Rafizi vs Khairy: Avoiding the panic button and why Malaysia is not far from a crisis

Concerns over Malaysia’s high level of public debts are real. It is not surprising that this will feature prominently in public debates for some time, not least because the fiscal problems faced by some countries around the world continue to hog the headlines.

So while it is timely that Khairy Jamaluddin penned his thoughts on fiscal responsibility (published in The Edge Feb 20) and in light of Deputy Minister of Finance Awang Adek Hussin’s insistence that our debt level is manageable (despite being only 2% away from the legal national debt limit), it is only proper that one of us from Pakatan Rakyat (PR) responds to further the public discourse on this issue.

After all, the culture of public debate has received a big boost recently and we (Khairy and I) have promised to continue to promote it after our first public debate in London in January. I shall start by acknowledging that there are common grounds on this issue across the political divide.

For example, although we may not hit the panic button yet, there is a strong basis for focused measures to alter the fiscal path the country is taking, without which there is a certainty in the future that Malaysia will face financial difficulties. Both Khairy and I can also agree that the concerns over the high level of public debts are justified and that politicians will be foolish not to pay heed. The most important common ground is to minimise the political bickering in any discussion on public debt as it is a national issue that cuts across different groups of society.

Khairy’s take on this issue is clear and simple. First, his criticisms of what he considers PR’s conflicting positions vis-a-vis the public debts. He opined that PR proposed national policies will send public debt skyrocketing despite its vocal demand that the current level of public debt be mitigated.

Second, he says there is no parallel between Malaysia and other countries currently struggling in the aftermath of high level government debt (such as Greece) because a substantial portion of the government’s debt is sourced domestically.

Third, he believes the cost to service our national debt is still manageable compared with the country’s revenue.

(Of course, the biggest chunk of his opinion was dedicated to his criticisms of PR with much less insight on the other two).

Lack of understanding of financial markets

My biggest concern as I peruse his column is the lack of appreciation of the nature of the financial markets (including banking sector, equity and money markets) which has a significant impact on any policy measures aimed at managing a nation’s debt level. In fact, Khairy seems to focus solely on “national debt” (presumably government’s borrowings), leaving household debt out of the deliberation.

I prefer to tackle the issue holistically, looking at the combined effect of government borrowings and household debt (what I shall collectively refer to as “public debts” from here on) because the dynamics of either (or both) will determine the stability of the financial markets. It is precisely because most of our debt is sourced locally that an erosion of confidence in the soundness of the financial markets will quickly cause a panic that will destabilise the economy.

We should not restrict ourselves to lessons learnt from the Greece crisis in formulating sound economic and financial policies for the country. The world has seen successive economic and financial crises over the last 50 years, each contributing to the way the global economy and financial markets have evolved over the years. The Malaysian economy that we manage today is a by-product of the reactions and pre-emptive policies in response to these crises, so we should broaden the learning horizon beyond Greece.

If we need to understand the danger of populist economic programmes, look no further than Latin America in the 1970s and 1980s when it was suffering from alternating banking crises and hyper-inflation. If we need to be convinced that even a seemingly stable economy (with a balanced budget, pro-growth policies and huge foreign investments coming in) can quickly descend into an economic nightmare, one only has to revisit the days of the so-called Tequilla Crisis engulfing Mexico in 1995.

To fully appreciate how intertwined debts taken by the public (which has nothing to do with government debt) is with the stability of the financial markets – which in turn quickly drag the whole economy down into recession – remember the word “subprime” and mortgage implosion experienced by the US in 2008.

If Khairy and Awang Adek Hussin had fully digested the similarities and uniqueness of these crises, I am sure they would be more alarmed of the country’s high level of public debt. For within these crises and our own experience during the 1998 East Asian financial crisis, we should appreciate that the intertwining of our economy with the regional market, global sentiment and the herd mentality of the market players means a small financial hiccup is contagious to the whole economy and can quickly snowball into a full blown crisis.

Not reassuring at all

Let’s look at our present situation objectively. Federal government debt stood at RM456 billion as at Quarter 4 2011 (the latest available statistics from Bank Negara Malaysia). If we were to take into account the debt guaranteed by the federal government, the total debt exposure of the federal government hit RM573 billion in 2011 (equivalent to 67% of the GDP).

On its own, we can argue that 67% debt exposure is a cause for concern. Frankly, there is no definitive band of what constitutes a safe debt level for a particular country. Nor can a fair comparison be made against other countries. So, those who argue that Malaysia is in a better position than, say Japan (at 67% debt level), is making a rhetorical argument.

