Whatever the results may be for the gross domestic product growth rate for the first quarter of the year, let us be clear about one thing. The two fiscal stimulus packages have only insignificant impact, if not at all, to Malaysian economy in that period.

Any effort to paint the stimulus packages as having helped to cushion the impact economic slowdown we saw in the first quarter should be received with extreme skepticism.

One has to remember that, while the first fiscal stimulus package was announced by the Abdullah administration in November 2008, there was no real spending done even as February 2009 passed us by with the speed of a tortoise. The government at that time was still scrambling to distribute money to various ministries and not actually spending it.

This has been admitted by the Second Finance Minister himself. In early March, he was reported as saying that barely half a billion ringgit from a total of RM7 billion had been spent.

Two months later — by May 12 2009 — according to a website established by the Treasury to inform the public of the status of the two stimulus packages, only a further quarter billion ringgit was spent from the RM7 billion.

Given the horrifying demand gap caused by weakened external demand, actual spending derived from the first fiscal stimulus is very much irrelevant to the GDP growth figure for the first quarter of the year.

If one insists that the RM750 million did cushion the fall that certain Ministers claimed it would earlier in the year, perhaps I am obliged to share the following analogy: it is only akin to preparing a mattress on the ground with the intention of saving a person who has just jumped off from level 88.

One also has to remember that the second, much larger, stimulus package was only announced on March 10 2009, which was already close to the end of the first quarter. Furthermore, it is impossible to believe that the second stimulus package came into effect immediately, especially accounting for the kind of lag suffered by the first stimulus package.

How much of the second stimulus worth RM15 billion of government spending has been spent is unclear. The same website commissioned by the Treasury is coy about divulging the same information it shares when it comes to the RM7 billion stimulus package. Nevertheless, experience tells us to be rational and not to expect too much.

Consider this: if the government faces trouble in spending RM7 billion even after approximately 7 months have passed, how exactly does one expect the government to spend another RM15 billion within just over 2 months?

That skepticism should be strengthened further with the knowledge that the government only began to borrow massively in April. We know that the second fiscal stimulus needs to be financed through borrowings. And we know that April is not part of the first quarter.

The best hope of making the second stimulus relevant is the RM3 billion tax cuts as well as the loan guarantees attached to the second fiscal stimulus, or the mini-budget in the language of the government. Alas, information about that is not so forthcoming for us to move beyond mere speculation.

Hence, the effect of tax cuts and guarantees notwithstanding, the effect of the two government spending-based stimulus packages has to be largely discounted if we are interested in explaining the results of the first quarter for the year 2009.

What might make the two stimulus packages all the more irrelevant is the manner which the economy behaved in the first quarter. While the jury is no doubt still out there, early indications do not bode well for proponents of government spending as the heart of fiscal stimulus.

The reason is that the economy — as indicated by various indicators — is arguably performing better with each passing month since January, on the margin. It is better in a sense it has been less bad than before; to be precise, the change of sign of the second derivative.

This happens in spite of the lack of significant interference in the economic cycle as planned by the two fiscal stimuli. The significance of this is that it may prove to those who lack confidence in the market that the economy does not desperately need government spending. This also provides a damning evident that we do not need a third stimulus package at all.

So far, the best factor to explain possible turning of the economy may be the very factor that brought the economy to a tailspin in the first place: external demand.

It is hard to resist connecting the improved local condition with the health of the blessed Chinese economy. Even in the US — another major destination for Malaysian goods — talks of green shoots are aplenty.

If the trend continues, we may see a bottoming out soon enough even without additional government spending as allocated by the two fiscal stimuli. Indeed, the chances that the economy gets better before the full effect of the stimulus packages kick in are becoming brighter now than anytime before.

As it may turn out, the billions of ringgit of government spending may only increase our public debts. That will increase the cost of borrowing in the future and possibly later, the imposition of higher taxes for all, on average.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

First published in The Malaysian Insider on May 26 2009.

11 Responses to “[1994] Of fiscal stimuli did not factor in Q1”

  1. on 29 May 2009 at 15:32 hishamh

    I’m having trouble reconciling this statement:

    “That skepticism should be strengthened further with the knowledge that the government only began to borrow massively in April.”

    Official data shows a net increase in government debt of RM10.8b in the first quarter, and just RM1.49b in April – where did the “massive” rise you are refering to come from? There was no MGS issuance in April, although there was RM8.5 billion issuance in May – but I wouldn’t call this massive either, compared to the truly massive overhang of liquidity in the financial system.

    As far as borrowing costs are concerned, yields and spreads on MGS have already risen in anticipation of further issuance – but not much relative to conditions last year, and well below rates seen in the last two downturns. Demand still exceeds supply, so I doubt borrowing costs will increase that significantly.

    One thing I think you should consider is debt relative to the ability to repay. On that score (one of the very few real economic achievements of the Badawi administration), Malaysia’s situation is pretty decent with debt at 41% of GDP.

  2. on 29 May 2009 at 16:34 Hafiz Noor Shams

    the govt sold sukuk. anyway, in the first half of april, there was RM5 billion worth of paper offered.

    And you are right about ability to refinance. It’s not debt per se that is worrying but rather ability to refinance, i.e. fiscal deficit. When I writes “increase in public debts”, I refer to fiscal deficit.

  3. on 29 May 2009 at 17:03 hishamh

    Yes, I saw that RM5b issue. I also noted RM3.5b in sukuk redemptions the same month, which resolves to the RM1.5b net increase I mentioned. But thanks for the clarification.

    I don’t think the fiscal deficit is as relevant under the circumstances as overall debt to GDP. It is just the marginal increase in debt, which while important in itself, doesn’t convey much about repayment capability.

