Category: Economics

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Economics History & heritage Politics & government

[2966] A short history of soft-budget constraint in Malaysia, and the challenge the Anwar administration faces

For the past few days, I have been thinking about the 2020-2022 roles reversal in the Malaysian version of soft-budget constraint, but ended up trying to trace the history of SBC in Malaysia.

First off, a short primer on SBC: soft-budget constraint is usually a problem between a government, and its state-owned enterprises. In Malaysian parlance, those enterprises are government-link companies. It is called soft-budget constraint because the budget of those enterprises is hard to be fixed; company revenue does not provide a hard limit on company expenditure. The government ends up financing those companies beyond what the latter’s revenue provides. That financing comes in the form of subsidies, loans, tax breaks and grants, and designed to meet various political, social or even economic objectives.

This problem is most prevalent in command economies, but it also exists elsewhere where the market is more open, like Malaysia.

Now, let us dive into the history of SBC in Malaysia.

From the 1970s until the 1990s: NEP and privatization

Malaysia had several influential state-owned enterprises prior to the 1980s and this made SBC a common problem, especially with the New Economic Policy running at full steam.

Luckily for Malaysia, raw material prices—petroleum, rubber, tin—were high at that time, making budget constraint problem manageable. These companies’ budget constraint was soft, but government revenue was bountiful.

Troubles came in the 1980s, when global recession depressed commodity prices. Budget constraint suddenly became very pressing, when government coffers could no longer support growing expenditure needs. Here, Mahathir Mohamad, addressed it through rapid and widespread privatization. Market discipline was instilled, and these companies found their budget constraints becoming stricter than in the past.

During the 1990s, through rapid modernization and super economic growth, along with privatization, SBC seemed like it had been consigned to history. SBC became a curiosity. The government enjoyed large growing surplus, and there were fewer companies requiring government support, save several instances where Mahathir insisted on import-substitution industrialization (Perwaja?).

When the Asian Financial Crisis hit Malaysia, all the bailouts meant the return of SBC.

SBC of the 2000s

The 2000s is significant in this telling because it was during this decade that off-budget spending took off earnestly. Government revenue did not grow fast enough to meet the country’s rising spending needs, especially so soon after the late-1990s recession. The government overcame its finance gap by devising clever methods to circumvent various accounting rules, and expand its spending capacity enormously. The methods are complex, and I will not go through it here except by sharing a post I wrote several years back, which explains various liabilities the government carried, but previously undisclosed.

Expanding off-budget obligations necessarily means growing SBC problem. Off-budget approach gave the government extra leverage, but it does not mean the government not having to fund them.

Off-budget approach, and SBC, came under intense scrutiny when 1MDB corruption came into the picture, and brought onto the government severe public demand for transparency. That demand, along with other concerns, led to collapse of the Barisan Nasional government, and the rise of Pakatan Harapan administration.

PH attempted to solve the problem by instituting greater transparency (this is part of the RM1 trillion debt and liabilities controversy), putting some off-budget spending back on budget (this partly raised the 2018 fiscal deficit ratio) and adopting accrual accounting, to make sure all financial obligations get recorded properly. But the SBC problem, intertwined with complex off-budget method, has become so big that it needs time to be addressed. And PH fell short of two years into office.

Reversal of roles during Covid-19 pandemic

The fall of PH coincided with the Covid-19 global pandemic. The new government needed to expand its spending fast to save lives and to preserve the economy’s productive capacity. But those in power were reluctant to boost government spending, possibly out of inexperience while facing a steep learning curve. With that reluctance, they looked to state-owned enterprises for solutions.

This caused a reversal of roles between the government and its companies. The government leaned on its GLCs to support its spending needs, instead of the other way round in the normal SBC problem. This made government budget to be softer than it was. GLC’s capacity became the government’s capacity.

Those financial supports from GLCs to the government come in the form of extremely long delayed payments. More specifically, the government throughout 2020, 2021 and 2022 engaged in massive subsidies and these subsidies were financed by the GLCs. The GLCs were supposed to be reimbursed immediately but that did not happen. To put it more plainly, these GLCs ended up financing the government.

For proofs, I would encourage everybody to inspect some of the largest utilities-GLCs out there. Check their growing receivables listed in their balance sheet (receivables refer to amount owned by buyers to suppliers).

There is another way to understand the roles reversal: these companies’ budget constraint becomes stricter than it was during normal times. Soft-budget constraint at the GLC level becomes really hard-budget constraint.

The problem became more complex in the post-Covid recovery, where subsidies ballooned tracking surging commodity prices.

2023 and into the future

Unlike the government, companies have troubles going over their budget constraint without outside support for too long. The cash crunch is coming.

The new Anwar Ibrahim administration will have the misfortune of having to address the roles reversal problem. It will be painful, involving large payments to be made/reimbursed by the government. Anwar Ibrahim the Finance Minister does not have much time: the cash crunch at several GLCs is coming.

