Malaysia’s central bank (BNM) left its fiscal policy unchanged at a meeting on Thursday, keeping the central bank interest rate at 3 percent. However, it will likely hike its interest rate in the first half of 2014 if the economy improves.

“As the economy gains a firmer footing on the back of improving export prospects over the next year, we expect to see 50bp worth of rate hikes,” Capital Economics said in a research note.

The decision to keep the interest rate the same was widely expected, despite a spike in inflation in September to 2.6 percent compared to the same period last year, and from 1.9 percent in August this year, after the government cut fuel subsidies. Nonetheless, following the 2014 budget announcement that outlined the implementation of the Goods and Services Tax (GST) in 2015, the government may wish to preemptively contain inflation in 2014 by tightening fiscal policy. 

Unlike neighboring Indonesia, Malaysia’s economy appears to be rebounding. Recent economic data have seen exports and industrial production pick up, and if key export markets in the developed world recover as expected, the continued strong exports should offset any negative effects from fiscal tightening on growth in Malaysia, the Capital Economics note said.

The biggest risk for Malaysia's economy in the medium-term remains the rapid growth of household credit, which has been above 10 percent for a few years. Interest rate hikes could help slow this growth and stem the rise in household debt levels, now at 83 percent of GDP, up from the 72 percent in 2009.

“Overall, we expect the BNM to keep the policy rate steady at 3.0 percent in the near-term,” the Capital Economics research note said. “However, an export-supporting recovery in global demand would give the central bank scope to start hiking rates in the first half of 2014.”