A FAQ On Malaysian Government Debt: Part II

[Continuing on from Part 1]

Q4. All this increase in debt will be a burden on our children and our children’s children

A. This is based on the idea that debt has to be repaid eventually, and the main source of government income is taxation – basically a corollary of the idea that a government is similar to a household. Hence, in this view, the greater the debt build-up the greater the expected future level of taxation. The popular notion is thus that of the current generation borrowing from future generations.

There’s a problem with this conception. First, since governments are collective enterprises on behalf of the governed, there’s no natural lifespan involved. There’s no necessity for debt to be fully paid off and it can be effectively carried in perpetuity. Some governments have actually taken advantage of this fact to issue perpetual bonds that never mature, and at least one major government has issued a 999 year bond.

But the most important point is this – whether government debt accumulation will become a burden on future generations depends greatly on who the debt is owed to. If the debt is held by citizens or agencies acting on the citizens behalf (for example EPF), then the taxes raised to pay for maturing debt comes from citizens and the debt payment goes back to citizens. All that occurs is a change in financial obligations and possibly some redistribution of wealth, but not a net burden on taxpayers.

That’s how Japan has managed to raise public debt to over 200% of GDP, yet is barely penalised by bond investors – most of that debt is held by domestic institutions like postal savings banks and pension funds. The Japanese are in effect lending to their government so that the government can spend it on them.

In Malaysia’s case, the ratio of foreign holdings of federal government debt has been rising steadily since 2005, but its still at a fairly low level (Government debt, not including BNM bills):

For the rest, about a quarter is held by social security institutions like EPF and SOCSO, the financial sector (banks, insurance companies) hold another quarter. Holders of general investment issues aren’t specifically classified, but foreign holdings of GII are relatively minor according to RENTAS.

Q5. Government debt growth is being aided and abetted by our pension and investment funds, which are now at risk

A. Here’s an interesting question for you – which is the better credit risk, a household or company who faces hard budget constraints on income and expenditure, or a government with discretionary powers of taxation and a printing press?

Government debt typically forms the benchmark for all bond issues in an economy. Even the best rated companies pay more on their debt than the government of their country. It goes back to the safety factor. That’s why pension funds and insurance companies put most of their investible funds into government securities. Whatever the risk of investing in government securities, every alternative except cash is riskier.

Q6. Since most of government debt is owned by Malaysians and only some by foreigners, the foreigners will get paid first while we have to pick up the bill

A. Actually, the reason why there’s such elaborate care and concern over foreign bond investor perceptions and rights – not just here but globally – is because historically when countries dodefault, it’s almost always a default on external debt, not on the debt held by domestic institutions.

It’s not hard to figure out why – when we’re talking about citizens, no democratically elected government would dare default on its debt obligations as it risks being booted out otherwise. Same thing for institutions such as pension funds and insurance funds, which take care of the future financial needs of their investors (read: voters). For banks, a domestic default could mean the government needing to bail them out, which makes a default worthless.

So foreigners are always first in the firing line, which makes them understandably skittish.

Q7. The government went on a spending spree during the recession

A. In 2008, in response to the Lehman Brothers collapse and the resulting shutdown of the international financial system, Malaysia instituted a fiscal stimulus package worth RM7 billion. When that didn’t appear to be enough, a bigger spending package with a face value of RM60 billion was passed through Parliament in March 2009, which put the total up to RM67 billion. That sounds like a lot, especially since both were enacted under conditions where tax revenue was expected to drop.

But here’s what really happened: Of that RM67 billion, RM5 billion was for National Savings Bonds paying 5% interest intended to help retirees and pensioners to raise their income even as BNM cut banking interest rates (i.e. it was actually revenue, notexpenditure); RM7 billion was in Private Finance Initiatives, where the government didn’t pay a sen; RM20 billion was in credit guarantees for SMEs and small businesses, where again the government didn’t pay a sen; and only the remainder of RM35 billion was allocated for direct spending. That’s still a lot, and helps explain why debt ballooned in 2009/2010.

Or does it?

