December 2011 Monetary Conditions

Now that we know interest rates aren’t going to be cut, at least until March, what did the latest data tell BNM?

The money supply situation doesn’t look too gloomy (log annual and monthly changes; seasonally adjusted):

In fact, it looks positively healthy to me – maybe even too healthy. Both M1 and M2 are growing at near 14% on an annual log basis, and monthly growth is pretty positive as well. Breaking it down, there were decent increases in pretty much all major categories except in forex deposits, which isn’t too surprising given the turmoil in global markets during the holiday period.

On the asset side, loan growth was pretty solid as well (log annual and monthly changes):

Most of the growth, as has been true for the past couple of years, is concentrated in the non-household sector, though household borrowing continues to remain in the low teens. Loan applications turned down a bit, but year on year growth – after dipping in 3Q2011 as Europe started to headline the business news – is back up again (log annual and monthly changes):

Credit conditions haven’t changed much (ratio of loans approved to loan applications):

This is of course before the revised guidelines on consumer lending, which might crimp approvals (and hence total loan growth) from January onwards. I don’t think we’ll see the full impact of that until March, as it’ll take a couple of months for the loans applied for in January to work through the system. There’s already anecdotal evidence that the new guidelines – using net instead of gross income – have teeth, as Perodua have recently reported lower sales in January, and are pleading their case for special treatment with Bank Negara. I think BNM will stand firm on this, as the reduction in the household borrowing trajectory is precisely what BNM is aiming for.

On the flip side, tighter credit regulations within the banking system might drive households to borrow more from non-bank credit providers. MBSB has already reported their loan portfolio (and profits) to have doubled in the past year, and I expect the others like Bank Rakyat and BSN to show the same pattern. Given the poorer credit controls involved here, there’s likely to be a build up of financial sector risk, but outside the banking system. This won’t be a threat to systemic stability but the chances of households becoming over leveraged (especially low income households), with subsequent deleveraging and taxpayer funded bailouts (again), are rising. That’ll eventually crimp consumer confidence and private consumption, unless the threat is contained soon.

My stand is that if it walks like a bank and talks like a bank, then by golly it better be regulated like a bank.

Moving on to the interest rate front, conditions on the interbank markets were pretty stable, and the money markets gained some semblance of normality after a turbulent year (trading volume; RM millions):

Yields on MGS have trended down across most of the term structure while flattening a bit at the short end:

This I think was partly due to a slight drop in issuance (RM millions):

…as well as stronger foreign demand (MGS, GII, and TBills; RM millions):

Whatever the case, what we’re looking at here is a downtrend in MGS yields for basically the whole of 2011. Never mind thoughts of “bankruptcy” by 2020 –after a short pause in September, investors certainly haven’t lost their appetite for Malaysian government debt.

As much as this supports the case that Malaysia’s government debt is long term sustainable, foreign ownership of government debt – even local-currency denominated debt – is a potential source of vulnerability. At close to a quarter of total government debt, a sudden stop capital flight scenario could push yields much higher, making borrowing that much more expensive.

Bear in mind here that what we’re looking at is secondary market yields, not yields at issuance, and that the banking system has more than enough moolah to absorb even this much securities being dumped. I personally don’t think a sell down at all likely, and any damage could be confined to about an increase of about 100bp or so at the most. That’s still a cumulative RM400-RM500 million in additional interest costs a year that might be avoided.

Equivalently, you could see the current situation as being one where the government is paying RM400-RM500 million less than it otherwise would, if holdings of debt was purely domestic. Given that the policy bias is towards greater opening up of Malaysia’s financial markets, I suppose this vulnerability is the price we have to pay and continue to pay.

Technical Notes:

All data from the December 2011 issue of Bank Negara Malaysia’s Monthly Statistical Bulletin