Monetary Policy

The bigger question that we need to answer before analyzing the

monetary policy is: What is Monetary Policy? What are the instruments
used to monitor the monetary policy of any country? What are the
objectives of the monetary policy? Lets try to answer these questions
first.
Defining Monetary Policy Monetary Policy can be defined as the actions
taken by the monetary authorities (Generally a Central Bank) of the
country to use control of the supply of the money in the economy as a
measure/ instrument to achieve the objectives of general economic policy.
The Objectives of Monetary Policy The various general objectives of the
monetary policy of any economy are stated below:
1. Full Employment Full Employment is regarded as one of the most
important objective of the monetary policy of a country as lack of
employment leads to loss of potential and social inequality.
2. Price Stability The stability of prices in an economy is of vital
importance especially in a developing country. The inflation, if rises
sharply might affect the buying behavior of the citizen of the
country and therefore the business expansion rate also slows down
due to loss of revenues.
3. Economic Growth Economic Growth of a country means that the
real per capita income of the country rises over a long period of
time. It is therefore, a major objective of any monetary authority of
the country to achieve.
4. Balance of Payments Last but certainly not the least, each country
wants to maintain its balance of payments in an equilibrium and be
self-sufficient. The Monetary Policy of the economy also strives to
achieve this target by implementing various changes from time to
time.
The Instruments of Monetary Policy There are two types of monetary
policy instruments First, Quantitative, General or Indirect, and Second,
Qualitative, Selective or Direct.
1. Bank Rate Policy This belongs to the first category of instruments.
The bank rate policy takes care of the general price trends in the
economy. The Bank Rate is defined as the minimum lending rate at
which the central bank rediscounts first class bills of exchange and
government securities held by the commercial banks. It keeps a
check on the inflationary pressures in the economy by altering the
bank rate from time to time.
2. Open Market Operations Open Market Operations refer to the sale
and purchase of securities by the central bank in the money market.
The Central Bank keeps a check on the recessionary and inflationary
conditions in an economy through these money market operations.

3. Changes in Reserve Ratios Reserve Ratios are the ratios governed

by the Central Money Authority of the country under which every
bank or financial institution is mandatorily asked to keep certain
portion of its deposits in its vaults for liquidity and certain portion
with the Central Money Authority of the country.
4. Selective Credit Controls All the above mentioned instruments
affect the economy indirectly, but this instrument is used to directly
keep a check on a particular sector if it is showing signs of inflation,
recession or any other speculative activities in that particular sector.
All the above instruments can be used selectively for that particular
sector to keep a check on the growth of that sector.

Monetary Policy of Malaysia

Now, as we have learnt a bit about the terminology and meaning of
Monetary Policy, we are in a position to analyze the Monetary Policy of
Malaysia, the country we have chosen for our project. The Central
Monetary Authority of Malaysia is resided in the hands of Bank Negara
Malaysia, which is the Central Bank of Malaysia governed by the Central
Bank of Malaysia Act, 2009. It is headed by Governor and Chairman Dr.
Zeti Akhtar Aziz.
The Bank Negara Malaysia formulated a significant development in the
monetary policy mechanisms and transmission mechanisms by
introducing the Overnight Policy Rate (OPR) to monitor the overall
monetary policy functioning in the economy. The new framework included
the introduction of new policy rate and improvements to the conduct of
monetary operations, as well as the removal of ceiling on base lending
rates (BLRs) and prescribed lending rates. Banking institutions now set
their BLRs based on their respective cost structures and business
strategies. The new framework also serves as a catalyst for the efficient
pricing of financial products and services by banking institutions. The
deregulation of pricing is a key initiative under the Financial Sector
Masterplan to ensure greater efficiency in the allocation and distribution of
resources in the financial system.
The New Monetary Operating Procedures:
a) The Overnight Policy Rate OPR will be an indicator of the monetary
policy stance. The OPR will have a dual role as a signaling device
to indicate the monetary policy stance and as a target rate for the
day-to-day liquidity operations of the Central Bank. Any change in
monetary policy stance will be signaled by a change in OPR.
b) Overnight Rate as the Sole Operating Target Monetary operations
of BNM will target the overnight interbank rate. Liquidity
management will aim at ensuring the appropriate level of liquidity
that would influence the overnight interbank rate to move close to
OPR.

c) Introduction of Overnight Operating Corridor and Standing Facilities

To minimize excessive volatility in the overnight rate, BNM will
specify a corridor around the OPR. The corridor was set at 25 basis
points around the OPR. Day-to-day liquidity operations will aim to
hold the overnight rate close to the announced OPR.
With the introduction of OPR, BNM didnt just let the rates (lending and
deposit) to be market driven but were regulated in the initial phase of the
introduction of OPR. The lending rates for SMEs were monitored by the
Central Bank while also allowing the SMEs with special needs to take
redress. Also the deposit rates for Fixed Deposits were also regulated by
the Central Bank.

