This article first appeared in The Edge Malaysia Weekly on May 7, 2018 - May 13, 2018

THE Klang Valley’s mass rapid transit (MRT) system built this past decade is one project the country can take pride in. Even with its shortcoming in fare pricing, more people can potentially benefit from it than, say, a new towering skyscraper. There are certainly more of the latter in the Klang Valley, along with empty retail malls and unsold homes priced way above what most Malaysians can afford.

The Goods and Services Tax (GST) and Bantuan Rakyat 1Malaysia (BR1M) — subjects of heated populist debate in the run-up to the 14th general election — are also relatively new additions to the country’s economy.

Experts have said BR1M needs to be better targeted so that people are not just getting assistance to cope with rising costs but are also being helped up the income ladder. This way, they will no longer need handouts. Proof of the latter should silence criticism that BR1M is dole for the vote bank.

GST, which broadens the federal government’s income base, is seen as more burdensome to the middle-income group.

In the past two decades, Malaysia has spent more money than it earned, so much so that 13% of federal government revenue this year will go towards servicing debt or interest payments.

To be sure, sovereign rating agencies reckon that our resource-rich country can still pay up. Yet the endorsement pales in comparison with the US$1 trillion saved up in the coffers of the high-income city state across the Causeway with scarce natural resources.

Conversely, our federal government debt could reach RM1 trillion by 2021 if it continues to grow at the same average rate of 10% as in the past decade. Clearly, there is need for better financial planning and execution.

If changes brought about by the Fourth Industrial Revolution globally in recent years is any measure, the coming decade will prove a lot more challenging for those ill-equipped to move up the value chain or reap benefits from new opportunities. Already, human baristas are being replaced by more sophisticated coffee-vending machines here. In some parts of Japan, intelligent robots already do the job. For Malaysia, there is also that long-overdue need to wean itself off low-skilled foreign labour that is depressing wage growth for many locals, so that people can feel the benefits of the strong headline GDP growth.

The pace at which technological change is happening globally means painful policy mistakes could well set back the country’s progress towards developed nation status by another decade.

Here, we recap the country’s economic growth path in the past decade and where change is needed and why.

Different quality of growth

Looking at the country’s GDP growth over the past decade — from 6.2% in 2007 to 5.9% in 2017 — one gets the sense that not much has changed.

But the factors behind the respective figures could not be more different. In 2007, GDP growth was driven by robust domestic demand against the backdrop of a weak external environment that moderated export growth.

That year, private consumption grew 11.7% — the highest rate seen since 2000 — as high commodity prices led to a rise in disposable income. Private investments recorded a growth of 12.3% but gross exports only rose 2.7%.

In 2017, the Malaysian economy was still supported by domestic demand but it benefited more from a global economic recovery that saw gross exports grow 18.9% — the fastest pace since 2000.

“The materialisation of positive spillovers from the external sector further reinforced domestic demand,” says Bank Negara Malaysia in its 2017 annual report.

In the last decade, GDP suffered a contraction of 1.9% in 2009, stemming from the US subprime mortgage crisis that shook the global economy. This was also the year Datuk Seri Najib Razak became prime minister following the resignation of Tun Abdullah Ahmad Badawi.

But the country rebounded quickly from the global financial crisis (GFC), charting a growth of 7.2% in 2010 on the back of strong expansion in the private sector.

In 2011, GDP growth fell to 5.1% as the European sovereign debt crisis inevitably impacted the global economy. It improved to 5.6% in 2012 before falling to 4.7% in 2013.

In mid-June 2014, crude oil prices, which had been climbing steadily since the GFC, started to crumble from a high of US$115 per barrel.

That year, the Malaysian economy still managed to grow 6%. However, growth dipped to 5% and 4.2% in 2015 and 2016 respectively due to a double whammy of low crude oil prices and a fast falling ringgit.

For this year, the central bank estimates GDP growth to hover between 5.5% and 6% while economists expect growth to cool down from 5.9% in 2017 due to a higher base effect and a stronger ringgit.

