Emerging Markets, Asian Development Bank annual meeting editions, Bali, May 2009

Author’s note: this is the article as filed and may differ from the published version

Dr Zeti Akhtar Aziz isn’t given to strident statements. The governor of Bank Negara Malaysia, now nine years into her tenure, is a cautious and understated speaker in her regular engagements around the world. But when asked about Malaysia’s contrarian stance to interest rate policy over the last 12 months, her response is as close to heated as one imagines she ever gets in public. “It is very important to afford countries the flexibility to assess what they think to be effective,” she says. The message: don’t lecture us, we know what we’re doing.

Zeti takes this view following the bank’s behaviour when oil and food prices were rising a year ago. The market, seeing inflation, called for hikes; the bank, seeing no excess demand, refused to make them, and continued to do so after the government reduced petroleum subsidies in July, increasing inflationary pressure. “In that environment it brought tremendous criticism,” she recalls. “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 didn’t respond.”

Instead, Zeti outlined a view that a slowdown in growth was coming, and she was right: subsequent changes in interest rates have been downward, not up, and in a manner that was again in contrast to market expectation, with a surprise 75 basis point cut in a single hit that Zeti describes as “front-loading”.

Suspicious at the time, the market has since applauded this ignore-the-herd 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 economist at UBS. “Not raising interest rates over the summer last year was the right thing to do in hindsight. And cutting interest rates more than expected coming into this year was also the right thing to do. They’d probably get high marks for performance over the last 18 months.”

If Malaysia has made a modern history of doing its own thing, Zeti fits the tradition rather well: although the vast majority of the capital controls from the Mahathir age are gone, Malaysia still takes some strikingly distinctive approaches at the central bank level, notably in its championing of Islamic finance. Zeti’s latest step has been to propose a new piece of legislation, the Central Bank Bill, which if passed (its first reading in parliament comes in June and it should pass this year), ought to give Bank Negara greater power.

Zeti doesn’t present it in those terms, instead referring to a “greater clarity of mandate,” institutionalising many practices the bank has adopted over the years such as the monetary policy committee and the required levels of transparency and disclosure. But the fact is, it does make the bank more powerful, partly because it will be able to move much quicker. “It is important because it will provide the ability for the bank to be effective in a very changed environment,” she says. When, in the last financial crisis, the government had to set up an asset management corporation to recapitalise banks, it was done quickly but still took about three months for the processes to go through, she says. “Now, as this Act becomes enacted, we would be empowered to respond immediately.” Other changes that will come with the act include greater ease in working with other regulators, clear lines of accountability in the areas where there is overlap with the Securities Commission (such as oversight of investment banks), and a clear mandate to promote what she calls financial inclusion. “It is very important that future generations of central bankers in our country will always give regard to that, because we want balanced growth, we don’t want it concentrated in urban areas.”

Zeti says the Act is not a response to the crisis, and has been under development for two years, although she adds “the crisis brought to the forefront many issues” addressed by the Act. But it seems at this stage it won’t lead to any reversal of other policy initiatives, notably the relaxation of restraints on foreign exchange.

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