Wednesday, April 1, 2009

BNM Watch

A more up to date account will have to wait until next week, but there are a few things going on that should be noted.

First, the loss of reserves I noted here, has leveled off:

I'm taking it that what we saw was part flight to safety on the part of foreign funds, part a desire to increase liquid assets, and part deleveraging. Whatever the reason, the massive outflow of foreign exchange we saw last year has stopped, which reduces the pressure on BNM to equilibrate domestic money supply (loss of forex is contractionary), as well as pressure on the MYR.

Nevertheless, M3 growth has continued to slow:

We won't see the impact of velocity until at least the 1Q GDP data is out, but my basic feeling is that money velocity is dropping and will continue to drop this quarter. That said, I'm much more comfortable with growth in the monetary base as it is than I was a couple of months ago - there's enough liquidity in the market.

What concerns me now is real interest rates - they're too high. CPI inflation is dropping fast, but the headline rate is probably less of a guide than the level of the CPI itself, considering the rapid rises in the first half of 2008:

The last three months have been effectively flat - about as close to zero as you can get it without someone fiddling with the figures. The annualised m-o-m growth is about 2.1% in February, which roughly equates to price stability. That's the same level as the OPR, but 350bp lower than average lending rates. Between November and February, the OPR has been cut 150bp, but average lending rates have fallen just 50bp:

I think another 50bp cut in the OPR is definitely on the cards, but more importantly there has to be some pressure on the banking system to reduce lending margins. It's not dropping fast enough or far enough for my tastes, and the loan-deposit ratio (total loans over M3) has been below 80% for most of the last two years and hasn't been above 90% since 2002. This financial conservatism (which I'd applaud any other time) renders BNM monetary policy stance rather meaningless.

While I understand bankers' caution in light of 1997-98, this might be taking liquidity preference a little too far. I'm not ignoring credit evaluation concerns here - but there should be a few more projects out there that might be helpful, but require a lower cost of capital to be viable.


  1. Hi HishamH,

    Hope you can shed some lights on:
    1. How does economist calculate money velocity in practive ? (how much is the lag, period useds etc..)

    2. How low the money velocity, then is considered liquidity trap ? What is the typical money velocity ?

    Thx in advance.

  2. Hi WY, thanks for dropping by!

    Money velocity is an unobservable variable - there's no metric for it. However, it is possible to calculate a reasonable proxy, which I talked about here. It's basically a rearrangement of the Fisher Identity, and is unfortunately a static mechanical approach (rule of thumb) rather than dynamic.

    I haven't come across any research into defining or calculating money velocity per se, so it's difficult for me to state what constitutes a "normal" velocity any more than what velocity is associated with a liquidity trap.

    It also depends on which "money" you're refering to, as I got different velocity figures for different definitions of monetary aggregates.

    No hard and fast rules here I'm afraid.