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Malaysia, Indonesia central banks find their hands tied

Central banks in Malaysia and Indonesia were widely expected to keep interest rates steady on Thursday, constrained by fears of currency outflows.

Oliver Salmon, senior economist at Oxford Economics, told CNBC's "The Rundown" on Thursday that both countries were in similar boats, facing pressure on their currencies and vulnerability to outflows, especially with high foreign ownership of their government bonds.

But he noted that while Indonesia's rupiah has been relatively stable, Malaysia's ringgit has been one of the worst performing emerging Asia currencies since the U.S. election.

"They've already taken steps to try to shore up the ringgit. For example, they've compelled exporters to convert about 75 percent of proceeds into the ringgit. This should help boost reserves," Salmon said. "We've seen a significant decline in reserves in the last 18 months, but they'll be a lot more cautious in setting policy over the next year as a result of this fear of capital outflows."

He doesn't expect Malaysia's central bank, Bank Negara Malaysia (BNM), to move on rates until around the end of 2017, when he expects a hike.

"We've got base effects coming out of inflation, higher oil prices and also with the Fed likely to move a couple of times this year, clearly they won't want to see interest rate differentials narrow too much to stoke fears of capital outflows," he said.

Malaysia's benchmark rate has been set at 3.0 percent since July, when it was cut by 25 basis points.

In December, the U.S. Federal Reserve raised its benchmark rate by 0.25 percentage point to 0.50-0.75 percent. But over the next year, the Fed has signaled it expected to hike three more times, and some analysts were forecasting four hikes.

Sha Ying | CNBC

As the difference between Malaysia's and the U.S.' benchmark rates narrow, funds were likely to flow out of Malaysia to head to the U.S. in search of less risky returns.

But Salmon noted that while Malaysia may keep its rates unchanged, it was now more likely to allow the ringgit to weaken. The central bank was suspected of intervening in the foreign-exchange market late last year as the ringgit tumbled, coming within a hairsbreadth of 4.50 ringgit to the dollar.

"A weaker ringgit will help boost export competitiveness and this comes at a time where export growth is really starting to pick up toward the end of last year and early this year and so external demand is really seen as a catalyst to growth for next year especially as there are some soft patches in the domestic economy," he said.

But he added that he expected the BNM would draw a line in the sand at 4.50 ringgit to the dollar.

Others also noted that the Indonesian and Malaysian central banks were likely to hold policy steady.

"Lingering commodity headwinds arguably leave room to ease amid benign inflation. But theoretical ability to ease is limited and overstated," Mizuho said in a note on Thursday.

"In practice, weaker currencies not only provide substitute accommodation, but averting excessive ringgit and rupiah drops takes over as policy priority. High foreign debt exposure ups gearing, and consequently capital (and foreign-exchange) volatility to rising global interest rates."

That means the two central banks will have to shift toward a neutral, rather than a dovish stance, Mizuho said, noting the likely impact from U.S. President-elect Donald Trump's likely policies.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1

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