Tag: debt

Categories
Economics

[2882] The spirit, not the letter, of government debt and liabilities

Now that the dust has settled somewhat and the conditions are now more conducive for rational discussion, I would like to discuss about the nature of the debt and liabilities of the Malaysian government. This an non-accountant view, so pardon the terminology.

I know the current government’s approach in the matter has diverged from the norm. So unorthodox that it has caused some complications in various calculations enough that there are parties out there unconvinced with the appropriateness of the new approach.

Yet, there is sound logic behind the government’s approach and is backed by an actual standard maintained by the IMF. But to understand that, we require comprehension in traditional definitions of debt, government guarantees, the nature of liability and weaknesses relating to the various definitions.

Traditional definitions

First, we will talk about the definition of debt, which is the easiest part to grasp. This is the case of the government borrowing money from the market, and what is borrowed has to be repaid. The ownership of the debt and the party responsible in servicing the debt are clear: the government. The instruments used to raise these debt are the typical ones found in the market, namely the Malaysian Government Securities (MGS, the bonds) and its Islamic counterpart, the Government Investment Issues (GII, the sukuks). There are other novel instruments which can be read at a page maintained by the central bank, Bank Negara Malaysia.[1] These government debt are used to finance the government’s fiscal deficit and the government’s development (capital) spending like the building of schools and hospitals.

The second definition we need to understand is government guarantee. GGs as it is called and easier to type, is exactly what it is: the government guarantees a non-government debt (like that of a company). In case of default, the government would come in to take over the debt and start servicing it. So, the ownership and the burden of servicing the debt belong to the company but in case of default, both factors will be transferred to the government. In Malaysia, GGs are generally given to government-linked companies for various large infrastructure projects like airports, highways and railways. There are also cases of bailouts but the bottom line is, a guarantee is provided by the government to a company to lower the latter’s cost of borrowing and increase the financial viability of the company (for the uninitiated, under normal times, government debt has the lowest interest rates in the market and any other kinds of debt almost always have interest rates higher than the ones enjoyed by the government proper).

For the whole of 2018, total government debt stood at MYR741 billion, or 52% of the GDP.

For 2018 government guarantees, its value were RM266 billion, or 19% of the GDP.

Both government debt and government guarantees as far as its definitions go are not controversial and well-established in the mainstream understanding of public finance.

Weaknesses with the definitions

And so, there are two important factors to consider: the ownership of debt, and on who exactly the liability of that debt falls onto. In the traditional case, both belong to one party.

Human ingenuity has created instruments and financing methods circumventing limits set by these definitions by playing around questions relating to ownership and the servicing responsibility of the debt. These innovations make the traditional definition deficient in the literal sense, defeating the spirit of the definition of debt while obeying strictly to the letter. What this means is that with use of these innovations, the financial burden of the government can be actually heavier than what the official debt tell us.

And indeed that is the case for Malaysia and that is the prime mover behind the current government’s unorthodox reporting of debt and liabilities, which is an attempt to refocus attention away from the letter, towards the spirit of debt.

Abuses relating to GGs

It is simplest to start with abuses relating to GGs. Now, in spirit and in theory, as long as the beneficiaries of the GGs do not default on their debt obligations, then the government does not bear the burden of the debt. Therefore, that kind of GGs do not count as part of the government debt and liabilities. It may be contingent liabilities, but it is only that, contingent.

But in reality, that description does not describe all of the GGs. Many GGs are designed in such a way that the one servicing the company’s debt is the government. This is because the company in truth has no resources at all to service the debt and without direct funding from the government allocated in the government budget, the company would default in no time.

This is not a matter of the government providing temporary support waiting for the company or the project to breakeven and achieve profitability some time in the future, which would allow the company to pay back the government later. To the contrary, this is largely a case of the company or the project will never be able to service its debt through its internal operations.

But government’s full support ensures the company will not default, and so avoiding the guaranteed debt from becoming government debt. To put it simply, the ownership of the debt belongs to the company, but the burden of servicing the debt falls on the government regardless of default.

Since that is the case, it begs two questions:

  • First, is such GGs merely a way for the government not to classify a debt as government debt?
  • Second, is such GGs in the spirit of government debt?