Judging by the country’s GDP growth figures, Malaysians probably do not have much to complain about. But the quality of growth could be different altogether.

In terms of GDP growth by economic activity, the composition has not shifted much over the last decade. The services sector still heads the list with its contribution rising marginally from 53.4% in 2007 to 54.4% in 2017. The manufacturing sector is second, although its contribution shrank from 30.2% in 2007 to 23% in 2017.

Interestingly, the contribution of the agricultural and construction sectors to GDP picked up in the last 10 years. Construction contributed 4.6% in 2017 compared with 3% in 2007 while agriculture contributed 8.2% in 2017 compared with 7.6% in 2007. The contribution of mining and quarrying remained flat at 8.4% in 2017 compared with 8.6% in 2007.

The root cause of rising cost of living

In the past decade, one economic issue that hit Malaysian households the most, one way or another, was surely the sharp depreciation of the ringgit and its repercussions — weaker purchasing power and the rising cost of living.

Jaws dropped when the ringgit depreciated from around 3.50 against the US dollar in January 2015 to an all-time low of 4.46 on Sept 29, 2015, surpassing the 4.18 mark seen during the 1997/98 Asian financial crisis. And for most of 2016 and 2017, the ringgit stayed above 4.00.

The pressure on the local currency was partly attributed to the strengthening greenback at the time, on top of a meltdown in crude oil prices plus domestic factors, such as concerns over the whopping debt of 1Malaysia Development Bhd (1MDB).

Malaysians saw at least a quarter of their wealth wiped out in terms of US dollars. Worse still, the weak ringgit resulted in imported inflation, which in turn added to the cost of living for Malaysians — the common complaint of the past three years.

In the past 12 months, however, the ringgit has been one of the best-performing currencies in Asia, appreciating 11.76% against the US dollar. Year to date, it has gained 2.76% from 4.01 at the start of the year, closing at 3.93 last Friday.

The ringgit’s current strength has been attributed to, among other factors, a rebound in crude oil prices, a weaker US dollar, Bank Negara’s requirement that exporters convert 75% of their proceeds to the ringgit and the central bank’s shift to a more hawkish stance given the country’s robust economic outlook.

It is worth noting, however, that export-oriented companies, especially furniture makers and semiconductor companies, benefited from the strong US dollar, given that the bulk of their exports and transactions was done in US dollars.

But when the ringgit strengthened, some of these companies started to feel the pinch, as evidenced in the first quarter of the year.

Experts believe that a stronger ringgit is here to stay, saying that the currency was oversold last year. Some see the ringgit trading at 3.70 against the US dollar on the back of Malaysia’s healthy economic fundamentals.

Saving oil wealth for future generations

That Malaysia is less dependent on oil revenue is a much-publicised fact, especially after Brent crude prices tumbled to as low as US$27.10 a barrel in January 2016 — less than a third of the US$100 to US$120 a barrel it fetched in its heyday from 2010 to 2014. From 41.3% of government revenue in 2009, oil-related income dropped to only 14.9% in 2016, and is expected to be 15.7% this year.

The fact that the Goods and Services Tax was only finalised during the tabling of Budget 2014 in October 2013 when Brent was US$107 a barrel, though, is less mentioned. After all, its long-intended introduction was likened to political suicide. Yet, given the rise in federal government expenses in recent years, its introduction on April 1, 2015, seemed inevitable and was welcomed by economists rooting for a reduction in the country’s fiscal deficit.

What is also less mentioned is Malaysia’s natural resource fund, called the National Trust Fund, or Kumpulan Wang Amanah Negara (KWAN), which was set up in 1988 to conserve wealth from oil and other natural resources for future generations. Managed by Bank Negara Malaysia, KWAN had RM16.4 billion in assets as at end-2016, of which RM9.1 billion was contributions from Petronas, the fund’s sole contributor since its inception.

If more oil money had been stored away in KWAN or a similar entity, Malaysia could have had its own version of Norway’s celebrated oil fund to boost its hand. Already, a persistent budget deficit is preventing the benefit of a lift from the net investment returns contribution, as seen in Singapore’s annual budget since 2000.