We ought to look at government and household debt in totality because that would be a good gauge of how such a level of public indebtedness would impact the stability of the economy and financial markets.

As at Quarter 2 2011, the household debt-to-GDP ratio stood at 77.6%, according to Bank Negara Malaysia. That roughly translates into household debt of RM662 billion. Thus, the combined public debt (government debts and household debts)- to-GDP ratio as at end of 2011 can easily surpass the 143% mark with most of this RM1.24 trillion of debt owed to local financial institutions.

In this respect, we seem to have gone to the extremes to insulate our borrowings from foreign exchange risks. While the financial authorities continue to reassure us that the fundamentals of our banking sector are strong, I would not be quick to celebrate because all the previous world financial crises were preceded by strong reassurance of the soundness of economic and financial fundamentals.

Imagine the worst case scenario for Malaysia.

Most of the depositors of local banks, statutory bodies (for example EPF, SOCSO and Tabung Haji), state-controlled investment agencies (for example PNB) are Malaysians. They put all their life savings in these institutions, fully convinced that everything is guaranteed by the government.

These institutions, in turn, subscribe for most of the government-issued bonds and provide loans to the government. They also make investments in many national projects at the behest of the government, some did not provide good returns, some others went miserably wrong.

Wages stagnate while the cost of living continues to climb. House and car instalments made to banks as a percentage of net household income grow higher by the year, leaving less and less in the pockets of the common people. The bankruptcy risk faced by the common people also grows as a consequence of this economic malaise.

At the same time, the local financial institutions get caught in the state’s involvement in huge projects and their deposits (taken from the public) are exposed to what traditionally was the realm of the government. Instead of investing in profitable projects, these institutions are sometimes forced to lend depositors’ savings to the government to build public housing, managed by a newly set up foundation with no experience. Over time, this type of lending habit, spirals and stretches the local institutions’ resilience to internal or external economic shocks.

And let’s say that one day, news that there was a big jump in bankruptcy comes out at the same time as an announcement of the failure of a mega project that was financed with public funds. What happens next? The banks and local institutions will be forced to write off their loans and investments, which would quickly start a run on them.

Anything could happen

From this point onwards, anything could happen. The panic could cause the government to print more money to increase liquidity in the financial sector, resulting in inflation shooting up; or the newly printed money is quickly changed into other currencies, depreciating the value of the ringgit. This would create another problem – Malaysian corporations with loans in foreign-dominated currencies would begin to suffer and they find it difficult to meet their debt demands.

Concerned about the spiralling effects and devaluation of the ringgit, the government would decide to raise interest rates and hope that this would encourage money to pour in and stabilise the ringgit. But this may have an adverse impact on growth as companies struggle to service their loans.

The extent of iteration that we could make on this spiral effect is endless. Once the panic button is hit, anything can go wrong.

And we are not that far from hitting the panic button, looking at our public debt-to-GDP ratio of 143%, even if most of the debt is sourced locally. What I am trying to say here is that the policy options leftopen to the government, should it face a financial or economic crisis caused by excessively high public debt, are limited.

Separating politics from financial facts

The implied argument by Khairy that we will be able to manage our debt since it is sourced locally (presumably by printing more money) does not hold water. In fact, it is such mentality (borrowing and printing money to pay debt) that condemned Latin America to decades of economic turmoil from the 1960s to 1980s.

Thus, the most responsible action of a public office holder is to carefully monitor our debt level and put in place an early warning system, so that a certain disastrous fiscal path can be altered before it is too late.

In the context of the worst-case scenario for Malaysia that I have presented, we can avoid it by asking these key questions now:

1) Have the local banks and institutions been lending too much to the government and investing in doubtful projects that may cause them to write off their investments?

2) Are we comfortable with huge household debt that is tied mostly to vehicles (that have hardly any value after a few years) and a nervous property market?

3) Can our wages support the rise in the cost of living so that the public can cope with their debt obligation and secure the banking sector’s stability?

4) Is there much trust and confidence in the government’s governance and transparency in managing public funds?

5) Is it possible that panic could set in?

I leave the public to answer these five questions because I am confident the answers would justify our concerns over what we consider an excessively high level of public debt. Our responsibility to the public is to become their ears and eyes so that we never come close to the panic button.

As for Khairy’s criticisms of PR, I shall keep to my promise of not engaging in political bickering when discussing the issue I set out to analyse at the beginning of the article. It is too important a subject to point fingers at each other. We can always indulge in political banter in a different forum and platform.

Rafizi Ramli is the strategy director for Parti Keadilan Rakyat