If one holds to the view that only ownership of the debt matters, then the answer would be no. This is a strict adherence to the letter of the definition.

If one appeals to the spirit of the definition by considering both the ownership and the actual responsibility over the liability, then the answers would be in the affirmative instead. From this perspective, the use of GGs in such a way is a paper shifting exercise designed to make the reporting pretty, while the actual liability falls on the government regardless of the owner of the debt.

In my opinion, the latter view is a more holistic approach to government finance, and more robust in terms of reporting compared to the former, which is a narrow model to use.

Further discussion on committed GGs

One criticism about the inclusion of GGs as part of the MYR1 trillion figure is that these GGs are not new. As the criticism goes, all the GGs have always been listed and publicly acknowledged by the previous government. And so, the revelation by the government is not really a revelation but only a repackaging exercise for political consumption.

This criticism misses the nuance about where the liability of these guaranteed debt falls.

The nuance is that the current government classifies the GGs into two classes:

  • One, non-government debt guaranteed by the government which are not currently serviced by the government. This class is called uncommitted GGs (more simply, both the ownership and the responsibility of servicing the debt do not fall to the government). Examples are debt owned by Khazanah Nasional or Tenaga Nasional that are guaranteed by the government but are fully serviced by the companies with their own revenue.
  • Two, non-government debt guaranteed by the government which are currently serviced by the government. This class is called committed GGs, committed in the sense that the company has not defaulted but the government carries the burden of the debt anyway (ownership belongs to the a company but the liability explicitly falls on the government). Examples are 1MDB and Prasarana Negara (if I remember correctly).

It is the latter class that is being included into the MYR1 trillion calculation, and not all GGs. Although those who track GGs religiously could make accurate guess about which GGs fall under the second class, the nature of the debt servicing of these GGs had not been explicitly and systematically disclosed to the public previously.

This government has done so, explicitly and systematically, for the first time.

Abuses relating to lease payments

GGs were the favorite way to circumvent the definition of debt. That was until it became too big to escape notice. After a while, rating agencies which are fiscal hawks when it comes to debt, began questioning the ballooning GGs even when the size of government debt itself relative to the GDP remained largely stable. This partly fueled the needs to find other ways to circumvent the definition of debt. Here is where lease payments come in.

Lease payments under cash accounting system the government currently runs on is a creative method used to avoid classifying certain liabilities as debt. How it happens is that a company borrows a large sum of money to fund a project that the government wanted built. The government then supports the project by signing a lease contract with the company in a way that lease payments from the government match the interest payments the company needs to pay, as well as other items like construction cost. So in the government’s books, it is recorded as lease payment when in fact in spirit, the government is servicing the interest payment of a debt (and in fact the interest to the whole project cost plus margin) held by the leasor. Or again, to put it simply, the government does not own the debt but the liability is completely transferred to the government by way of lease. Example for this is Pembinaan BLT.

Summary government debt and government guarantees

As you can see, both GGs and lease payments have been abused in a way to place the debt outside of the government proper, but with the government still services the interest payments of the debt. Even if the owner of the debt is not the government, the liability of the debt falls on the government.

It is in this recognition that the government has decided to account for the relevant GGs and lease payments as part of the MYR1 trillion government debt and liabilities.

The reform that is accrual accounting

Another factor making the orthodox accounting used by the government at the moment prone to abuse is that the government runs on cash accounting, which only records a transaction only when it happens, while ignoring the full liability effects relating to the transaction. This makes circumventing the definition of debt doubly easy.

The current government is preparing to adopt accrual accounting by 2021, which would provide the public a full view of the government’s total liabilities beyond increasingly deficient definition of debt that is dependent only on the question of ownership. Under the new basis, all transactions including those committed in the future but have not been paid yet would systematically be included as the government’s liability list. This is unlike currently where calculation of such committed GGs and lease have to be done manually, which is a painful process.

Upgrading from IMF Government Finance Statistics Manual 1986 to 2014

Finally, the current government calculation is not unorthodox as much as it is old. More than 30 years old in fact. I am not an expert in standardization but I have been informed that the Malaysian government runs on cash account based on a IMF standard from 1986.

