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Tuesday, 10 January 2023

Interest and inflation rates, how high is high?

AS we welcome 2023, one of the central themes this year will be how high will interest rates rise after the relentless pursuit taken by global central banks in fighting inflation with persistent and measured rate hikes in 2022.

As can be seen from Chart 1, from the 75 basis points (bps) hike by the Bank of Thailand to the 425 bps hike by the US Federal Reserve (Fed), the year 2022 has certainly been a busy year for central banks.

Central banks had no choice but to raise rates to fend off inflationary pressure that has been persistent throughout the year, although there have been some signs of easing lately.

Not to be left behind, even the Bank of Japan, while not lifting key benchmark rate, allowed its 10-year Japanese government bonds to move 50 bps from its 0% target, instead of 25 bps earlier.

It is a move that is seen recognising that inflation is finally biting the Japanese too.

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Chart 2 shows that based on November 2022 statistics, the depositors are at the losing end as the 12-month deposit rate was 132 bps lower than the monthly inflation print of 4%.

Can inflation be tamed?

Reading inflationary pressures and forecasting where it is going is not an easy task especially when inflation prints itself is a combination of many factors and not just commodity prices and supply chain disruption that has been the core issues among central banks the past year. Although the global economic momentum has eased, global aggregate demand is still rising and much higher than it was before the pandemic.

Hence, there has been not only a persistent rise in consumer demand but one that is not matched by consistent supply provided in the marketplace, resulting in a hike in aggregate prices.

In theory, inflation is tamed by using monetary tightening measures as it is believed that by raising interest rates, consumers and businesses will be impacted by higher borrowing costs, resulting in lower consumption as well as a slower pace of investments, which in turn will reduce aggregate demand.

Nevertheless, rate hikes have also other consequential impacts on the economy in the form of a weaker or a stronger currency, depending on the relative increase in domestic rates vis-à-vis the comparative increase in other corresponding currencies.

For example, for the United States, the relentless increase by the Fed has caused a significant rally in the US Dollar Index, which rose to a high of US$114 (RM501) last year, up almost 20%, before easing to close the year at US$103 (RM454), down 9.3% from its peak, but still higher by more than 8%.

The surge in the dollar made US imports cheaper from the rest of the world, in particular those from China, even cheaper, which allows the US retail prices at the store to be relatively lower than they used to be before the rally in the dollar.

In essence, while the surge in US interest rates has reduced disposable income due to higher borrowing costs, which in turn lowered consumer demand, it has also caused imported end product prices to be relatively cheaper than before, allowing aggregate prices to be lower as well.

This suggests that US consumer products are in for a double-whammy in terms of prices as aggregate demand has been reduced due to lower disposable income and at the same time for products that are imported, prices too have eased due to the strength of the greenback.

For an economist, this is good news as the intended outcome will likely be achieved in taming inflationary pressure due to persistent hikes in interest rates. A look at inflation prints from the peaks in 2022, both the core Consumer Price Index (CPI) and the Personal Consumption Expenditures index (PCE) have eased, falling by 67 bps and 62 bps from the highs and were last seen at 6% and 4.7% respectively.

Are we there yet?

After a 425 bps hike, the Fed’s message in the minutes of the Federal Open Market Committee (FOMC) released this week was an important one as it guided the market to expect higher rates going into 2023 but at the same time also signalled that the war against inflation is far from over and the Fed will continue to raise rates until it can achieve its targeted inflation print.

Compared with its September forecast of 4.6%, the Fed has now raised its median Fed Fund Rate (FFR) for 2023 to 5.1%, an increase of 50 bps while at the same time, the Fed also expects median FFR to drop by 100 bps each in 2024 and 2025 to 4.1% and 3.1% from earlier projected rate of 3.9% and 2.9% respectively.

Core PCE inflation, which is the Fed’s benchmark rate for inflationary pressure, is now expected to hit a median rate of 4.8% in 2022 before easing to 3.5% and 2.5% in 2023 and 2024 respectively.

