Role of Bank Negara Malaysia in Monetary Policy

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Role of Bank Negara Malaysia in Monetary Policy
How the central bank influences interest rates
and the ability of the banking system to extend
credit and create money
2
Outline of the presentation

• Objectives of Monetary Policy
• Monetary Policy Framework of BNM
• Monetary Policy Instruments
• Case studies and current issues

3
Monetary Policy Objective of BNM

• To promote sustainable economic growth in an
  environment of price stability

4
Why is price stability important?

• Confidence in the value of money reduces
  uncertainty and inflation risk premium
• Reduces the risk of bubbles
• Reduces the risk of upward spiraling inflation,
  i.e. hyper inflation
• Efficient allocation of resources
• Changes in relative prices are easily observed
• High and variable inflation results in arbitrary
  redistribution
• Managing expectations of the general public

Better conditions for stability and growth
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How have prices changed in Malaysia?

• In 2003, inflation remained low and stable, owing
  to
• existence of excess capacity
• price competition
• stable labour market conditions

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Monetary policy in an open economy

• Managing policy in open economy is more complex
  than in a closed economy
• External and internal objectives
• Two-way causality between international
  transactions and domestic policy actions
• Volatility of international markets and capital
  flows
• In an open economy, the nature of the policy
  problem varies with
• The type of exchange rate regime in place
• The ease with which financial capital flows
  between countries

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Malaysia is a very open economy

• Malaysia is a highly open economy with the size
  of international trade double the size of GDP
• Exchange rate is fixed since Sept. 98
• The policy of non-internationalisation of ringgit
  meant that ringgit exchange rate is insulated
  from speculative pressures. This gives more
  freedom to pursue domestic-oriented MP
• The pegged regime is fairly valued and supported
  by sound fundamentals.

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Monetary Policy Framework of BNM
9
Monetary Policy Framework of BNM
The evolution of the monetary policy framework in
Malaysia has been largely influenced by the need
to maintain the effectiveness of monetary policy
in a changing financial and economic environment

• Monetary Targeting

Interest Rate Targeting
Interest Rate Targeting amidst a Fixed Exchange
Rate Regime

• Up to 1970s Narrow Money M1
• Up to early 1980s Broad money M2
• Up to early 1990s M3

• Mid 1990s Sept 1998

• Since Sept 1998, the exchange rate is pegged to
  the US at RM3.80/US

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Transmission Mechanism of Monetary Policy

• Policy Tools

• Direct
• Interest Rate Ctrl
• Reserve Req
• Credit Ceilings
• Liquidity Ratios
• Directed Credit
• Moral Suasion
• Indirect
• Direct borrowing/lending
• OMO
• Rediscount window
• Public sector deposit
• FX Operations

Operating Targets

• Interbank rates
• Market liquidity

Intermediate Targets

• Retail interest rates
• Money supply
• Exchange rate

Ultimate Objectives

• Note on the BNM 3-month Intervention Rate
• Main policy rate
• Closely linked to retail pricing of the banks
  base lending rate (BLR)

• Output
• Inflation

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Monetary Policy Instruments
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Monetary Policy Instruments

• The choice of instrument is crucial to ensure an
  efficient transmission mechanism of monetary
  policy
• Choice of instruments is based on the following
  factors
• Degree of controllability by the central bank
• Degree of sensitivity or responsiveness of the
  monetary instrument
• Efficiency of the financial system and depth of
  the money market and capital market in response
  to the central banks operations

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Monetary Policy Instruments of BNM
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Monetary policy implementation is carried out in
both conventional and Islamic money market

• Main instruments
• 1. Money market operations
• Money tender
• Intervention via agent banks
• 2. Open market operations
• Repo and reverse repo
• Sales and purchases of securities
• Issuance of Bank Negara Bills

• BNM

• Main instruments
• 1. Money market operations
• Mudharabah interbank investment (MII)
• Wadiah interbank acceptance
• Bai Al-Inah transaction
• 2. Open market operations
• Sales and purchases of Govt Investment Issues
  (GII)
• Issuance of Bank Negara Negotiable Notes

Conventional Money Market
Islamic Money Market
Interbank rates
Deposit rates
Lending rates
Bonds and equities prices
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Main monetary policy instruments used in
liquidity management