The truth is, Government expenditure in 2009 was only aboutRM1.4 billion higher than the original 2009 budget proposals sent to Parliament in 2008:

By my estimates, about RM14 billion of both stimulus packages were actually spent in 2009, yet the increase in total government spending was only a tenth of that. The implication is that most of the funding for the extra spending didn’t come from extra borrowing, but from cuts in other government programs. From my point of view that’s no spending spree, that’s being overly tight fisted – 90% of the stimulus effect was swallowed up by cutbacks in other areas..

So how come government debt rose sharply in 2009? Because government revenue came in at 10% below the budget estimates - in fact a little worse than the contraction in 2009 GDP of 9.9%:

Q8. We’re in trouble because debt has doubled in the past five years while income hasn’t

A. This is almost true: at the end of 2005, Federal Government debt stood at about RM229 billion and rose to RM407 billion by 2010. Nominal GDP on the other hand only rose from RM522 billion in 2005 to an estimated RM766 billion in 2010. But this little calculation is also wholly misleading as an indicator of debt sustainability.

The key point is that the recession seriously dented not just government income but the nation’s nominal income as a whole – the recovery in 2010 saw national income only just passing the level reached in 2008. In the meantime, the government had to deal with the drop in revenue in 2009, and thus had to borrow to cover the difference.

Looking at the growth rates, debt growth actually lagged income growth from 2005-2007:

It was only the recession that caused debt growth to jump, and it has now come down to more sustainable levels. As long as debt growth falls more or less in line with income growth, we should be fine.

Looking at the experience of the last recession (2000-2001) will give you an idea of why just taking a five year comparison won’t give you an accurate picture of the real situation.

Q9. Government debt isn’t sustainable because operational spending is greater than revenue

A. I think this came from a misunderstanding of what was said by Idris Jala at the recent ETP anniversary event. But it’s pretty easy to disprove:

The government’s operational balance has been negative in just three years out of the last 40, and it has not been in deficit since 1987. As required by law, the government only borrows to finance development expenditure, i.e. investment that will raise future capacity to produce.

Q10. Government debt is nearing the legal debt limit, and they won’t be able to borrow anymore so we’ll have to default

A. satD has covered this question in detail, so I won’t post more than a summary – the legal limit is a paper tiger and the government can change it anytime it wants. If at any point the government fails to gain legislative approval to raise the limit, in our system of parliamentary democracy that means an immediate dissolution of parliament and fresh general elections.

You’re not going to see a repeat of what happened in the US in August here. The US uses a presidential system, where the executive is elected separately from the legislative. Since this system is designed to promote checks and balances, that almost always means that a Democratic President has to deal with a Republican Congress and vice versa. The result is typically political gridlock.

Q11. The Treasury says the national debt is RM240 billion but the outstanding government debt is RM437, someone must be lying

A. It’s a funny thing but in Malaysia, we don’t use the term “national debt” in the way it’s commonly used elsewhere. Here the term refers exclusively to external debt only, of both the public and private sectors, and not to government debt.

So in Malaysia, government debt and national debt mean two very different things. The government’s external debt, by the way, is all of RM17 billion.

Q12. In ten years time, we’ll be like Greece

A. Greece has a 2000 year history of defaulting on its external debt. Malaysia has never defaulted on its debt.

Greece has had a debt to income ratio over 100% for the last twenty years, a ratio that is expected to climb to over 150% this year. Malaysia’s debt to GDP ratio peaked at 70% 25 years ago, and is at most 54% today.

Greece has something like three quarters of its debt owing to foreigners. Malaysia only owes about one fifth of its government debt to foreigners.

Greece is part of the Eurozone, and thus has no control over the issuance of its own money. Malaysia through Bank Negara controls the supply of Ringgit.

Worse, the European Central Bank is legally bared from becoming a lender of last resort for the Eurozone governments. Bank Negara has no such restrictions.

Greece is uncompetitive – it costs 40% more for a Greek worker to produce a unit of output compared to a German one. (Unfortunately the relevant statistics aren’t available for Malaysia).

Malaysia is not Greece, and we’re not exactly in danger of becoming one in the next ten years.

[If there are any other questions that I haven’t thought of here, feel free to post in the comments and I’ll add it to the FAQ).

Technical Notes:

Data on Federal Government borrowing and expenditure from Bank Negara’s Monthly Statistical Bulletin and from the Economic Planning Unit. Population estimates from EPU and the Department of Statistics