By all means, the Fed is forecasting that inflation will be tamed in time to come. Hence, in all likelihood, we have seen the peak in inflationary pressure but perhaps we will be in for a higher US rate for longer before we see the Fed’s pivot.

Contrary to market expectations, the FOMC minutes this week revealed that the Fed is not expected to cut rates in 2023.

As for the market, based on Fed Fund Futures the Fed is expected to raise the FFR by 25 bps each over the next three meetings to reach 5.00% and 5.25%, followed by two rate cuts of 25 bps each in the second half of 2023, bringing the FFR back to 4.5% and 4.75% at the end of 2023.

Bank Negara to stand pat?

Compared to many central banks in the region or globally, Bank Negara move to raise the benchmark Overnight Policy Rate (OPR) by 100 bps last year is seen as rather muted.

Based on the year-to-date core CPI of 2.9% up to November 2022, the inflationary pressure experienced by Malaysia remained within Bank Negara’s forecast of between 2% and 3% for the year and going into 2023, core inflation prints will remain elevated at the beginning of the year but may ease later on, especially with the current government’s efforts in reducing the cost of living.

Given that scenario and the likelihood that the Fed and other regional central banks too are almost done raising rates, Bank Negara may stand pat and leave the OPR unchanged for 2023 at 2.75%. After all, a higher rate of between 25 bps to 50 bps as predicted by many broking firms will only result in higher borrowing costs for consumers and businesses, a move that will likely accelerate the pace of economic slowdown in 2023. By leaving the OPR unchanged, Bank Negara is signalling that it is done with raising rates and the current rate remains commodative and supportive of economic growth.

Positive real returns?

One of the arguments for higher interest rates is whether depositors are getting positive real returns, which is the difference between fixed deposit rates and inflation prints.

Chart 2 shows that based on November 2022 statistics, the depositors are at the losing end as the 12-month deposit rate was 132 bps lower than the monthly inflation print of 4%.

However, interestingly, as the market is anticipating rate hikes of 25 bps in the January 2023 Monetary Policy Committee meeting and another hike in March 2023, 12-month fixed deposit rates of many banks have passed the 3% mark and depositors could even easily enjoy rates up to 4% as promotional activities to attract fresh deposits have intensified over the past month. With that, depositors are already getting returns close to the headline monthly inflation prints.

In conclusion, while it makes sense for Bank Negara to stand pat and not raise rates in its first two meetings this year as widely expected, the market has already priced in the scenario that the central bank is ready to raise rates by 50 bps to take the benchmark OPR to 3.25%, the level last seen in March 2019, almost four years ago.

Pankaj C Kumar Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.

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Monday, 11 July 2022

Uptick in loan defaults likely

Average NIMs of some local banks are expected to broaden slightly this year from the 2.28% registered in 2021.

Higher loan defaults, among individual borrowers and corporates, are expected to emerge as interest rate hikes to reduce inflationary pressures grip the economy.

Although the higher rates are good news for banks in terms of profitability, they may also result in loan defaults in the near term.

UCSI University assistant professor in finance Liew Chee Yoong, who is also a fellow at the Centre for Market Education, said the gross impaired loans (GIL) ratio would be higher due to the latest interest rate hike.

UCSI University assistant professor in finance Liew Chee Yoong

“The rise in interest rates will raise the interest expense of loan borrowers and increase their financial risk.

“Therefore, I will not be surprised if more individual and corporate borrowers will be in financial distress due to higher interest servicing this year.

“More loans will be impaired due to the higher likelihood of credit default by borrowers,” he added. StarPicks Sunway TES ICAEW- The ideal pathway towards a global career for SPM leavers

The GIL ratio is defined as gross impaired loans as a percentage of gross loans, advances and financing.

Bank Negara has raised its overnight policy rate (OPR) by 25 basis points (bps) to 2.25% on July 6 amid positive economic growth prospects. It was the second consecutive increase after the 25 bps hike in May, which was also the first time the OPR was raised since the onset of the Covid-19 pandemic.