But such standard has been updated several times and the latest one came in 2014. Surprise surprise, it is an accrual standard. You can read more about this at the IMF website.[2]

This has bearing on how Malaysia reports its debt officially to international bodies like the IMF and the World Bank. As long as Malaysia is still under the GFSM 1986, Malaysia will always officially report its government debt to the IMF database as it is. When smart alecks smiling feeling smugly highlighting seemingly inconsistencies between the MYR1 trillion with international reporting, this is the side that they do not know. Once accrual accounting under GFSM 2014 is adopted, suffice to say, there will be a massive break in the series.

And there are countries that run on GFSM 2014. The UK is an example of a country that uses the standard that Malaysia is migrating towards.[3]

So, Malaysia is not that special when it comes to wanting to have a more holistic view on debt.

Is the government lying?

No.

The opposition likes to claim the government is lying about its debt position. The truth is that, the opposition is overly focused on definitional issues without carrying for the spirit of the definition, and ignorant of the implications relating to accrual accounting.

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

[1] — For conventional instruments, see here. For Islamic instruments, please click here.

[2] — The Government Finance Statistics Manual 2014 (GFSM 2014),1 and it predecessors are the internationally recognized statistical reporting framework, aimed at helping national authorities to strengthen their capacity to formulate fiscal policy and monitor fiscal developments. The GFSM 2014 supports the balance sheet approach to analyzing economic policy by bringing together stocks and flows in a transparent and consistent framework. The GFS framework provides a basis for analyzing public investment while providing a “common language” that fiscal analysts can use to develop a consistent approach to handling new, and often complex, government operations that create challenges in fiscal reporting and analysis. Also, the GFSM 2014 is better suited for inclusion in a quantitative macroeconomic framework because it yields source data for the measures of government saving, investment, and consumption; these measures have been harmonized with the national accounts framework. Equally important, the framework forms an integral part of the IMF’s effort to promote international standards for transparency in fiscal reporting. [About Government Finance Statistics. IMF. Accessed March 15 2019]

[3] — If a country adheres to Special Data Dissemination Standards Plus (SDDS Plus), it is required to publish data for the General Government Operations (see Annex table 3.1) using the Government Financial Statistics Manual 2014 framework (GFSM 2014), as set out by the International Monetary Fund. Data should be compiled on a quarterly basis for all components and should be disseminated within 12 months of the end of the reference period. [Economic Statistics Transformation Programme: Enhanced financial accounts (UK flow of funds) Government tables for the special data dissemination standards plus (SDDS Plus). Official of National Statistics. Accessed March 15 2019]

Categories
Economics

[2702] Tighter lending requirement has its cost

I am unsure what to think about the recent move by Bank Negara Malaysia (BNM) to tighten lending on the non-bank side of the lending system. While the statistics in that sector is scary when compared to the banks, the non-bank sector does provide financial services to the low-income earners. The financial services provided here are not the fancy derivative kinds but rather, it is pretty much bread and butter things: giving out vanilla loans for a lot of stuff.

Without these institutions, these low income groups would probably lack access to financial services that they are enjoying now. That in some way has to mean improved welfare because these loans have to be used for something, either investment or consumption. And investment is simply deferred consumption anyway, which improves welfare eventually.

I have to admit that there are some problems with lending in non-bank financial institutions (NBFI). There is an explosion of personal financing granted by NBFI but in the grand scheme of things, it is small compared to the safer banking sector. Still, in the personal financing sector, more than 50% of loans were granted by NBFI according to BNM in its 2012 Financial Stability and Payment Systems Report. What makes it more worrying is that NBFI has looser requirements compared to the banks. Also, average amount for personal financing given out by NBFIs in 2012 was RM68,000 per person while most of the borrowers are civil servants who do not make much. (Still, impaired loans ratio in 2012 was extraordinarily low in spite of looser requirements. That has to do with a government deduction program. While the program is useful in keeping the ratio low, one wonders what the disposable income level of these borrowers is given that the borrowers are mostly government servants who do not earn too much).

Nevertheless, what would happen if these finance services were restricted? Or tightened?