From its inception in 1974 to end-2016, Petronas had contributed RM971 billion in dividends, taxes, royalties and duties to federal and state coffers, company data shows. If one were to include the RM241.4 billion in foregone revenue (gas subsidy) from May 1997 when regulated gas prices came into effect, Petronas’ contribution to Malaysia’s economy would have amounted to a whopping RM1.21 trillion over the past four decades.

To put that into perspective, RM1.21 trillion would be enough to pay off the government’s debt of RM686.84 billion as at end-2017, cover the RM226.88 billion debt guaranteed by the government as at end-September 2017 and comfortably fund Budget 2018, with about RM10 billion extra to double cash transfers or repay part of 1Malaysia Development Bhd’s debt.

It is also 1.5 times the total investment assets of the Employees Provident Fund of RM791.48 billion as at end-2017 and 2.85 times Bank Negara’s foreign reserves of US$110 billion (RM425 billion) as at mid-April 2018.

If the dividends paid by Petronas to the government the past 10 years had been kept away in KWAN, the fund size would have been at least RM250 billion larger today. When oil prices were over US$100 a barrel, Petronas’ dividend was RM30 billion a year. This year, it has committed to pay RM19 billion, up from RM16 billion last year. Will there be political will to cut unnecessary spending and commit to saving more oil money for future generations?

Reaping benefits of higher tax revenue and subsidy rationalisation

The removal of blanket subsidies and the introduction of the Goods and Services Tax (GST) scored brownie points with the sovereign rating agencies. However, the jury is still out on the redistribution of wealth to the lower-income and vulnerable group and helping them move up the income chain.

Going by the average growth of 5.43% per annum in the federal government’s direct and indirect tax revenue in the past decade, its ability to expand the social safety net should have increased.

The cutting of blanket subsidies on petrol, sugar and cooking oil, which helped reduce the subsidy bill from a high of RM44.08 billion (21.4% of operating expenditure) to RM26.58 billion (11.3% of opex), also meant more money for more targeted cash transfers such as Bantuan Rakyat 1Malaysia (BR1M).

A large part of the RM26.6 billion spent on petrol subsidy in 2012, for instance, likely benefited the richest 20% with larger cars more than the poorest 20% with motorcycles or who took public transport.

For cash transfers like BR1M to function efficiently and be sustainable, continuous refinements need to happen so that the lower-income group can be mobilised to break out of the poverty cycle and move up the income ladder. One way is to link BR1M to promotional programmes to enhance human capital and productivity so that the recipients can successfully earn more and have no need for cash transfers.

More than seven million households and individuals were reportedly BR1M recipients in 2017, up from 4.2 million in 2012 when the programme was introduced.

The need for an exit mechanism for a programme like BR1M also ensures that the limited resources go towards helping only those who need it.

This is especially important when questions are being raised about the sustainability of rising government expenditure. And everyone is a taxpayer with GST, which is expected to rake in RM43.8 billion and contribute 18% to government revenue this year.

While GST revenue (which is more than that of the old Sales and Services Tax) helped make up for the decline in petroleum-related revenue, the middle-income group’s complaints of not earning enough to cope with the rising cost of living seem to be growing louder.

At the same time, the need for the government to expand its earnings base turned the spotlight on the Inland Revenue Board (IRB), tasked with increasing tax collection and compliance among businesses and individuals. Direct taxes, which the IRB is tasked with collecting, make up 53% of total government revenue. Corporate tax collection alone is expected to bring in RM72.48 billion in 2018 or 30.2% of government revenue.

Businesses are also lamenting the rising cost of doing business while the generally low income levels of most Malaysians are forcing individual income taxes on middle-income wage earners and professionals who really do not earn that much. Only 2.27 million or about 15% of the country’s 15 million workforce pay individual income taxes that form 13% of total government revenue. As a percentage of tax revenue, contribution from individual income tax revenue has risen from 13.3% (RM14.97 billion) in 2008 to 16.7% (RM30.09 billion) in 2017 and 16.8% (RM32.23 billion) this year.

