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.