Malaysia Bucks Asian Trend of Raising Rates; Focuses on Growth

By Stephanie Phang

July 26 (Bloomberg) -- Malaysia's central bank broke with its Asian neighbors by keeping interest rates unchanged, putting economic growth ahead of fighting the fastest inflation in a quarter century.

Bank Negara Malaysia kept its overnight policy rate unchanged at 3.5 percent for an 18th straight meeting yesterday. The move had been predicted by seven of the 20 economists surveyed by Bloomberg News.

The decision spurred traders to bet the ringgit will weaken over the next 12 months. Malaysia has avoided following Thailand, Indonesia, India, Vietnam and the Philippines in raising borrowing costs this year as the government tries to regain public support after its worst electoral performance in March elections.

``It's a highly risky decision, a decision which could well undermine the credibility of the central bank,'' said Robert Prior-Wandesforde, an economist at HSBC Holdings Plc in Singapore. ``I think the ringgit will sell off, I think bonds will sell off. They've lost credibility in not moving. That will be reflected in the markets.''

Malaysia's currency dropped to its lowest level in more than two weeks yesterday, losing 0.2 percent for the week to 3.2490 per dollar, Bloomberg data showed.

Ringgit to Weaken

Traders abandoned expectations for an appreciation in the ringgit, non-deliverable forwards contracts showed after yesterday's decision. They bet the ringgit will drop to 3.2515 per dollar in a year, versus a bet for an advance to 3.2310 before the policy decision, according to prices by Tullett Prebon Plc. The contracts are agreements in which assets are bought and sold at current prices for future delivery.

``While both the risks to higher inflation and the risks to slower growth have increased, the immediate concern is to avoid a fundamental economic slowdown,'' the central bank said in a statement in Kuala Lumpur. ``The appropriate monetary policy response will be taken'' should price increases spread beyond food and fuel.

Bank Negara yesterday raised its inflation forecast for 2008 for a second time this year, to a range of 5.5 percent to 6 percent from a June estimate of 4.2 percent and a March prediction of as much as 3 percent. The rate decision was two hours late.

It didn't say if it had revised its March forecast for a 5 percent to 6 percent expansion in the $151 billion economy. Growth was 6.3 percent in 2007. Governor Zeti Akhtar Aziz had said earlier the central bank would review the economic growth target yesterday.

`Behind the Curve'

Malaysia's delay in raising borrowing costs risks fueling inflation further, says Lye Thim Loong, who helps oversee about $500 million at Avenue Invest Bhd. in Kuala Lumpur.

``They will really be behind the curve,'' he said. ``At the end of this year they will have wage pressure, and the impact on the economy is far-reaching. They have to do something to cool it off a bit.''

Concerns that inflation will hurt growth and erode investors' returns have added to a slump in Southeast Asia's stocks and bonds. Philippine and Indonesian bonds have lost the most this year among 10 Asian markets tracked by an HSBC Holdings Plc index. Vietnam's key stock index is the world's worst performer in 2008.

Asian central banks need ``decisive tightening'' of monetary policies to combat inflation, and many are too slow to raise borrowing costs, the Asian Development Bank said this week. The Philippine central bank said it is considering further rate increases after successive moves in June and July.

U.S. Slowdown

Still, higher interest rates may cool domestic demand, which the government is relying on for growth as a U.S. slowdown hurts overseas sales.

Malaysia has tried to ease inflation through other measures, including increasing spending on agriculture to boost food supply and loosening import restrictions on steel. Oil has declined 14 percent since reaching a record $147.27 a barrel on July 11.

Inflation accelerated to 7.7 percent last month after Prime Minister Abdullah Ahmad Badawi announced a 41 percent increase in retail gasoline prices in a bid to trim government subsidies that keep pump costs artificially low. Diesel went up 63 percent, and electricity rates rose in July.

``Much of the jump in inflation of late has been due to rising food and energy costs,'' said Azrul Azwar Ahmad Tajudin, an economist at Bank Islam Malaysia Bhd. in Kuala Lumpur. ``If the current runaway inflation is expected to be a transient phenomenon without causing a generalized rise in prices, then raising rates doesn't appear to be an appropriate answer.''

The central bank's overnight policy rate is at the highest since its introduction in April 2004, and, together with Hong Kong's and Thailand's, is the second lowest in Asia according to Bloomberg data.

To contact the reporter on this story: Stephanie Phang in Singapore at sphang@bloomberg.net