Ramadhan Ruminations

Throwing this out there because this is a narrative that really ought to change:

In the runup to BNM’s latest MPC, there was a lot of market speculation that BNM should cut the OPR, because the numbers appear to justify it (lower credit growth, poor business and consumer sentiment, slowing GDP growth etc). In fact, even as the MPC stayed on hold, there continues to be opinions out there that a rate cut is and should be in the offing, with some thinking that the weakness in the MYR vis-a-vis the USD is what’s holding the central bank back from easing monetary policy.

Under different circumstances, I’d fully agree that monetary policy should be loosened. But I think in the present case, the narrative should be turned on its head, as I think the causality runs the other way.

In the context of an interest rate pegging regime with floating exchange rates in an open economy, the exchange rate isn’t and shouldn’t be a policy objective. But it does form an input into the decision making process. So when I think of Malaysian monetary policy and the MYR, it should be:

Look at the exchange rate and decide on interest rates

…and not…

Look at interest rates and decide on the exchange rate

To put it more simply: the reason why BNM didn’t and shouldn’t change policy is because the depreciation of the MYR is a de facto rate cut anyway (in fact, it has been the equivalent of a multiple rate cut delivered very quickly). That makes an OPR cut largely unnecessary, especially since the MYR has retraced much of the gains it made in Mar-Apr. I’d only think of a rate cut as a possiblity if the MYR had continued to strengthen, which quite frankly, it was quite unlikely to.

I know this sounds like nit-picking but there’s more than a semantic difference involved. The market narrative – and truth to tell, it’s a narrative common to all currencies in the region – thinks of exchange rates as the intermediate target of policy (sorry, technical jargon here), whereas what I’ve outlined above looks at the combined impact of both interest rates and exchage rates on the domestic economy, but with interest rates as the intermediate objective.

Continuing to think of exchange rates as the policy instrument is a good way to get your interest rate forecasts wrong.