27-Day Countdown to 13GE – IMF Report Card warns of an austerity scenario for Malaysian economy not too dissimilar to that of several EuroZone countries

The nation is just weeks away from choosing a Government to steer the ship of state.

The upcoming General Election will be momentous and will demand a choice between Barisan Nasional, a coalition that has ruled the nation for almost five and a half decades, and Pakatan Rakyat, an alternate group that offers change and a new direction.

Meaningful choices should ideally be based on full information about the current state of affairs and the alternative visions offered by the two coalitions.
The information on the state of the economy is less than transparent and that which is available is skewed in favour of the incumbent regime. The opposing coalition lacks full access to information.

Under these circumstances, it is necessary to look to alternative independent sources to arrive at objective assessments.

Such an objective and comprehensive assessment is indeed available. The International Monetary Fund (IMF) conducted its Annual Article IV Consultations in Nov –Dec 2012. A report based on the consultations was considered by the IMF’s Board of Executive Directors in late February 2013. The Fund has released the report and posted it on its website.

The Report can be downloaded from:

http://www.imf.org/external/pubs/ft/scr/2013/cr1351.pdf

It is no surprise that neither Government officials nor the main stream media have disclosed the contents despite the fact that the Report is publicly accessible from the IMF’s website.

Like most IMF Reports, it is highly nuanced. It gives credit to the authorities for some aspects of recent economic developments but it nevertheless is critical and points to areas where reforms are needed.

The Report also touches on several policy positions that the Government has not as yet shared with the country at large.
Some of the key issues taken up in the Report deal with:

• The size of the deficit and the Federal debt approaching the self-imposed ceiling of 55% of GDP; the size of debt guarantees extended by the Government (15 % of GDP) – the contingent liabilities. If these are taken into account the ceiling has been breached.

• The Report refers to the sharp and rapid increase in the loans extended to households by the banking sector (mainly for housing and car loans). These have grown faster than loans to businesses. The Report notes that the Banks are likely to become over exposed.

• The Report notes that while private sector investment has increased, a sizable part has been by GLCs investing, a lot of investments being abroad.

• The Report implicitly criticizes the pattern of spending and inefficiencies involved.

• The Report is also critical on the over dependence on oil and gas revenues and notes the need for broadening the tax base; it calls for a removal of subsidies and their replacement by targeted transfers to households.

• There are a number other policy recommendations e.g. about pension reforms, civil service restructuring, the need to closely monitor the new minimum wage policy etc.

The Report contains some disclosure of Government thinking and proposed actions over the near term. It is significant that there are clear indications that the Government will go forward with the introduction of the GST and removal of the fuel subsidy. There is also a sort of pledge that the deficit will be brought down to about 3% from the current level that is above 4% without an indication of how.

THE IMF REPORT CARD

The IMF Report is in a sense a Report Card on the performance of the Malaysian economy. Credit is given where appropriate; nuanced cautionary recommendations are offered; and note is taken of unpopular policy actions the Government will take, presumably, after the General Elections.

While it is not feasible to provide a comprehensive summary, it is pertinent to highlight the following quotes from the Report, viz:

• Consumption growth has also been vigorous, supported by a strong labor market, credit to households, and government transfers.

• Net exports, on the other hand, have declined. This has led to a significant external rebalancing, with the current account surplus moderating by about 5 percentage points of GDP relative to 2011

• Domestically, elevated housing prices and growing household debt may pose risks for the financial sector. Also, a slower-than-expected pace of implementation of fiscal and structural reforms could pose risks. For instance, a protracted increase in unit labor costs resulting from slower-than-envisaged medium-term productivity increases or a higher-than anticipated impact from the minimum wage could harm potential growth. Finally, the upcoming general elections could lead to some market volatility.

• The Federal Government debt is projected to rise to about 53 percent of GDP in 2012−13, close to the authorities’ self-imposed ceiling of 55 percent of GDP. On the other hand, the overall public sector deficit is projected to have risen to 5.1 percent of GDP in 2012 (from 3.3 percent in 2011), partly reflecting higher investments by nonfinancial public enterprises (NFPEs), and is expected to widen to 6.3 percent of GDP in 2013 (Figure 5).3

• However, the FG’s relatively high debt level affords limited space for a fiscal response in a downside scenario. Any fiscal stimulus should be well targeted, temporary, and anchored in an ambitious medium term consolidation plan.