  4. on 29 May 2009 at 17:47 Hafiz Noor Shams

    I kindly differ. We have to remember that it is exactly fiscal deficit which determines the rating of Malaysian government bonds. And this rating help determines the yield. Higher yield means greater risk and vice versa. And yield signals the ability to repay.

  5. on 31 May 2009 at 08:03 hishamh

    There is a lot more taken into account when formulating sovereign ratings than just the fiscal deficit. This paper for instance outlines the methodology for S&P ratings (see ppg 13-24), and lists ten different analytical areas with eleven different metrics, of which the fiscal deficit is but one.

    In any case, ratings don’t have much of an impact when 90% of government debt is raised in domestic markets

  6. on 31 May 2009 at 13:40 Hafiz Noor Shams

    Sure, there are other factors that affect rating but fiscal deficit affects many other factors which are listed in the rating.

    Fiscal deficit for instance affect “interest burden”. When the deficit is due to government spending (especially spending that has nothing to do with investment) it affects inflation. By that, it affects the exchange rate. And that affects the ability of others to finance external debt. Even that of the government.

    Therefore, fiscal deficit maybe one of the factors but it is a large factor.

    Furthermore, the reason why ratings of Malaysian govt bonds haven’t improved for a long time is due to persistent fiscal deficit.

    Finally, it doesn’t matter where is the source of financing. Fiscal deficit affects yields on ;

    Consider that in light that a major part of revenue for Malaysia originates from petroleum. With lower oil prices, how does that affect the ability to repay the borrowing?

    This is a risk that has to be compensated by the yield, regardless of origins of finance.

  7. on 01 Jun 2009 at 07:36 hishamh

    Hafiz, every single one of those points you made could equally be made in support of looking at total debt or the debt/GDP ratio instead. After all, the fiscal deficit (flow variable-short term impact) is nothing more than the rate of change in total debt (stock variable-long term impact). To my mind the fiscal deficit is not a useful metric without its context.

    In other words I would not judge the sustainability of fiscal policy without looking at both the fiscal deficit as well as the debt/income ratio. A 5% fiscal deficit means one thing when debt to gdp is at 40%, and quite another when the ratio is 100%. The latter would attract investor demand for punitive compensatory yield, the former might see a 1% or 2% increase at worst. In short, I don’t believe the yield follows a linear function.

    The origin of finance does/ matter for external debt (where ratings are relevant) because it carries foreign exchange risk, and because foreign investors require risk-premia on top of the yield. This isn’t America; we do not have the luxury of denominating our external debt in our own currency.

    “Furthermore, the reason why ratings of Malaysian govt bonds haven’t improved for a long time is due to persistent fiscal deficit.”

    You mean increasing political instability, rising inflation, and the doctrine of consistency (other countries with similar risk profiles are at the same rating) have nothing to do with it? Especially since the deficit has been falling since 2004?

  8. on 01 Jun 2009 at 21:08 Hafiz Noor Shams

    Of course fiscal deficit is not a useful factor without context but that is a non-sequitur; we are discussing it within Malaysian context. The necessary variables have been set.

    And tell me, how exactly one is to finance a debt when one experiences deficit? By borrowing more? Even is the debt is 999%, a fiscal surplus of 1% says that debt is being repaid. Even is the debt is at only 1%, a fiscal deficit of 1% informs all that that debt is not being repaid. But of course, the gravity of the matter are different in both of course and an entire matter altogether but the fact is that it tells about ability to pay.

    Back to the dispute on yield and rating, regardless of origin, fiscal deficit affects yield. Perhaps I should say, fiscal deficit affects yield ceteris paribus instead?

    Even if 90% is locally sourced, it still worsen fiscal deficit and that affects rating.

  9. on 05 Jun 2009 at 23:56 hishamh

    Governments are not subject to the permanent income hypothesis – nothing says that debt must be cleared at some putative future date. My actual point, which I may be describing badly, is that an increase in debt matched by an increase in income is irrelevant in terms of determining the cost of funding.

    But we could go on until kingdom come arguing over this, so…

    MGS_1 = -25.33*DEBT_GDP + 13.93 (R2=0.57 SIC=3.18)
    MGS_1 = 59.48*DEFICIT + 5.79 (R2=0.86 SIC=2.10)
    MGS_5 = -27.63*DEBT_GDP + 15.53 (R2=0.69 SIC=2.82)
    MGS_5 = 55.16*DEFICIT + 6.33 (R2=0.75 SIC=2.62)
    MGS_10 = -25.60*DEBT_GDP + 15.24 (R2=0.68 SIC=2.72)
    MGS_10 = 46.50*DEFICIT + 6.58 (R2=0.61 SIC=2.92)
    MGS_20 = -23.35*DEBT_GDP + 15.23 (R2=0.57 SIC=3.02)
    MGS_20 = 31.91*DEFICIT + 6.98 (R2=0.29 SIC=3.52)

    …all for sample period 1996-2008, at annual frequencies. As you can see, the fiscal deficit is a good predictor of yield at the lower end of the yield curve, but gets progressively worse at longer maturities, where the debt to GDP ratio does rather better. Unit root tests also suggest that the fiscal deficit only has a short term impact on yield as it is a borderline I(0) variable (the MGS series test as I(1), debt/GDP as I(2)), which is corroborated by cointegration testing (no long term relationship).

  10. […] Secondly, with effectively none of the stimulus money was spent in the second quarter, it suggested that the first and the second stimulus was worthless in that quarter, just as it did not in the first quarter. […]

  11. […] really, not a bad assumption given the incompetence of the Abdullah administration. We know that by May 2009, only three quarters of a billion of the first fiscal stimulus was spent. Only half a billion was […]

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