As mentioned earlier, Bank Negara signals their monetary policy stance by changing the Overnight Policy Rate (OPR). How can this change affect the economic climate in the country?
Well, we are awared that the OPR serves as the primary reference rate in determining other market rates, such as the Overnight Interbank Rate (OIR), Base Lending Rate (BLR), deposit rate, etc.
If the OPR increases, so do the other rates. This will cause borrowing cost to increase as interest expenses become higher. Business and investment activities might become less aggressive, investment institutions might allocate more funds in the money market than in the stock market. People are more encouraged to deposit their money with bank and earn interest. Cost of ownership of house and car will increase as the interest rate increased.
Higher interest rate could also attract short term foreign fund (hot money) to flow in, as the multi-national institutions can earn more interest by putting their fund in countries with higher interest rate. This will in turn strengtern the currency exchange rate of the country. When the currency rate is strong, cost of imports goods will be lower.
Theoritically, all these chain reactions will eventually slow down the inflation rate in the country.
If the OPR decreases, the opposite will happen. As interest rate decreases, borrowing cost will be lower, and this encourages more aggressive business and investment activities by leveraging on liabilities. Banking instittutions need to be more aggressive and competitive in order to maintain their profit with the lowered interest rate, and this will cause getting loan from bank become easier. People are discouraged to leave their money with the bank as interest earned become too little, and they are more tending to use their money in buying properties, insurances, unit trusts, shares, etc. The automotive industry will also be benefited with the lower interest rate.
If the interest rate is comparatively lower than other countries, this could cause short term foreign fund to flow out, as the multi-national institutions can earn more interest by putting their fund in countries with higher interest rate. This will in turn weakening the currency exchange rate of the country. When the currency rate is weak, cost of imports goods will be higher.
Theoritically, all these chain reactions will eventually accelerate the inflation rate in the country.
Therefore, Bank Negara need to be extremely careful in changing the OPR, as a wrong move will be disasterous to the economy of the country, and a good move will be benefitial to the economy of the country.