Policymakers have said there is a need to review individual income tax brackets so that the right kind of talent is incentivised to move up the income chain and stay in Malaysia. There is also a need to relook the corporate tax rate for the country to remain competitive regionally while repositioning tax incentives to attract the right kind of investment.

Debt-fuelled economic growth unsustainable

This year’s 2.8% budget deficit would mark the ninth consecutive year of fiscal consolidation from a deficit of 6.7% of GDP in 2009. The decline in ringgit terms, however, would have been more impressive had there also been nine straight years of absolute reductions.

From as high as RM47.42 billion in 2009, the budget deficit narrowed to RM37.19 billion in 2015, only to rise again to RM39.8 billion in 2018.

Put simply, these amounts reflect what the federal government spends (using debt) on top of all the money it collects in a particular year. This excess spending has already more than doubled from about RM20 billion a year in the 2003 to 2007 period.

Some may argue that the ringgit amount disregards the fact the country’s economy too has grown in size. Others, however, reckon that it is not all that different from having a good pay increase but spending even more of one’s higher income on servicing credit card bills and finance charges, leaving little for a rainy day or old age. That is why some experts argue that economic growth fuelled by debt is unsustainable.

It does not help that 13% of federal government revenue is going to debt service charges this year when there are many other more productive needs. Debt service charges of RM30.88 billion represent 71% of the estimated RM43.8 billion GST collection and 96% of the estimated RM32.2 billion personal income tax collection for 2018. It is also enough to build at least 100 hospitals and 100 schools or the entire Pan Borneo Highway.

Is anything being done to cut debt service charges, which is way above the RM12.9 billion (9.2% of revenue) in 2007?

While the current headline debt-to-GDP ratio of 50.8% remains below the self-imposed 55% ceiling and is an improvement on 54.5% in 2015, we also know that in January 2016, RM21.9 billion of civil service housing loans was transferred off the balance sheet to the Public Sector Home Financing Board (LPPSA), which is a statutory body. On the list of government-guaranteed debt, only RM4 billion showed up under LPPSA in 2016.

Total government-guaranteed debt is rising. The latest figure of RM226.88 billion as at Sept 30, 2017, pushes Malaysia’s debt-to-GDP ratio nearer to 70%. And that is also not the full extent of what economists and sovereign rating analysts call contingent liabilities.

As only debt with direct government guarantees will show up on this list, only RM5.7 billion of 1Malaysia Development Bhd-related debt, for example, was reflected on it as at end-2016. The US$3 billion bond with a “letter of support” from the Ministry of Finance Inc that received much publicity in parliament was not on the list. A recent search on Bloomberg revealed that RM29 billion of 1MDB-related debt was maturing through 2039.

If federal government debt is allowed to continue growing at the rate it has grown in the past decade, it could reach RM1 trillion by 2021, RM2 trillion by 2028 and RM3 trillion by 2032, back-of-the-envelope calculations show.

Already, for every ringgit the government collects, nearly 99 sen goes to operating expenses. This cannot be what sustainable growth looks like.

Higher export complexity may boost current account balance

Malaysia’s current account balance had dwindled from about RM100.4 billion in 2007 to RM40 billion as at end-2017. The sharp decline happened in 2012, when the figure fell to RM57.3 billion from RM102.4 billion in 2011, and it has yet to climb above RM100 billion again.

However, the fact that it remains in positive territory is good news. Otherwise, Malaysia would have a so-called “twin deficit” where both the current account (in the balance of payments) and the budget are in the red.

Strong export growth is part of what is helping to keep Malaysia’s current account balance in surplus.

Exports are projected to grow 8.4% this year to RM1.014 trillion — below last year’s 18.9% but above 2016’s 1.2% and the average of 2.5% between 2012 and 2016.