That will add pressures for a broad tax hike, that Malaysia needs even before the pandemic.

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Economics WDYT

[2964] Guess the 3Q22 Malaysian GDP growth

It is almost certain the third quarter growth will be massive as far as year-on-year calculations are concerned. Consensus compiled by Bloomberg has it at 12.1%. What do you think the number would be? The official figures will be released this Friday.

How fast do you think did the Malaysian economy expand in 3Q22 from a year ago?

  • Slower than 8.0% (64%, 7 Votes)
  • 8.0%-9.9% (0%, 0 Votes)
  • 10.0%-11.9% (18%, 2 Votes)
  • 12.0%-13.9% (18%, 2 Votes)
  • 14.0% or faster (0%, 0 Votes)

Total Voters: 11

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Big as it will be, it will not inform us much about the state of the economy. At least, not by itself alone. So, do not be taken by it and read it with extra context.

It is important to remember what happened a year ago: the third quarter 2021 real GDP dropped by 4.5%, as shown in the chart below (in the same chart, you could see another instance of massive base effect in the second quarter of 2021, responding to the drop the year before).

One simple way to avoid the problem of base effect altogether is to look at quarter-on-quarter growth, and compare it with historical numbers.

For 2015-2019, quarter-on-quarter growth for the third quarter averaged around 3.5% (range: 3.1%-3.9%). Let us ignore 2020 and 2021 due to the usual circumstances those years represent. Since 2022 appears to be a more normal year (as far as normality is concerned, we could probably take the first quarter of this year as the beginning), 2015-2019 appear like a reasonable for casual comparison.

Now, if third quarter growth is indeed 12.1% year-on-year, then quarter-on-quarter growth would be 2.9%.

That 2.9% is below the quarter-on-quarter average of 3.5%, and misses the lower bound of 3.1% (see the second chart above). This also means, if the year-on-year growth figures is to be truly impressive, third quarter growth will have to be significantly higher than 12.1%. Maybe 13% or 14%. Else, it would be either bad, or normal at best.

The quarter-on-quarter growth is something to watch out for, especially at a time when the global economic outlook points toward recession in Europe and the US, along with a weak China. Ignore the year-on-year one for the time being.

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Economics

[2963] Is inflation the reason behind BNM hikes, at a time when the output gap is big?

Bank Negara raised its benchmark rate yesterday, from 2.50% to 2.75%. While the general reasoning is fighting inflation, I am not that convinced of it. My primary reason is, Bank Negara’s own analysis shows inflation (demand-push) is not a problem. Yes, consumer price index has been rising high, but most of those price increases are not something monetary policy can address without exerting damage to the economy.

The central bank regularly published estimates of output gap in the economy. Looking at the output gap is the easiest way to understand the economy quickly. To put it simply, the gap tells us about the capacity utilization of the whole economy. It is the difference between total (or maximum) capacity, and capacity used. When the used capacity is well below max, then inflation should be relatively low with unemployment high. When resources are not used up, there will be slack in the economy which is reflected in inflation and unemployment numbers. The same is true vice versa.

And based on the latest estimates published by Bank Negara back in March 2022, there is a huge slack this year (and estimated to be bigger than last year’s):

When the gap is big and when there are no other concerns, you would want to encourage the economy to keep going. You would want to close the gap, and approach full capacity (which is another way of saying full employment). And you can do this without much concern for inflation. That means, rates could be left low.

When you raise rates in these circumstances (as Bank Negara is doing), it means widening the output gap. You would lower demand-pull inflation (if there any), but since you have no control over supply-push inflation, you are just targeting the wrong part of the economy. You are pulling demand down almost immediately, but do nothing to the supply side, which is out of your immediate control (in fact, low rates improve supply, but not in the short term). Hence, widening the gap.

Beyond domestic considerations and on top of the current gap situation, there are concerns the global economy will go into yet another recession so short after the last. The US economy is close to experiencing one although its growth resilience so far has surprised many economists (and demand-pull inflation is problem there). Europe is almost certain to enter recession next year (war and gas supply are exacerbating supply-push inflation). Growth in China has been weak but there is some hope it would provide some cushion in an otherwise sullen world. When we look ahead, Bank Negara’s rate hike feels even more jarring and lags behind expectations, when they should be ahead of the curve.

So, when I read the Monetary Policy Statement and the references to inflation, I am not so sure inflation is the primary driver for the hikes. I have been suspecting so for a while now.