The OPR, which is a benchmark rate that allows banks to determine their lending and deposit rates, had been reduced by a cumulative 125 bps during the pandemic to a historic low of 1.75%.

RAM Rating Services Bhd co-head of financial institution ratings Wong Yin Ching said higher interest rates could impinge on some highly leveraged borrowers, although most borrowers would likely be able to absorb the slightly higher loan instalments.

RAM co-head of Financial Institution Ratings Wong Yin Ching, https://apicms.thestar.com.my/uploads/images/2022/07/11/1654838.jpg

“We may see the banking sector’s GIL ratio rise to 2.5% by end-2022, which is still deemed manageable in our view.

“Provisioning expenses, however, are not anticipated to increase in tandem with impaired loans as banks had judiciously built up provisioning reserves since the start of the pandemic.

“With most of the loan relief measures being progressively wound down in the first half of the year, defaults have begun to trend up,” she added.

The banking industry’s GIL ratio rose from 1.5% as of end-December 2021 to 1.64% as of end-May.

CGS-CIMB Securities analyst Winson Ng also expected higher GIL ratios this year.

“We expect the gross impaired loan ratio to increase 1.8% to 2% at end-December due to the credit risks from the Covid-19 and negative impact from higher inflation and interest-rate hikes.

“Headwinds, including higher inflation, could also be negative for asset quality and loan growth,” he said.

AmResearch banking analyst Kelvin Ong saw a gradual uptick in GIL ratio as the broad repayment assistance (including the Pemulih moratorium) had expired at end-June.

Asset quality ratio for the sector is expected to be higher at around 2% compared with 1.4% as of end December 2021, amid the transition towards targeted repayment assistance, according to him.

Commenting on the downside risk for the sector this year, Ong said: “Any prolonged or worsening supply chain disruptions will impact the pace of economic recovery and consequently affect our estimates for earnings growth of banks.

“Higher inflation pressures will impact consumer spending as well as profit margins of business loan borrowers which will lead to a potential deterioration in asset quality.”

Although most analysts expected the higher net interest margins (NIMs) to boost banks’ earnings from the latest OPR hike, UCSI’s Liew disagreed.

“I don’t think the higher OPR will improve the NIMs of banks. My prediction is that it will be reduced due to lowering demand for bank loans, which reduces the banks’ interest income and average earning asset value (that is, the amount of bank loans that are given out to borrowers).

“The increase in interest rates by the central bank will reduce the demand for bank loans from companies and individuals as the cost of financing becomes more expensive,” he said.

On the other hand, Liew said lenders would need to continue paying interest to risk-averse depositors who put their monies in banks during an economic uncertainty and this would reduce the NIMs.

According to RAM’s Wong, rising interest rates are a boon to NIMs as a majority of the domestic banking industry’s loans are floating-rate facilities, which would reprice faster than deposits.

That said, Wong added that the uplift in NIMs would be moderated by the increasingly deposit competition, as well as slower current and savings account expansion as some depositors go for term deposits.

Overall, Wong said the average NIMs of some local banks are expected to broaden slightly this year from the 2.28% registered in 2021.

NIM is a measure of the difference between the interest income generated by banks and the amount of interest paid out to deposits.

CGS-CIMB’s Ng, who forecast loan growth of 4% to 5% for this year, is projecting a 4% net profit growth, mainly driven by the OPR hike and lower loan loss provisioning.

Ong is maintaining a loan growth projection of 5% to 6% this year, premised on an expected gross domestic product expansion of 5.6% this year.

With the additional taxes due to Cukai Makmur or prosperity tax, the earnings growth for banks are expected to be flat at 1.5% this year, according to Ong.

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Sunday, 10 July 2022

BANK NEGARA RAISES OPR TO 2,5% , Still a good hedge against inflation

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PETALING JAYA: The Monetary Policy Committee (MPC) of Bank Negara has increased the overnight policy rate (OPR) by 25 basis points to 2.25% amid positive growth prospects for the local economy.

