[2923] Watch out for the current balance in Budget 2021

The fiscal balance gets a lot of attention from the press on Budget Day. It is usually in deficit (it has been so since the 1990s) and the theme has always been fiscal consolidation. Even when Pakatan Harapan was in power, reassessed the government’s fiscal goal and raised its 2018 fiscal deficit from a projected 2.8% of GDP to 3.7%, the consolidation narrative was intact and bought by credit rating agencies.

This time the fiscal deficit will be much larger. Understandably so given the current economic condition brought by extraordinary circumstances. I would think any mention of fiscal consolidation would be inappropiate.

But the more important figure this time around would likely be a different kind of balance: the current balance.


For the uninitiated:

  1. Fiscal balance is the product of all of government revenue subtracted from all of government expenditure. Here, total expenditure is the sum of operating and development expenditures.
  2. Current balance is all of government revenue minus only the operating expenditure.

By definition, operating expenditure involves the day-to-day running of government, like paying wages, interest payment, grants, subsidies and various supplies and services. Development expenditure involves investment into some kind of long-term assets.

There is a logic behind the division between the two expenditures (although it is being increasingly questioned in the past year). As the reasoning goes, the government’s daily operating concerns should be fully funded by the government revenue. This prevents the government from borrowing for non-capacity improving purposes.

Accounting and law, but not economics

But it feels the distinction between the two expenditures is blurry because money is fungible. More than anything else, the distinction exists in concrete terms only because of accounting definitions operationalized by the law. In Malaysia, all borrowings (specifically MGS, GII and Treasuries as I understand it) must be used for the purpose of development expenditure. This is specified by the Loan (Local) Act 1959 and the Government Funding Act 1983. In the 1959 act, it is written so in Part II and in the 1983 act, Article 4. More precisely, any borrowing raised must be deposited into the government’s development fund, which is used for development expenditure, and not operational spending.

If that is wordy, the bottom line is this: the law demands that the current balance must never be in deficit.

Indeed, in the whole modern history of Malaysia, for the most parts, the government has maintained current surplus. The last time Malaysia had a current deficit was in 1987. See the following chart.

The thing with laws like this is, when it comes face to face with economic forces, the economics usually win. If the laws are to be followed down to the letters in this regard, the government would probably be forced to resort to some extraordinary measures.

Current deficit likely for 2020

For year 2020, regular revenue has been falling dramatically, while expenditure has likely gone up. The spending is not developmental in nature too. Things like wage subsidies sound more operational than developmental. As a result, it is likely for the government to face its first current deficit in more than 30 years and it should be big, if nothing is done.

Strict adherence to current balance restriction is one of the reasons why Malaysia is considered as having limited fiscal room to maneuver. Refer back to the chart and observe the small surplus since the late 2000s.

Change the law, loosen the artificial limit

The truth is, the restriction is artificial and it only exists because of the law and given the crisis we are facing, the law is counterproductive to the maintenance of our welfare and the health of the economy. The crisis that we are facing is just out of this world and traditional tools are inadequate to handle the situation well.

Here is a proposal: amend the Local (Loan) Act 1959, Government Funding Act 1983 and other relevant laws to allow for borrowing for operational spending. This will give the government greater flexibility, and more fiscal room to act.

Safeguards could be put in place if the restriction removal is too radical. For instance, we could demand the sum of 5 years’ worth of current balance must be in surplus. Such 5-year instead of yearly schedule could enable government finance to accommodate economic cycles better, and allow for more effective counter-cyclical spending.

Other current balance things to look out for

Finally, here are a set of things we should look out for when it comes to current balance:

  1. Extraordinary revenue measures. I probably mean something like extra dividend. The government has demanded and will be receiving an extra RM10 billion worth of dividend this year. Other entities we should look out for are the central bank and Khazanah. There are other entities with sizable reserves and money doing nothing that potentially could be given out as dividend to the government.
  2. Reclassification of spending. Despite the distinction between operating and development expenditure, the actual classification between the two can be fluffy. So, watch out for some operating expenditure being reclassified as development expenditure for accounting purposes. You know the joke about accountants. No? See the notes.[1]
  3. Off-budget spending done by companies owned by the Ministry of Finance Inc. Pakatan Harapan tried to rein in on this by making it more transparent and slowly bringing it into the book proper. The shift toward accrual accounting should make off-budget spending less controversial and irrelevant. But with this new government in place, progress toward accrual accounting is in doubt and commitment toward not using off-budget spending is likely non-existent.