Some might not go to the banks because they would likely be unqualified to obtain loans. If you cannot qualify for loans from NBFIs, what are the chances of getting loans from a sector with tighter regulation?

Others might not borrow at all, which is probably the ideal outcome for advocates of tighter lending requirements. For those who used the loose requirement to buy unnecessary stuff like buying an iPhone, a widescreen television or an expensive laptop to show-off, then the non-borrowing outcome is good.

But if they borrowed money for education, for food or essentially for smoothing their basic consumption, tightening will make them worse off. In their case, those loans give them a chance to build their life. These loans give them a leg up. Making it costlier for them sounds exceedingly cruel.

The worst outcome is probably if they go to the shadowy part of the economy and that quite possibly means going to the loan sharks. Having borrowers migrating to the least regulated (or even unregulated) sector of the economy cannot be considered a success of regulation. Protection in the underground economy is not as robust in the ”upper ground” economy. There is no bankruptcy law there. Here, not only one increases the systemic risk rather than reducing it through regulation, there will like be human cost — that is costlier than being condemned to bankruptcy — by becoming victims of crime.

That said, the restrictions by BNM are not drastic and those regulations, while it may reduce lending by NBFI, it is unlikely to cause mass exodus from NBFI to elsewhere. So, it is hard to imagine if BNM’s move increases systemic risk at all.

Yet, a small group of individuals will probably do just that and this group may be worse off.

Here is the point I want to stress. There is human cost to the tightening and that has been ignored while the mass media praises the tightening.

Categories
Economics Education

[2547] PTPTN debt a cost of affirmative action

Social mobility is crucial to the maintenance of a healthy liberal society. Inflexibility will have elites entrenched within the state apparatus and eventually becoming de facto dictators themselves, unless there is some sense of altruism among the elites. The monopoly of power itself is illiberal in so many ways.

There are ways to address the concern about social mobility and its illiberalness. The provision of education to the masses is one of them.

Education grants individuals the confidence to overcome haplessness. It provides the tools for individuals to rationalize the world and then encourage them to take fate into their own hands. With a good education, individuals will no longer be dependent on holy men’s words or beg the political elites for benevolence. Individuals will have their minds sharpened to make their own decisions. Education permanently grants individuals the motive for self-initiative for secular improvement and that is the engine of social mobility that will later help in creating a dynamic society that is liberal.

It is in this sense that equal access to education — basic education — is important.

The ability to read, write and count open up the doors of opportunity. Without these basic abilities, individuals will be disenfranchised from society. The disenfranchised will forever begin a race hundreds of steps behind, even before the race begins. They will likely form the underclass. Once one becomes an underclass, without intervention, it will be incredibly hard to break out from it. That calcifies social stratum and makes the journey towards an authoritarian society one step closer.

No self-respecting liberal will want to live a society with calcified social stratum. Permanent political monopoly is harmful to a free society. An intervention is required and justified and that intervention is the provision of mass education. That is the liberal rationale for basic education for all.

There is a limit to that rationale, however. Indeed, the rationale for education at the tertiary level changes. At the upper level, it is less about mass education than it is about meritocracy and specialization.

Not everybody has the aptitude for university education. That is why upper-level education has to be more meritocratic than primary- and secondary-level education. Even if it opened all without any filter, many would fail to make it to the end.

Under a meritocratic setup, those without the necessary aptitude must consider other tertiary options besides university education. The continuous pursuit of university education without the necessary aptitude will prove disastrous because there is heavy cost involved in terms of time and money.

To put it in another way, a meritocracy system will try to prevent a person from embarking on a costly journey that may end in failure anyway. It tries to save both time and money of the person and the society.

If one assesses the rationale for education at the individual level, it is mostly all about finance: one pursues university education with the expectation of earning higher wages in the future than he or she would without the same education.

Even without the explicit financial intention, it is generally true that the financial reward of having a degree is potentially tremendous. According to The Condition of Education 2011 published by the National Center for Education Statistics of the US Department of Education, those with a bachelor’s degree on average earn USD40,000 for the whole year in 2009. Those with high school diploma on average earn only USD25,000 for the year. The number will differ in Malaysia but the wage premium still exists.