While the strength of Malaysia’s exports could be impacted by the unfavourable effects from rising trade protectionism, equally important are our efforts to move up the value chain. Some experts, including those at Bank Negara Malaysia, call it the need to “further diversify its product mix and deepen its product complexity”.

While Malaysia’s so-called economic complexity has improved from 0.61 in 2006 to 0.82 in 2016 to make it the world’s 29th most complex economy, “most regional countries have accomplished greater complexity gains than Malaysia’s improvement of 0.21” to 0.82 in 2016, Bank Negara says in a recent report. China’s economic complexity, which only had a 0.02 advantage over Malaysia in 2006, had risen to 0.94 in 2016 from 0.63 in 1996. In the same 10-year period, South Korea added 0.26 to 1.79 while Singapore added 0.28 to 1.61. Vietnam is still below the global average but its 0.30 gain has exceeded Malaysia’s.

To be sure, strong export growth helped Malaysia’s economy grow faster than expected last year.

Looking at the past decade, however, gross export growth has hit double digits only twice. The first was in 2010 when it staged a comeback of 15.6% growth following a decline of 16.5% during the 2008/09 global financial crisis. The more recent double-digit growth of 18.9% was recorded last year. Outside the two, year-on-year growth hovered between 0.7% and 9.8%.

Last year, Malaysia was coming off a weak gross export growth of 1.2% in 2016. Some experts would also say that the strong export numbers should be partly attributable to the persistent weakness in the ringgit.

RHB Research, for one, expects exports to grow 6.5% this year, on account of a slightly weaker global trade outlook, slower Chinese demand as well as the effect of a higher base last year. The balancing factor would be resilient demand for electrical and electronics shipments.

Commenting on the current account, RHB Research says the surplus will narrow slightly to RM39.3 billion this year, likely driven by higher deficits in services, income and transfer accounts.

More revenue for development expenditure

In seven of the last 10 years, Malaysia spent 99% of its revenue on operating expenses.

Yes, almost all the money the federal government collected in 2009, 2011, 2012, 2013, 2014, 2015 and 2016 was spent on operational expenses such as paying salaries and pension, subsidies and interest on debt. The exception was in 2010, when 95% of revenue was spent on operational expenses.

That most of the federal government’s income went into operating expenditure (opex) was why the development expenditure that was needed to build competitive advantage was only 15% to 19% of the annual budget from 2012 to 2018 compared with a more desirable 33% to 36% from 1999 to 2003.

With the exception of 2000, opex only took up about 80% of government revenue between 1999 and 2003.

Incidentally, 2010 — the same year when the least amount of revenue went into opex in the past decade — saw 25.8% of government budget going into the desired development expenditure.

The co-relation is simple. Debt is taken to fund development expenditure because most of the money collected by the government has gone into opex — likened to overheads in the business world.

The federal government’s emolument and pension bill alone is expected to take up 43.2% of the money it will collect this year.

It is not known whether the RM103.7 billion spending projected last October took into account the RM1.46 billion cost of the recently announced second pay rise for civil servants and government pensioners from this July. What’s known is that the civil service emolument and pension bill had already doubled in the past decade from RM51 billion in 2008 when emoluments, pension and gratuities swallowed about a third of government revenue. Note, however, that the 1.6 million-strong civil service makes up only about 10% of the country’s official labour force of 15 million.

Coupled with 13% of government revenue going towards debt service charges, over 56% of the RM239.86 billion the government expects to collect this year has already been earmarked for the 1.6 million civil servants and 800,000 pensioners as well as holders of government debt securities.

Then, there’s still the need to provide RM33.6 billion for supplies and services, RM26.5 billion for subsidies and social assistance, RM13 billion for grants to statutory bodies and RM8 billion to state governments, among other things, leaving little choice but to borrow for development expenditure.

Critics, including former prime minister turned opposition leader Tun Dr Mahathir Mohamad, have questioned the rise in government expenditure. Whether or not the opposition wins the chance to prove its point, the incumbent government needs to prove to the people that the country’s income and resources are being used in areas that benefit the rakyat the most and Malaysia’s future growth.

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