Hafiz Noor Shams. Some rights reservedHafiz Noor Shams. Some rights reservedHafiz Noor Shams. Some rights reserved

[1] — For the fun of it:

A businessman was interviewing job applications for the position of manager of a large division. He quickly devised a test for choosing the most suitable candidate. He simply asked each applicant this question, “What is two plus two?”

The first interviewee was a journalist. His answer was, “22”.

The second was a social worker. She said, “I don’t know the answer but I’m very glad that we had the opportunity to discuss it.”

The third applicant was an engineer. He pulled out a slide rule and came up with an answer “somewhere between 3.999 and 4.001.”

Next came an attorney. He stated that “in the case of Jenkins vs. the Department of the Treasury, two plus two was proven to be four.”

Finally, the businessman interviewed an accountant. When he asked him what two plus two was, the accountant got up from his chair, went over to the door, closed it, came back and sat down. Leaning across the desk, he said in a low voice, “How much do you want it to be?”

He got the job.



[2601] A thought, or two, about federated and unitary states finance, and consolidated public sector finance

I have been doing some preparatory work for a report on the 2013 federal government budget. The budget will be tabled at the Parliament this Friday.

In the course of doing so, I have come to wonder if the comparison of budget deficit (as typically understood) across governments of the world is really fair. Specifically, I do not think it is fair to compare the fiscal balance of a federated state with that of an unitary state, especially if one is concerned with the health of the overall economy and not just the financial health of the government.

This suspicion came after I read the consolidated public sector account for Malaysia.

One reason for the suspicion is this: one way to measure the solvency of the government is to see if the government can finance its operating expenditure and pay all of its borrowings interest purely by its revenue. This is called the primary surplus/deficit or the primary balance.

The reason is that through this, the government can fulfill all financial claims against it without embarking on new investments that require further financing while providing essential services to citizens and others largely unimpeded. To put it in another way, for government finance to be sustainable, it should be able to purely finance its consumption through its revenue only, and not by borrowing further (this comes with the assumption the interest rate is above zero. If the rate is zero and below, well, borrow away).

Looking at the federal government, most of the times there were no problem. According to the latest Bank Negara Malaysia’s Monthly Statistical Bulletin, most quarters registered a surplus as far as the primary balance is concerned. On yearly basis, there have been surpluses since 1981 (the earliest data available in the bulletin) with the exception of 1987 and 1986.

But according to the consolidated account (the Treasury identified it as consolidated public sector account which includes the finances of the federal government, all state governments, various statutory bodies and all local governments), then there is a huge deficit to contend with. In fact, it is estimated that there was a RM35 billion primary deficit for the first half of 2012. In 2011, it was estimated to be RM30 billion.

A little word of warning: the numbers for the federal government revenue from the Treasury significantly differ from the ones produced in the BNM Monthly Statistical Bulletin. So, the comparison is somewhat off.

Even so, if the Treasury numbers are right, then the consolidated public sector account tells a very different story than the one we used to. This may suggest that the wider public sector may have a problem balancing its primary balance.

As far as comparing federated and unitary states is concerned, maybe only the federal and the state government accounts should be combined to allow for a truer comparison. Without the necessary adjustment, a federation may have better financial health than a unitary state only artificially.

Another thing about the consolidated account is that it tells us that in 2011, the public sector suffered from 9.9% deficit to nominal GDP. This is much higher than the federal government’s 4.8% deficit to GDP.

On the 9.9% deficit to GDP, the point of comparing the deficit to nominal GDP is to incorporate the idea that a growing economy allows for more fund raising by the government. More generally, it informs whether there is space in the economy to raise more money through borrowing. The deficit derived from the consolidated account suggests that there is less room compared to what is suggested by the federal government finance.