“For the Malaysian economy, economic activity continued to strengthen in recent months.

“Exports and retail spending indicators affirm the positive growth momentum, supported by the transition to endemicity, “ the central bank said in a statement yesterday.

The ceiling and floor rates of the corridor of the OPR are correspondingly increased to 2.5% and 2%, respectively.

The OPR, which is a benchmark rate that allows banks to determine their lending and deposit rates, had been reduced by a cumulative 125 basis points during the course of the Covid-19 pandemic, bringing it to a historic low of 1.75%.

Yesterday’s increase was a second consecutive one after a 25-basis-point hike in May, which was also the first time the OPR was raised since the onset of the pandemic.

OCBC Bank economist Wellian Wiranto said the fact that the central bank had not gone more “ballistic” with a 50-basis-point hike yesterday speaks of a “heavy preference for a gingerly approach in tightening.”

“That is a prudent thing, given how global recession fears are on the rise,” he said.

Going forward, he said he expects at least one more 25-basis-point hike this year that will be seen as a further normalisation of policy rate rather than outright tightening.

“It might then pause in the last meeting of the year in November to assess the balance between inflation and recession risks before undertaking any action thereafter,“ he added.

In its statement, the central bank said the extent of upward pressures on inflation will remain partly contained by existing price controls, fuel subsidies and the continued spare capacity in the economy.

“The inflation outlook continues to be subject to global commodity price developments, arising mainly from the ongoing military conflict in Ukraine and prolonged supply- related disruptions, as well as domestic policy measures,“ it said.

Year-to-date, headline inflation averaged 2.4%.

.In its statement, the central bank said the extent of upward pressures on inflation will remain partly contained by existing price controls, fuel subsidies and the continued spare capacity in the economy.

“While it is projected to remain within the 2.2%-3.2% forecast range for the year, headline inflation may be higher in some months due mainly to the base effect from electricity prices.

“Underlying inflation, as measured by core inflation, is expected to average between 2% and 3% in 2022, as demand continues to improve amid the high-cost environment,” it said.

Bank Negara said that in recent months, the unemployment rate had declined further, with higher labour participation and improving income prospects.

“Looking ahead, while external demand is expected to moderate, weighed by headwinds to global growth, economic growth will be supported by firm domestic demand.

“Additionally, the reopening of international borders since April 1 would facilitate the recovery in tourism-related sectors.”

Nevertheless, the central bank warned of downside risks to growth that continue to stem from a weaker-than-expected global expansion, further escalation of geopolitical conflicts and worsening supply chain disruptions.

“Even as it continues to project a strengthening economic recovery, things are likely to turn less rosy from here,” OCBC’s Wiranto said.

Bank Negara said that at the current OPR level, the stance of monetary policy remained accommodative and supportive of economic growth.

“The MPC will continue to assess evolving conditions and their implications on the overall outlook to domestic inflation and growth.

Rakuten Trade head of equity sales Vincent Lau told StarBiz yesterday’s hike was a reflection of confidence in the continued growth of the Malaysia economy.

“Any adjustments to the monetary policy settings, going forward, would be done in a measured and gradual manner, ensuring that monetary policy remains accommodative to support a sustainable economic growth in an environment of price stability.”

Meanwhile, Rakuten Trade head of equity sales Vincent Lau told StarBiz yesterday’s hike was a reflection of confidence in the continued growth of the Malaysian economy.

“With the increase in our benchmark rate, this may also stem the outflow of foreign money, which will technically see higher returns alongside the higher rate,” he said.

That said, the stock market fell over 20 points at the close yesterday after the hike was announced.

“It was probably a knee-jerk reaction as the hike had more or less been priced in already,” Lau said.

Bursa Malaysia’s fall was also in line with most regional markets as the fear of a global recession continued to rear its ugly head.

Nevertheless, at the close of the market yesterday, lenders like Malayan Banking Bhd and CIMB Group Holdings Bhd finished higher as investors bought the stocks, banking on a higher OPR that could likely boost the lenders’ earnings.