Monetary Policy and Results for the year 2014

The Inflation rate was above its long run average in the year 2014 for
Malaysia. So the Central Bank followed a contractionary monetary policy
by increasing the overnight policy rate (OPR) by 25 basis points to 3.25%,
expecting the growth to continue and inflation prices to remain at higher
than long run average. The monetary policy stance was last changed by
BNM in 2011 and since then, the economic growth of Malaysia had shown
steady growth amid external imbalanced environment. This was majorly
due to domestic demand and the monetary authority felt a need to

monitor the policy rate stance to stabilize the risks of broader financial
imbalances given the extended period of relatively low and unchanged
interest rates.

The two major concerns for the increase in OPR were as follows:
1. Balance of Risks to the Outlook for Growth In early 2014, the
Malaysian Government projected a steady growth of the Malaysian
economy. In line with the positive outlook of the global growth, the
Malaysian exports were expected to rise. Domestic demand was
expected to be the main driver of growth with robust investment
from the private sector. By May 2014, the government expected the
growth in 2014 to be the upper end of the initial forecast of 4.5% 5.5%. But the Monetary Policy Committee (MPC) recognized that
the downside risks to growth remained, particularly in relation to the
risk of moderation in private consumption growth and weaker
external demand.
2. Inflation The MPC expected greater upside risks to inflation which
was expected to trend above its long-run average of 3% in 2014
and 2015. This was expected because of the domestic cost factors
like upward adjustments in retail fuel prices, electricity tariffs and
introduction of GST in 2015.
Therefore, the MPC considered the rise in OPR to normalize the upside
risks of inflation in the economy and lower the downside risks of
Financial Imbalances. The adjustment in the policy rate occurred
smoothly without major disruptions to the financial system and the
overall economy. Retail lending rates adjusted quickly to the change in
OPR.

Monetary Operations
The average overnight interbank rate remained stable around the OPR
with an average deviation of 2 basis points.

Managing Liquidity
Total interbank money market transactions, which comprised deposits
and acceptances, bankers acceptance (BA), and negotiable instrument
of deposits (NID) in both the conventional and Islamic money markets,
recorded a marginal increase in volume to RM3.2 trillion (2013: RM3.1

trillion). Among the instruments, conventional deposits, which were

unsecured borrowing and lending, was the main instrument traded and
contributed 68.3% of the total volume. Aggregate surplus liquidity in
the system declined from RM336.8 billion as at end-2013 to RM269.9
billion at the end of the year due to capital outflows, particularly in the
fourth quarter following expectations for interest rate normalization by
the Federal Reserve amid the recovery in the US economy and
heightened concerns over the impact of the sharp fall in oil prices on
the Malaysian economy.
Despite the decline in aggregate surplus liquidity, liquidity conditions
remained ample at the system-wide level to support efficient
intermediation and orderly market adjustments. The variety of
monetary instruments available for the liquidity management of the
banking system accorded flexibility to the Bank in meeting market
expectations and liquidity needs. Amid rising yields on market
expectations for an increase in the OPR, higher issuances of Bank
Negara Monetary Notes (BNMNs), especially from July 2014 to October
2014, were undertaken to meet the strong market demand, including
that of the non-resident portfolio investors. Consequently, total
outstanding BNMNs rose from RM106.7 billion as at end-2013 to
RM122.4 billion by November 2014, in which non-resident holdings
accounted for more than half of the total outstanding BNMNs. In
December 2014, in response to the weak demand for BNMNs amid
capital outflows, the issuances of BNMNs were adjusted accordingly
and total outstanding BNMNs fell to RM107.1 billion at the end of the
year. Given the volatility in the global financial markets during the
year, BNMNs have been an effective tool in managing domestic
liquidity arising from short-term capital flows.

Major Indicators of Financial Imbalances