Q What is the outlook for interest rates this year? Do you see any inflationary trends in the Malaysian economy?
A Although we’ve experienced strengthened growth, we still have excess capacity in our system. In the second half of 2003 we saw capacity expansion beginning to take place. Therefore, we don’t see any inflationary pressures on the horizon, andinterest rate policy can remain supportive of the economy.
Q If the US Federal Reserve raises rates, would Bank Negara Malaysia (BNM) follow that lead?
A Our interest rate policy will be based mainly on our domestic conditions. From time to time, we’ve seen a decoupling of interest rate directions between this region and more advanced economies. We’re having more rapid growth but also capacity expansion, so inflationary pressure is not there.
The other factor is that we’re not seeing asset inflation, and in Malaysia’s case the improved stock market has followed economic performance and not the other way around.
The better performance of the stock market has a stronger underlying economic trend and it is well supported by that trend.
Q How do you assess business confidence in Malaysia? How much of this confidence is riding on US recovery in 2004?
A Asia is becoming a more important engine of growth for the world economy. Growth in our region is about two times the average global growth, which is a major factor contributing to growth in the region. It is self-reinforcing.
Of course, it is supported by the recovery in the major economies, particularly the US. So it is a factor that has reinforced the growth trends in Asia.
Open economies such as Malaysia have benefited from the generally improved external environment. Now, about half our trade is with [Asia]. South-east Asia is around 24% of our total trade.
There is a tremendous reinforcing of growth within the region as domestic demand grows. That is an important emerging trend. Business confidence has improved significantly due to both domestic and external factors.
On the domestic front, monetary and fiscal policy has been expansionary over last two years, and this has supported domestic demand, both consumption and investment.
Q What is BNM’s view on the future of the Malaysian ringgit peg to the US dollar, given the speculation over a possible re-evaluation of the Chinese currency?
A Let me explain this as concisely as possible. Malaysia moved to a pegged exchange rate regime six years ago. We wanted to have a mechanism that would facilitate international trade. We said at the outset that a change would be prompted if the rate became fundamentally misaligned, or if there was a structural change that occurred either in the region or in the global environment. At the same time, we did say that every country in the region would have to review their positions if such a situation took place. Such a review would not be unique to Malaysia just because we have a pegged exchange rate regime.
Also, we did indicate that we would review what we have in place, if there were a change in the international financial architecture that would reduce the prospect for market failure in the foreign exchange market. Our concern is over the frequency of crises, the frequency of sharp volatility and of pronounced misalignments that have occurred in the foreign exchange market. For a country such as ours, which is an emerging market economy that is highly open, such significant exchange rate movements have far-reaching and pronounced implications.
Furthermore, if we look at the significant movements that have taken place recently in the major currencies, we are seeing concerns being expressed also at the undesirability of such significant movements within short periods of time. So, essentially, the position is that every country should be permitted to decide on what is the appropriate exchange required for its stage of development in the prevailing circumstances in our countries.
There have been recent calls for Asian economies to have more flexible exchange rates. This has somehow given great significance to the exchange rate as a solution to correct global structural imbalances. However, it is an illusion to think that this can be achieved through exchange rate adjustments. The comparative advantage that Asia has is not mainly due to the exchange rate. It is due to other factors, such as the significant wage differentials, that have led to lower costs.
Then there is the other issue of whether countries in this region are overheating and that the exchange rate appreciation might rein this in. But there is a wide range of other measures that can be used to achieve this purpose.
Q How does US dollar weakness impact on the ringgit peg and Asia generally?
A During the strong dollar period, our currency strengthened with the US dollar, but our trade continued to increase and we had robust growth. This demonstrates that the exchange rate is not a key factor in determining export performance. Now the dollar weakness is unlikely to have any fundamental implications for Malaysia because trade has continued to grow and foreign direct investment has mostly been a steady inflow.
In the past, our exchange rates were determined by trade flows. Now they are determined by financial flows, and therefore they are unpredictable. The factors that are fundamental to growing and attracting foreign direct investments are the underlying economy, the macro conditions, the external balance, employment, debt levels, the banking sector and so on. Foreign investors often tell us they have a great preference for a more predictable exchange rate policy. We engage the private sector, including the multinationals [on this issue]. What is important to us is that the exchange rate reflects the underlying fundamentals and that it is not misaligned, and close to fair value.
Q So no change to the peg?
A It is not a rigid position. We have stated from the outset that if there was a misalignment or a major structural change, then we will have to look at our position. So would everyone else under those circumstances. The country that can adjust in the most orderly manner would be the one with the strongest fundamentals.
Q Do you expect further consolidation in the banking sector this year? What is BNM’s role in this process?
A The bank consolidation programme was prompted by our policy to raise the capital requirements to RM2bn, so forcing small institutions to merge. From having 71 institutions we now have 30 that are under 10 banking groups. We are beginning to see the benefits of that merger exercise. But as we go forward it will be the more competitive environment that will force the merger process and it is left entirely to the market.
We encourage mergers – not merger for its own sake but for the benefits that arise. There must be synergies between the entities and there must be advantages in terms of economies of scale and enhancing efficiency. Minimum size is important to reduce vulnerability and to take advantage of economies of scale, but there can be specialist banks within the system that focus on niches. Large banks can offer the full range of products and services, but at the same time there will be medium-sized banks that focus on more specialised areas. So there is no target or timeline for any further mergers.
Q Will there be a ‘Big Bang’ opening of the market to foreign competition?
A It has always been and always will be a gradual process. As we go forward it will probably be at a faster pace. The first phase of our financial master plan was putting in place the financial infrastructure. Then what is most important to us is institutional development and capacity building. We are seeing results already in the form of services offered, the delivery channels, the level of IT investment in the banking sector. We are seeing the narrowing of margins, showing greater efficiency. This is the progress that has been achieved and as it continues there will be further liberalisation.