• Direct borrowing/lending
• Mainly for ST liquidity management
• Conducted via money market tenders or via agent
  banks for overnight operations
• May be variable or fixed rate operations
• Overnight and 1-month tender are considered as
  policy signals

• Bank Negara Bills
• Mainly for longer term liquidity management

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Lowering of policy rate combined with SRR
reduction were effective tools during the crisis
period
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Open Market Operations constrained by limited
availability of Government papers
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BNM continues to monitor various financial data
as part of its information data set

• State of Economy
• GDP, IPI
• Aggregate demand
• Lead, coincident and lag indicators
• Balance of payments
• Price Pressures
• Price developments (CPI and PPI and asset prices)
• Wages

• Other Indicators
• Monetary aggregates
• Interest rates
• Exchange rate
• Credit conditions
• Fiscal policy
• External developments
• Commodity prices

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A Case Study of Monetary Policy
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A case study of monetary policy in Malaysia
(1989-97)

• Background
• Excess liquidity in banking system
• Volatile flows of external funds
• High credit and monetary growth
• Rapid economic growth, with capacity constraints
  toward later part of period
• Inflationary pressures, especially in the asset
  market
• Attack on Ringgit complicated monetary management
  by sharply increasing volatility in the financial
  markets.

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A case study of monetary policy in Malaysia
(1989-97)
Policy Response
Policy Outcome

• Absorption of liquidity from the market
• Prudential measures to limit credit growth
• Measures to reduce speculative capital flows

• Prevented excessive liquidity
• Inflation kept low without jeopardizing economic
  growth
• Contained price bubble in the asset market
• Limited the impact of the currency attack on the
  domestic money market.

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A case study of monetary policy in Malaysia
(1989-97)

• High growth rates sustained over the decade
• Inflation remained low

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Monetary policy in the post crisis period
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Post crisis recoveryLow inflation allows for
accommodative monetary policy

• Interest rates were promptly and aggressively
  reduced early during the crisis in
  August-September 1998.

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Post crisis recovery (cont) Fiscal and monetary
policy coordination important
Fiscal Balance
of GDP

• Fiscal policy is sustainable
• Low govt debt position ( 47.7 of GDP in
  2003)
• Financed from non-inflationary domestic sources
• Fiscal deficits lt 6 of GDP
• Govt has greater flexibility for the
  implementation of fiscal stimulus program to
  support growth

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Post crisis recovery (cont) Currency
volatilities Ringgit exchange rate peg at
RM3.80/USD acts as an anchor of stability
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Conclusion
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Key lessons learned in BNMs monetary policy
operations

• Monetary policy framework will continue to evolve
  in response to changes in the financial market
  and the stage of development of the economy
• Monetary policy in an open economy is complicated
  by capital flows and external shocks
• Going forward, monetary policy strategies are
  aimed towards greater transparency, focusing on
  managing market expectations.

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Thank You
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Additional charts
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Decision making process
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Framework for decision making

• Monetary Policy Committee
• Governor
• Deputy Governors
• Asst Governors

• Deliberates and decides on policy recommendations
  based on input from MPWG

• Monetary Policy Working Group
• Monetary Financial Policy Dept
• Economics Dept
• Investment Operations Financial Mkt Dept
• Bank Regulations Dept
• FX Administration Dept

• Deliberates on key issues related to monetary and
  foreign exchange policy
• Makes specific recommendations to the Monetary
  Policy Committee

Mandate

• Executes mandate
• Exercises careful discretion on tactical aspects
  of policy implementation
• Announces monetary operation to the market at
  regular intervals
• Availability of information enables market
  participants to analyze and form views on
  interest rate and decision making in the
  financial market

Investment Operations Financial Market Dept
Monetary Policy Implementation Section
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Can expansionary monetary policy accelerate
economic growth?

• The effects of monetary policy on income and
  employment are strictly TEMPORARY
• In the long run, growth is determined by real
  factors of the economy
• Technology
• Resources

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Fixed Exchange Rate
Fixed exchange rate with controls on capital
account (eg. China and Malaysia)
Fixed exchange rate with free capital mobility
(eg. HK)
Impossible Trinity Choose 2 out of 3
Independent MP
Free Capital Mobility
Freely floating exchange rate with independent MP
(eg. NZ and UK)