Be careful in raising rates

KUALA LUMPUR: In efforts to curb inflationary pressure and staunch the flow of hot money, policymakers should be careful when increasing the benchmark interest rate as it could backfire on the economy, said Jimmy Koh, head of research at United Overseas Bank Ltd.

Koh said although raising the benchmark overnight policy rate (OPR) is one of the tools in managing inflation, a high interest rate environment could drive excessive liquidity into the market and push inflation higher as these funds would have to be parked somewhere and lent out.

"The more you hike the interest rate the more liquidity will come. So they have to be a bit careful. In fact if you look across the region, Bank Negara has been one of the most proactive," he said.

The central bank has raised the OPR by 100 basis points since March 2010 in the fight against inflation as the economy recovers from the recession.

Bank Negara Malaysia (BNM) will convene its monetary policy committee meeting today to decide whether to raise the OPR. The country's inflation as measured by the consumer price index (CPI) rose to 3.3% in May from a year earlier, the fastest pace in two years.

BNM governor Tan Sri Dr Zeti Akhtar Aziz had said last month that central banks around the world should be wary of "over-adjustment" in managing inflationary pressures. She said after raising the interest rates by four times, the central bank would not want to overreact.

There are other ways of dealing with inflation, Koh said, such as raising the statutory reserve requirement (SRR), or letting the currency appreciate.

"The interest rate hike is because you have to cushion the inflationary pressure; the reserve requirement is to make sure you control the availability of credit in the market, and most of the central banks around the world will all be using this tool," he said, adding that it is not something new as other Asian countries such as China and Indonesia had done so.

"They could also allow the ringgit to appreciate; the ringgit now is at RM3 per US dollar. I think the ringgit has appreciated quite significantly. So, there are multi-pronged (ways) to deal with this inflationary pressure," he said.

Bank Indonesia has been holding back from raising its interest rate, maintaining it at 6.75% for a fourth consecutive month in June after raising it by 25 basis points in February following the surge in the republic's inflation to a 21-month high to 7.02% in January.

The Indonesian central bank is expected to keep the key rate at 6.75% on the back of slower inflationary pressure in June compared with the same period last year. The CPI in June eased to 5.54%, down from May's 5.98%.

In China, a debate has been raging whether the People's Bank of China has tightened its monetary policy too far in its effort to contain inflation. Some argue that the central bank's reserve requirement hikes have been choking off access to credit for small businesses.

Government economist Ba Shusong wrote in an article published by the Economic Information Daily that the central bank should raise interest rates again, having done it four times since October 2010 to address inflation.

However, the economist urged the central bank to lower the reserve requirement ratio for banks to provide an easier credit environment, especially for small and medium-sized enterprises.