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Malaysia’s central bank said it may increase interest rates further to avert asset bubbles and discourage risky investments by people seeking better returns, even as inflation will likely remain “modest” this year.

“We will review the conditions at our next monetary policy meeting and work towards further normalizing if necessary,” Governor Zeti Akhtar Aziz said in a March 12 Bloomberg Television interview in Kuala Lumpur. “Inflation will continue to be modest and therefore it would not prompt us towards tightening, but that does not preclude that we will continue to normalize interest rates.”

Malaysia raised its benchmark interest rate to 2.25 per cent this month, becoming the second Asian nation to increase borrowing costs as the region leads a recovery from the global slump. The central bank wants to prevent “financial imbalances” that could undermine the economy’s recovery from last year’s recession, Zeti said.

“There is no compelling evidence of asset bubbles in Malaysia based on current indicators,” Suhaimi Ilias, chief economist at Maybank Investment Bank Bhd. in Kuala Lumpur, said before the interview. Still “the risk is there if the interest rate is kept very low for an extended period as money searches for returns to beat inflation that is creeping up.”
China has started draining excess cash from the economy to prevent asset bubbles. Australia and Vietnam have raised borrowing costs as inflation accelerates, and the Philippine central bank last week pared back a lending program for banks.

Significant Risks

Keeping interest rates too low for too long may lead to the “mispricing of risks” by those who anticipate borrowing costs will stay low, as well as create asset bubbles, Zeti said. While the central bank doesn’t expect to see bubbles forming “on the horizon,” there are signs that people are buying higher- yielding assets “that pose significant risks,” she said.

Bank Negara Malaysia will monitor the strength of the economic recovery in deciding whether interest rates need to rise further, the governor said. Current borrowing costs are still “very supportive” of economic growth, Zeti said. The level at which rates are considered to be “normalized” would depend on the strength of the recovery, she said, adding that inflation won’t be “a factor” in 2010 even after taking into account possible increases in fuel and power prices.

The central bank, whose policy team next meets in May, raised its overnight policy rate from a record-low of 2 per cent on March 4, the first increase in almost four years, saying the economy’s recovery is “firmly established.”

Faster Growth

Malaysia’s gross domestic product expanded 4.5 per cent last quarter after contracting the previous nine months. Exports surged by the most in more than 11 years in January.

“We expect growth to improve from the levels we have seen in the fourth quarter,” Zeti said. “Certainly the first half of the year, all the signs are pointing to stronger growth” as domestic demand and investment recover, she said.

JCY International Bhd., a Malaysian supplier of hard-disk- drive components for Seagate Technology and Western Digital Corp., said last month it plans to spend 182 million ringgit ($55 million) in the financial year starting Oct. 1, 2010 to increase its capacity amid rising orders.

Inflation of about 2 per cent would be considered “modest,” Zeti said. Malaysia’s consumer prices rose for a second month in January, climbing 1.3 per cent from a year earlier from an average 0.6 per cent in 2009.

Should price gains accelerate further to 3 per cent, for example, “we would begin looking at what are the sources of inflation because if it was demand-induced then” the central bank would look at “tightening” monetary policy, Zeti said.

Ringgit’s Gain

Zeti refrained from raising interest rates in 2008 when consumer prices rose as much as 8.5 per cent in July and August amid soaring oil and commodity prices, saying inflation wasn’t driven by higher demand and would ease as global growth slowed. Malaysia’s policy makers aren’t “inflation targeters,” she said last week.

The Malaysian ringgit has climbed 2 per cent since the central bank’s decision to raise rates this month, making it Asia’s best-performing currency outside Japan during the period.

The currency’s appreciation has reflected Malaysia’s strengthening “fundamentals,” Zeti said.

“We have seen this level before and we are not concerned,” she said. “We have allowed our exchange rate to be market determined and we are there to ensure orderly market conditions. Our export sector has never relied on the exchange rate to gain competitiveness.”

Zeti, who said previously Malaysia will consider allowing the ringgit to be traded overseas once the country has a more developed foreign-exchange market, said in the interview the central bank has formed a task force involving the financial and banking industry to work toward developing the country’s foreign-exchange market “with a view to internationalizing” the ringgit.

“Once that market has become more vibrant and with the products and services being offered in terms of the forward market and so on, and in terms of hedging instruments, then we’ll look at internationalizing the currency,” she said. “Right now we don’t have a time frame.” -- Bloomberg

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