• Housing prices are running ahead of household incomes and housing rents. Household debt is high, as is bank exposure to households (55 percent of bank credit) (Figure 8).6 In response, the authorities have introduced a number of MPPs and fiscal measures since 2010.7 These measures have succeeded in slowing down household credit growth, particularly for unsecured loans, while preliminary data suggest housing price appreciation may have decelerated. Some pressure points do remain, however: growth in credit to households remains in double digits, the supply of low cost housing is tight, and prices are still rising strongly in some housing segments.

• if household credit growth and housing prices remain high, additional measures could be taken, including lower loan-to-value (LTV) caps, further increases in capital gains taxes on properties, higher stamp duties on real estate transactions, and a further tightening of regulations on unsecured personal loans. As noted by the FSSA, continued efforts to capture granular data on household assets and liabilities by income segment would strengthen monitoring of risks in this sector.

• Malaysia’s fiscal space has shrunk considerably following the global financial crisis. The FG debt to GDP ratio has increased by 12 percentage points since 2008, reflecting both substantial discretionary fiscal stimulus and declining growth and oil prices in the aftermath of the crisis. This debt ratio is elevated compared to countries with similar credit ratings. The structural fiscal position has also deteriorated, as evidenced by the persistent decline in the nonoil primary balance and the current balance. The significant increase in operating expenditures in recent years may put at risk the FG’s golden rule of maintaining a positive current fiscal balance. A weak structural fiscal position and a relatively high debt ratio reduce the ability to mount countercyclical fiscal responses in the future.

• The baseline assumes: (i) fuel subsidy reform; (ii) introduction of the GST (to replace existing sales taxes) at a rate of 5 percent along with offsetting revenue measures, yielding net revenue gains of about 0.5 percent of GDP in the medium term; and (iii) an increase in direct transfers to low income households of ½ percent of GDP per year.

• The FG’s revenue base is narrow and overly reliant on volatile oil and gas receipts, which account for about a third of the total. The planned introduction of the GST would help broaden the revenue base. In addition, the authorities should streamline fiscal incentives for investment, with their budgetary costs made more transparent.

• The public sector deficit is rising, reflecting a large increase in NFPE spending (Figure 5). Due to long reporting lags, the latter is difficult to monitor and control. Contingent liabilities for the FG are also growing from the rise in government’s statutory guarantees (which increased to 15 percent of GDP, partly reflecting borrowing by special purpose vehicles set up to finance large public infrastructure projects), and from public-private partnerships (PPPs) more generally.

• The authorities stressed their commitment to fiscal consolidation, tax reform and expenditure rationalization. They reiterated the government’s commitment to implement the GST, rationalize energy subsidies, and strengthen public financial management, including through a medium term budget framework. They also highlighted their intention to address long term spending pressures, including through reforms to the public pension scheme, to housing and student loan programs, and to the civil service.

The Report speaks for itself. It lays out in well nuanced statements that the Government will have to face up to taking measures to bring the fiscal house into order.
The Government acknowledges that this will demand measures to broaden the tax base, repeal subsidies, trim certain expenditures and adopt tighter policies to control operating expenditures.

These policies will translate into the introduction of the long delayed GST, a measure that will impact mainly on households. The removal of subsidies that is contemplated, in all probability, will be in the area of those subsidies covering consumer goods.

There is no indication that there is any intention to withdraw subsidies currently extended to Independent Power Producers or toll road operators or other recipients of “corporate welfare”.

Attempts to curb the growth in household debt will directly impact on the ability of households to borrow in order to finance housing and transport equipment.

Taken as a whole, the impact of the above policy package will largely be felt by the household sector.

The measures taken will push the country on an austerity path not too dissimilar to that adopted by several of the EUROZONE countries.

Were this scenario unfold, Malaysians will feel the pain of adjustment. No amount of “massaged” and even fraudulent statistics is likely to spare the country.