Post-Budget 2019: Going beyond statistics

This article first appeared in Forum, The Edge Malaysia Weekly, on November 12, 2018 - November 18, 2018.
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As the government explained prior to the tabling of Budget 2019, this is not an ordinary budget. It is meant to put Malaysia on a clean slate and move forward by removing some imbalances and excesses, and strengthening the fundamentals of the economy.

Thus, we can label it as “the new beginning” for Malaysia’s fiscal landscape. Budget deficit targets, raised to better reflect the government’s financial commitment next year, also call for certain expenditures to be rationalised if the country were to avoid a “fiscal cliff” in the future. It is also a budget that looks for avenues to buffer the government’s coffers against a reduction in income, following the abolishment of the Goods and Services Tax.

Statistics on operating expenditure (opex), if one were to scrutinise, would raise some eyebrows. A case in point — on average, the opex was RM7 billion more than its original amount budgeted per annum between 2008 and 2017. At a glance, these statistics do not look too bad. The actual opex growth was 4% per annum on a compound annual growth rate (CAGR) basis during this period. This compares with an annual growth in the country’s nominal gross domestic product (GDP) of 6.5%.

The breakdown of the opex components, however, reveals some intriguing facts. Pension and gratuities, as well as debt service charges, grew by more than 9% per annum. Expenditures on subsidies averaged at RM32 billion per annum, compared with only RM5 billion in the year 2000.

Admittedly, some opex components are difficult to trim. However, one particular component — debt service charges — is the price that Malaysia has to pay for incurring more debt year after year. Federal government debt service charges surged by roughly 9% per annum between 2008 and 2017. And in a rising interest rate environment, we can bet that this amount will only continue to climb.

In contrast, development expenditures were, on average, RM5 billion lower than the original budgeted amount per annum during the 2008 to 2017 period. Part of the reason for this, it would seem, is because of the greater importance placed on meeting the persistent shortfalls in opex budget allocations.

Lo and behold, we are now seeing a sudden increase in the budget deficit target. And the plan is to start over from there by reducing it back to 3% of GDP by 2020.

The million-dollar question is — and the answer is not immediately forthcoming — how will international credit rating agencies (CRAs) react to this increase in the government’s budget deficit target? CRAs rate the creditworthiness of countries by assessing their ability and willingness to meet their sovereign debt obligations on time. To some extent, they influence countries’ borrowing costs, as lower sovereign ratings attract higher borrowing costs. That is because foreign investors use sovereign ratings in their portfolio investment allocation decisions.

A country’s fiscal position is one of the critical factors assessed by CRAs in determining its rating (and rating outlook). Debt positions and their structures are also important assessment dimensions. Given that Malaysia’s fiscal balance and debt position are both highly correlated with its sovereign rating, concerns over CRAs’ assessment are understandable.

But here comes the story that many tend to forget — numbers are just one aspect of the assessment. What is more crucial is the story behind them. The message that came across even before the budget announcement hinted at the government’s determination to start on a clean slate.

The narrative being provided to justify the short-term fiscal trajectory, in order to put the fiscal house back on track, is vital. Also important are the proposed medium-term measures, as reflected in the government’s medium-term fiscal framework. In any case, the sudden increase in budget deficit targets does not reflect fiscal profligacy. It is just a one-off adjustment needed to repair the country’s balance sheet.

One should also not forget that the credit rating assessment is supposed to be done “across the (economic) cycle”, meaning that it is more of a medium-term assessment. A deterioration or improvement of the economy that takes place in one particular year should, in theory, not change CRAs’ views. Thus, the sudden increase in Malaysia’s budget deficit target should not be any cause for alarm. To convince CRAs that the country is on the right track, it is important to articulate clearly the concrete medium-term measures being proposed to generate revenue.

Looking back, one can see that the key supports for Malaysia’s sovereign rating have always been its growth trajectory and external position. Indeed, our growth story fascinates observers. Why? Malaysia’s growth volatility is among the lowest in the region, despite the openness of its economy. Low growth volatility indicates domestic strength. Hence, the government’s focus on sustaining development expenditures is a move in the right direction. An excessive cut would be detrimental for future growth prospects.

Given Malaysia’s commendable current account performance, its external vulnerability is not an issue that keeps us awake at night. Its current account is likely to remain in positive territory moving forward. However, with the ongoing US-China trade war, there could be some pressure on Malaysia’s external balance sheet. Thus, the decision to cancel several mega projects should help relieve some of the expected pressure. A slightly lower investment growth will ensure the country’s savings-investment gap remains positive in the near term.

We should be mindful that a sovereign rating is just an assessment of the creditworthiness of a country — nothing more than that. It is neither a report card of a country’s economic achievement, nor is it a seal of approval of a set of policies. We have seen various examples of how austerity measures that were supposed to fix fiscal woes ended up making things worse. Greece, in recent years, is one such example.

Nor Zahidi Alias is chief economist at Malaysian Rating Corp Bhd. The views expressed here are his own.

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