Malaysias central bank chief, like many of her peers, is a cautious and understated speaker in her regular engagements around the world.
But when pressed on Malaysias monetary policy stance over the past year, Zeti Akhtar Azizs response is as close to impassioned as she may ever get in public. Shooting back at critics of Malaysias refusal to hike interest rates in the wake of sharply rising food and energy prices a year ago, the veteran policy-maker delivers a simple message: dont lecture us; we know what were doing. The principle, she says, must be that countries are afforded the flexibility to assess what they think to be effective.
A year ago, the market clamoured for interest rate hikes, fearing inflation. But the bank, seeing no excess demand, refused to make them a stance it maintained even after the government peeled back petroleum subsidies in July, thus increasing inflationary pressure.
In that environment [our action] brought tremendous criticism, recalls Zeti. Malaysia is not an inflation-targeting central bank, and [it was] certainly made to feel highly uncomfortable during that period. The view was: the numbers show inflation has increased, and the central bank didnt respond.
At the time, Zeti argued that a growth slowdown was imminent. She was right: by February this year Malaysias exports had fallen for a fifth straight month, extending the longest slump in seven years. To spur the economy, the central bank, Bank Negara, slashed rates with surprising force, including a single 75 basis point cut that Zeti describes as front loading. The bank has made a cumulative 150 basis points cut in the overnight policy rate from 3.5% last November to the current 2%.
Although largely wary of the move at the time, the market has since applauded Bank Negaras approach. I think the central bank has done a much better job on interest rates than the market would have done had the market been in charge, says Edward Teather, senior Asean (Association of South-East Asian Nations) economist at UBS.
Although the vast majority of policies from the Mahathir era are gone, Malaysias approach to policy is still distinctive, not least its championing of Islamic finance. Zeti has also recently proposed a central bank bill, which, if passed this year, ought to give Bank Negara greater power.
The central banker says the new legislation would give the bank greater clarity of mandate, institutionalizing many practices it has adopted over the years, such as the monetary policy committee, as well as increased transparency and disclosure.
But the bank would also gain clout, partly because it would become more nimble. It is important because it will provide the ability for the bank to be effective in a very changed environment, she says.
During the last financial crisis, the government set up an asset management corporation to recapitalize banks; though relatively swift, it still took three months to implement, she says. As [the central bank bill] becomes enacted, we would be empowered to respond immediately.
The new proposals include greater ease in working with other regulators, clearly delineated roles (especially regarding oversight of investment banks, where there is overlap with the Securities Commission), and a clear mandate to promote what Zeti calls financial inclusion.
But Zeti insists the act is not a response to todays crisis and has been under development for two years. Still, she says, the crisis brought to the forefront many issues it addresses.
The new law is unlikely to lead to a reversal of other policy initiatives, including controls on foreign exchange. Malaysia has ditched all its controversial capital controls except one, the non-internationalization of the currency. At this point in time particularly it is important that we have that in place. It reduces the vulnerability of our currency being attacked by speculative activity that is financed from offshore sources.
The remark may seem a distant echo of post-Asia crisis Malaysia, where such fears ushered in the tight capital controls, but today Zeti attempts a more measured tone: It is fine to have flows of funds that have come into the country; they can flow in and out freely, now with no restriction. But to have speculators have access to ringgit financing, to sell the currency down, renders us vulnerable.
What has to change for this last restriction to go? We see an important precondition of removing that particular control is to develop our own domestic foreign exchange market, she says. Once we have a vibrant foreign exchange market, with all the hedging instruments and so on and the talent necessary in our own financial system, then we would see the potential to remove that.
Her stance reflects the pragmatism behind Malaysias currency reform, which led to its ditching a fixed exchange rate regime in 2005. Zeti insists there is no danger of regressing. In removing all the other controls it has brought new sources of business to the banks with their foreign currency accounts and all the foreign financial services that they can offer to exporters, investors and so on, she says. We are very pleased at the outcome.
Yet today, Malaysias economic position is uncertain. Macquarie analyst Rajeev Malik notes that among Asean nations, Malaysia is set to be the second-worst-hit economy after Singapore because of its dependence on exports (over 100% of GDP). A quarter of the economy is related to commodities, both mining and agricultural, so falling prices have also had a major impact.
It is one of the more exposed economies to the global financial shock through trade and its financial markets, Teather says. He predicts a below-consensus 4.5% fall in real GDP growth in 2009; but given its reserve levels, relatively low financial risk, healthy gearing and current account, Malaysia is nevertheless pretty well placed to handle this global shock.