The danger is that when one gets stuck in the system and fails to earn the degree. Another danger is that the degree earned does not give graduates a sufficient wage premium; not all degree commands the same wage premium. There are many reasons for that and one of them is quality of the degree.

In both cases, both the dropout and the graduate will learn that the cost of their university education will be too high compared to the returns of a university education. The education becomes less worthwhile.

The Malaysian problem is that there is or was a large-scale affirmative action with respect to university entrance. The proponents of affirmative action effectively and foolishly extended the rationale of mass education that is relevant to primary- and secondary-level education to the tertiary level, while ignoring the very different nature of tertiary education.

As a result, too many were encouraged to attend university and other higher education institutions without sufficient meritocratic consideration. Accommodation was made by rapid and significant expansion of places through the establishment of new education institutions. On the sideline, a state-backed mechanism—the PTPTN—was set up to help students to finance their education cheaply, and indirectly, to support private higher education service providers financially.

With the affirmative action and the disregard for meritocracy, quality eventually suffered. That affected the wage premium of those degrees.

This is probably what is happening to those who are unable to repay back their PTPTN loans. After having gone through university and other equivalent institutions and after having financed the cost through borrowing, they discovered the papers they earned did not command the wage premium necessary to make the education debt not a burden.

This can be linked directly to the issue of PTPTN and education debt. First of all, the financing option provided by PTPTN is cheap and it is effectively a subsidized financing option. On top of that, the cost of education at public universities is also cheap. The deputy prime minister was reported as stating that between 85 per cent and 95 per cent of tuition fees at public universities is borne by the government. The tuition fee itself is heavily subsidized.

Yet, graduates are having trouble repaying those cheap loans. When they are having trouble repaying, then it is likely that they are not earning enough. That in turn implies that their wage premium does not justify their investment in a university education. Further down the line, it suggests that those graduates should not have obtained their university education in the first place, if one assesses the issue strictly from a financial lens.

But they did obtain their university education, thanks to affirmative action. The graduates financed the cost of university by borrowing from PTPTN, an instrument of affirmative action. Now, what they have found is that the very instrument that enabled those graduates to become graduates is the very instrument that debased their papers, making the education debt a burden.

If that is still unclear, then let this be written: the debate about PTPTN debt in Malaysia is really a debate about the cost of affirmative action in the education system.

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 7 2012.

Categories
Economics

[1956] Of somebody is raising some money

Have you ever wondered how the Malaysian government plans to finance its stimulus package as well as its fiscal deficit?

Well…

KUALA LUMPUR: The RM2.5bil Sukuk Simpanan Rakyat government bond launched Tuesday is all snapped up. [RM2.3bil Sukuk bonds snapped up in 2 days. The Star. April 17 2009]

How about borrowing from PNB?

Permodalan Nasional Bhd (PNB), the country’s biggest fund manager managing RM76 billion worth of funds, will offer 3.33 billion new units of Amanah Saham Malaysia (ASM) and two billion Amanah Saham Wawasan 2020 (ASW 2020) units, Prime Minister Datuk Seri Najib Tun Razak announced today. [PNB offers 5 billion unit trust. Bernama via The Sun. April 20 2009]

Show me the money!!!

Malaysia: The government will today auction 4 billion ringgit ($1.1 billion) of Shariah-compliant bonds maturing in 2012. Bidding closes at 11:30 a.m. local time. The securities yielded 3 percent in pre-auction trading yesterday. Industrial production in February fell for a sixth month, declining 14.7 percent from a year earlier, a government report showed yesterday.

The yield on the 5.094 percent note maturing in April 2014 slipped one basis point to 3.66 percent, according to Bursa Malaysia Bhd. [China, Malaysia, South Korea, Thailand: Asia Local Bond Preview. Lilian Karunungan. Bloomberg. April 10 2009]

Oh, oh, oh…

The issuance of government bonds is expected to leapfrog by 80% this year to a gross amount of RM90bil. [Issuance of govt bonds expected to jump to RM90bil. Yap Leng Kuen. The Star. April 20 2009]

Are you keeping track?