Flirting with fiscal distress

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With this the season for elections, caution is being thrown to the wind.
The government has been rather cavalier in its spending. It has embarked on a policy of injecting higher spending in order to push up consumer sentiment.
This will have the added and pleasing effect of pumping up the confidence of the electorate.
Salaries of public sector employees have been increased in a number of ways. Various segments of the country’s demographic have been targeted with cash grants and handouts.There has been no attempt to curb the outflow of subsidies despite talk only a year ago of the need to get rid of the subsidy culture. Everyone will remember that the government wanted to reduce the subsidies for petroleum and sugar.
The positive outcome of these measures, though, has contributed to increased consumption.
The government, again, despite its earlier announcements to encourage private sector participation, has chosen to place itself in the driver’s seat. Its Economic Transformation Programme (ETP) will place the responsibility for driving economic activity in its hands instead of the private sector’s.
True, the ETP involves government-linked companies (GLCs); but GLC is a hotly debated acronym that is not vastly different from what are called state-owned enterprises in other countries. Government participation in business, as envisaged under the ETP, may give a bigger role to the GLCs than is deemed appropriate.
The Tun Razak Exchange (TRX), the government’s plan to launch a new financial district in the capital, is an example of repeating used strategies that have not always worked.
TRX has a gross development value of RM26 billion. It will offer fiscal incentives that include 100% tax exemption. It is envisaged that TRX will transform Kuala Lumpur into the region’s financial hub and it will emerge as one of the top 20 liveable cities in the world.
As is typical of a mega project such as this, TRX will be spearheaded by 1Malaysia Development Bhd (1MDB), a wholly government-owned strategic development agency.
The outcome of these initiatives is to boost investor confidence and increase public investment. This translates into higher economic growth.
The federal debt ceiling was 45% of GDP in 2009 and it has been raised to 55% currently.
The government has promised to maintain that ratio. Global rating agency Fitch points out that Malaysia’s debt-to-revenue ratio more closely resembles that of Italy.
Not a comforting comparison by any means. And that is because revenue is not moving ahead of the growth in debt.
Why does Malaysia take delight in this fiscal dare-devilry?

First, there is a strong obsession with economic growth.
It is thought that whatever happens, it is the government’s responsibility to deliver high growth rates. Often this is at the cost of attending to other structural issues such as income distribution, corruption, crime and education.
Second, fiscal indiscipline is the shortest route to tangible economic success. The Keynesian principle of increasing government spending to come out of a recession is abused when excessive spending is undertaken in non-recessionary times.
Government spending that exceeds its revenue does stimulate growth. It gives a semblance of strong growth and a vibrant economy when the fundamentals may be less solid.
Third, this is a well-tried economic strategy that has been practised for the last 30 years with no disastrous effects, so it continues to be a policy that quickly comes to hand. Fiscal indiscipline has become something of a quick-fix solution.
Fourth, with the election coming up, anything goes. It is thought to be necessary to paint a rosy picture of the economy, and to have a stock market that is doing well. And that this is the wrong time to admit to weaknesses.
Finally, the kind of generous spending that the government has undertaken in recent times could be a pre-emptive measure to soften the wounds that will come from a global slowdown.
But what, then, will the government do when the slowdown actually strikes? Commit to another round of spending?
The gamble is that the slowdown will not be severe and that even if a stimulus package will have to be executed in the future, it will be manageable.
At any rate, the government has enough foreign exchange reserves and its current account surplus is high. Besides, the banking system is flush with liquidity.
These factors give room to confidently take chances.
To date, there has been little need for foreign borrowing. The government can afford to finance its deficits through Malaysian Government Securities.
This is further grounds for self-assurance, but the question is whether fiscal wagers of this sort are compatible with a sustainable economy.
Are prudence and caution unfashionable values as far as fiscal management is concerned?

Dr Shankaran Nambiar is an economist who consults for national and international agencies.
 
 
This is appeared in The Edge Financial Daily on 21 September, 2012.