In my opinion, there are two other things at work that convinced the Committee to do what they did yesterday:

  1. It is about the ringgit. The currency along with many others out there have been under severe depreciation pressure due to US Federal Reserve’s series of drastic rate hikes. The end of easy money is upon us. And domestic benchmark rates are a big lever to relief the pressure partially: rising domestic rates would keep the difference with those in the US smaller than it would have been otherwise. And smaller difference means less depreciation pressure on the ringgit.
  2. The problem of zero-interest rate policy (ZIRP) and liquidity trap. Many conventional economists (of the 1990s?) believe monetary policy loses its potency the lower the rates go. And since Bank Negara Rates is already low by historical standards, maybe they are concerned about losing monetary influence and hoping to build up ammo for the next crisis.

In both cases, the cost of pursuing the goals will widen the gap today.

The relevant question is (especially with respect to the ringgit), how big would the gap be if the ringgit is allowed to depreciate beyond what the rate hikes allowed? Supply-pull inflation does hurt demand after all, and weaker ringgit means more imported inflation. Comparing the two gaps would help determine which policy to take.

I would love to read the minutes and see references to the gap, if any.

Categories
Economics Politics & government

[2960] Election time: my preferred transport policies

Recently, I wrote election manifestos should have overarching themes, while avoiding the kitchen sink approach. While I focus on Pakatan Harapan, Barisan Nasional also had a kitchen sink approach before. Kitchen sink is the favorite way of doing things among political parties.

I do not have the energy to come out with a manifesto myself, but if I had to choose one area, then it has to be transport policy, which intersects with many other areas that includes fiscal, climate and urban development policy.

My ideal transport policy will be constrained by at least 3 factors:

  • Promoting responsible fiscal policy to rapidly build up government capacity in healthcare, education, defense and overall industrial policy
  • Reducing carbon emissions with respect to concerns for climate change
  • Improving connectivity across the country, especially in and around major cities where most of the population work and live.

These constraints mean, especially in the cities, fewer private vehicles on the road, and greater reliance on public transport.

This list is not comprehensive, but I think the areas it broaches are major concerns. Here are my preferred policies.

Fuel policy: Switch from petrol subsidy to cash transfer

Current fuel subsidy policy is expensive. It takes resources away from many other areas. As reported in the media, as of June, 2022 subsidy bill alone (not including other social assistance) was expected to hit RM78 billion. This is bigger than 2022 allocation for the Ministry of Health (RM32 billion), Ministry of Defense (RM16 billion) or Ministry of Education (RM53 billion). While subsidies alleviate short term pain, it does not build long term capacity: it takes resources away and weakens already underfunded health, defense and education systems, among others. Imagine what these systems would look like if they had an additional RM78 billion for their services and asset acquisition.

Here, I would like to return to the late-2000 policy of switching from fuel subsidies to cash transfers (before it was abused as goodies). It does not have to be a one-to-one switch since cash has higher value than fuel subsidies: the former has many more use cases than fuel subsidies.

Cash transfer implementation will have to be discussed elsewhere, together with the introduction of tax identification number.

Fuel policy: Tax petrol through SST (or GST)

Simultaneously, I advocate fuel tax. SST (or GST) should be charged on purchase of petrol. While I do not support ring-fencing income from fuel tax for any particular purpose, additional income here should be able to fund a large cash transfer program, as well as to introduce new public transport service while improving existing ones (more about public transport later).

Such tax will discourage excessive use of private vehicles, which will:

  • Improve journey time by taking cars off the road
  • Shift some traffic from private vehicles to public transport
  • Reduce carbon emissions

I would think removal of subsidies and introduction of fuel tax alone would provide the government with resources to build its capacity in multiple areas. And of course, in public transport too.

Specific subsidies (however the implementation is) can be provided to a limited number of people based on geographies or industries. I would imagine logistics service providers and other transport operators should have access to fuel subsidies. Small-time farming and fisheries probably should be subsidized too.

Public transport: government to fund rail transport directly

The current state of public transport is deplorable, and part of the problem is that rail service providers are putting financial rather than service performance first. That financial focus is part of the reason city rail policy in the country has become a bit of a real estate play, rather than about moving people around efficiently.

It is time we admit public transport, city rail in this current state especially, are financially nonviable. While admitting so, we must take into account those rail services are a public good.

With these two things in mind, the government should directly fund these rail services, and reform various rail service providers’ key performance indices from financial-based, to primarily performance-based. (Let us not play with paper-shifting accounting anymore and get serious about public transport).

Besides, for all intends and purposes, these services are already funded by the government indirectly through committed guarantees. It is just that too many people are in denial about public transport finances in Malaysia (see the chart below for the 2023 Fiscal Outlook report, which is the result of lasting reporting reforms made in 2018-2020. Observe commitment linked to DanaInfra, Prasarana and Malaysia Rail Link). They hide behind accounting standards to avoid the truth: the government is already funding these rail services through convoluted means.

This however does not mean public transport is free, but it should be cheap enough, particularly with respect to costs of private vehicle ownership.

Which rail services should under this? I am thinking primarily monorail, LRT and MRT in KL.

