wishes to announce the increase in the Statutory Reserve Requirement (SRR) Ratio from 1.00% to 2.00%, effective from 1 April 2011...

...In the case of Malaysia, the assessment is that the increase in liquidity in the domestic financial system has thus far been well intermediated. The decision to raise the SRR is now undertaken as a pre-emptive measure to manage the risk of this build-up of liquidity from resulting in macroeconomic and financial imbalances.

The increase in the SRR is thus an instrument to manage liquidity and not a signal on the stance of monetary policy. The Overnight Policy Rate (OPR) is the sole indicator used to signal the stance of monetary policy, and is announced through the Monetary Policy Statement released after each Monetary Policy Committee meeting.

I find it interesting that they found it necessary to explain the purpose of the increase in the SRR – worried over affecting growth expectations, perhaps?

In any case, I found myself wondering whether an SRR increase would really have the effect of reducing excess liquidity. On the one hand, a 1% increase in the reserve ratio doesn’t actually involve a great deal of money, relatively speaking. Furthermore, the effective impact is likely to be just a shift in the composition of BNM liabilities, and won’t drain excess deposits in the financial system.

More importantly, given that the primary monetary policy target is the interbank overnight rate, it’s more than conceivable that successive increases in the SRR will NOT result in a withdrawal of excess liquidity in the system.

Think through this: BNM influences the interbank rate via open market operations, through the issuance and redemption of BNM Bills. Let’s say a high enough level of SRR succeeds in actually reducing loanable funds in the interbank market. But that results in an increase in the interbank deposit rate – supply has gone down relative to demand – despite BNM’s commitment to maintain overnight rates at the OPR target. That then requires a liquidity injection (redemption of BNM Bills) to bring the overnight rate back down to the target rate.

In other words, an effective increase in the SRR won’t reduce liquidity much if at all. Which leads me back to my original supposition (see this post) that the SRR is mainly going to be used as a cheaper alternative to open market operations, and not as a complement to it.