Public transport: Postpone MRT3 and HSR to later years when ridership demand is more appropriate, and improve existing rail services instead

Given the current state of rail transport usage and efficiency in Kuala Lumpur, I am unconvinced of the need for MRT3 at the moment. I rather wait until the current rail system nears full or even three-fourths capacity before moving ahead with MRT3. At the same time, with the ringgit weakening, it might be a good idea to control government-induced imports: MRT3 and HSR would definitely need large imports that would exacerbate the situation we are in.

I also am not too warm about having new city rail services in other cities. There are very few cities in Malaysia that have enough population to rationalize building a new city rail line.

As for HSR, I rather we strengthen and expand KTMB’s ETS.

For ECRL, it is too late to do anything about it. But I suppose, the long run goal is to integrate it into KTMB. We should streamline such rail service instead of fragmentizing them.

At the same time, improvement in services will require purchases of new assets. This, obviously, has to be done through open tender. No more sweet deal with China-based companies, which has proven to be overpriced in the long-term despite appearing cheap at the outset.

Furthermore, improving existing rail services would be a chance to further develop Malaysia’s industrial capacity, instead of importing from China technology that we already have.

Public transport: More bus services, and bus lanes in the cities

To improve public transport around in cities all around the countries, buses are likely the most cost-effective ways doing it. And it is flexible unlike rail. Focus on buses instead of rail should keep Malaysia’s transport policy from ballooning the way it has (without the associated improved performance) in the past decades.

Two things:

  1. For buses operated by Rapid, the same government-funded model used in rail applies. These are city-buses.
  2. For buses run by private entities, the government to subsidize fares given some service-level requirements. This is likely applicable in small cities, and interstate services, which do not compete with government-provided services. This should also help with rural buses, where low ridership might kill off services.

It is also time to consider dedicated bus lanes on existing roads. Here, we have Jakarta to learn from. More bus lanes will also discourage private car use in the city, by taking lanes away from private vehicles.

Highway: No new highways in the Klang Valley

With the exception of Sabah and Sarawak, and some parts of the East Coast, the Peninsular West Coast probably does not need new highways (particularly so the Klang Valley). So, no need highways in the Klang Valley.

Tolls: Congestion charges in the cities

I prefer to have congestion charges in the cities. This also means no abolition of tolls, or lower of tolls outside of congestion charges model (abolition of toll means the barrier of switching from private vehicles to public transport will be higher and we need to avoid that). The implementation of total congestion charges may have to come with stages and the easiest is probably to wait for all the concession to end and have the government, or the relevant city authorities take it over. This is probably most relevant for KL and its satellites, and possibly George Town too.

For interstate tolled highways, I am ambivalent. We could keep the current system, but refrains from seasonal toll discounts.

Tolls: payment methods

There are too many lanes for different payment methods.

Makes all lanes capable of accepting all payment methods. Also, no express lanes. Everybody should line up and wait for their turns.

Private vehicle ownership/etc

I am going to list down several items without much elaboration:

  • Doubling (tripling) of excise duties on luxury vehicles for carbon emissions
  • Banning of large vehicles (i.e. pick-up trucks) for individual uses for carbon emissions and safety concerns
  • Banning of white headlamps for safety concerns
  • Cash for clunkers program to address emissions and safety concerns
  • I am ambivalent about this, but we possibly need ideas on investment for electric vehicle infrastructure.

Aviation

Yes, refunds mean refunding in cash, not in funny credits. This shall be the law.

Categories
Economics Politics & government

[2959] Budget 2023 and Undi Banjir are examples of BN irresponsibility

Barisan Nasional believes the yet to be approved Budget 2023 is an asset to them, with their supporters are taking it as their election manifesto. Unfortunately for them, a yearly government budget is no replacement for a 5-year manifesto. To me, using Budget 2023 as a manifesto, with its process halted midway, is a sign of irresponsibility.

Irresponsibility, because we are no longer living in at a time when BN is assured of returning to power. It could be PH, PN or any other permutation out there. If a different government gets elected, the budget process will have to be recalibrated. Any government will want to execute their own agenda. Indeed, even if BN gets into power, there is no guarantee Budget 2023 will not change. Even BN PM candidate is uncertain, with assurance given incredible.

The smooth running of the government should sit beyond partisan politics, but BN places that below their political fortune. The risk of disruption to the budget process is of no cost to them, but only to the people of Malaysia at a time when the global economy is risking recession.

Such irresponsibility of course should be apparent to many in the past two years through various instances of double standard in the application of rules during the Covid-19 pandemic that brought so many unnecessary deaths.

But such irresponsibility should not be a surprise. After all, BN wants a general election during flooding season. Just like during the pandemic, they are willing to gamble our lives for their partisan benefits.

The Budget 2023, unapproved, and risked being redone, is just yet another example of BN irresponsibility.