Wednesday, June 13, 2018

Here We Go Round the Mulberry Bush

Our PM in Japan (excerpt):

Malaysia asking for yen credit to help with national debt, says Dr Mahathir

MALAYSIA is asking Japan for credit as part of efforts to resolve its debt problem, Prime Minister Dr Mahathir Mohamad said today.

Speaking at a joint press conference with Japanese Prime Minister Shinzo Abe, Dr Mahathir said he was told Japan was considering the request.

“I have explained the financial problem faced by Malaysia, and towards solving this financial problem, I have requested for yen credit from Japan and Mr Abe, the prime minister, will study this request,” Dr Mahathir said.

I don’t have much time, so I’ll keep this short. I’ll give TDM the benefit of the doubt here – he could be talking about refinancing some of the USD debt under 1MDB, which makes sense since the yield on that debt was way above market. However, using JPY loans to cover MYR debt makes no sense at all.

Tuesday, June 5, 2018

No, International Reserves are NOT Government Savings

I’m starting to read this in social media comments about Malaysia’s public debt. That the government doesn’t have reserves; no, that Malaysia has plenty of international reserves; but Singapore has more reserves than we do! etc.

This is almost wholly nonsense.

Monday, June 4, 2018

RM1 trillion debt? Don’t Panic

I realise in writing this that I’ll probably be a very lonely voice in the wilderness, but I think this needs to be said and intellectual honesty forbids doing anything else. I also promised years ago that I would defend a Pakatan government when keeping an elevated level of government debt. I’m going to keep that promise now.

As the news of the Malaysian government’s real debt position has been slowly been revealed over the past two weeks, the reactions have predictably ranged from horrified to furious. Unfortunately, the prevailing thought is mostly about how this debt is to be paid back, and the burden on taxpayers as this is being done.

Let me flip my usual practice, and begin with my conclusion, before going into the reasons why.

Except under very specific circumstances, on no account should the Malaysian government:

  1. Shift from a budget deficit to a budget surplus; or
  2. Make any attempt to reduce the absolute level of government debt.

This is of course, completely at odds with the “conventional wisdom”. However, the conventional wisdom is in this case, mostly wrong. There are two strands of thought I have in mind in making the above recommendations:

  1. Historically, successful sovereign debt rationalisations have almost never involved actually reducing the absolute level of debt, with most of the heavy lifting done by growth and inflation (in roughly equal proportions);
  2. Most schools of economic thought outline the unintended and unwanted consequences of public debt reduction, even if implicitly.

The clearest most recent example of point 1 is Indonesia, where debt to GDP dropped from 87% in 2000 to just 23% in 2012. This was despite the absolute amount of government debt actually doubling during this period; it currently stands at 3x the level in 2000.

How was this done? Again, growth and inflation. Indonesia saw inflation mostly hovering between 5% and 15% for most of the 2000s, and averaging about 5% for most of the past decade. Nominal GDP growth was similarly high, at between 10% to 25%(!), which made the size of the economy 5x-6x larger:

Under those conditions, it’s not hard to reduce the debt burden to something more manageable. Other successful debt rationalisations followed similar modalities (offhand, the one I remember best is the sharp reduction in the US debt to GDP ratio following WWII).

The lesson here is that it is not necessary or even optimal to pay down debt to reduce the debt to GDP ratio. The other lesson here is that the best debt reduction strategy is to deploy fiscal policy to maximise growth and potential growth, rather than to pursue fiscal austerity. The latter route is filled with cautionary tales of failure e.g. Europe since 2011.

On the theory front, what happens when you try to actively reduce government debt? I won’t go into the reasons why a certain level of government debt is always desirable – I’ll save that for some future post.

In a New Classical paradigm (and Austrian thought), a negative fiscal shock results in an expansion of the private sector (the opposite of “crowding out”). New Keynesians would indicate a temporary slowdown in growth, but with the economy moving towards a new equilibrium with, again, the private sector leading the way. Post Keynesians (and I daresay MMT) would say a permanent slowdown would occur. Monetarists would point to an independent central bank responding to the fiscally induced slowdown, with a resulting expansion of private economic activity.

The mechanisms underlying these analyses would be similar – a reduction in public debt reduces market interest rates, which induces the private sector to borrow and spend more. Monetary theorists would suggest this comes from monetary policy (interest rate cuts) taking over from fiscal policy expansion. Others could point out the effect on the yield curve from public debt reduction. Others still would place their bets on a depreciation of the real exchange rate. Loanable funds theorists would think its a release of real resources from an inefficient public sector to a more efficient private sector.

Fundamentally however, the end result is roughly the same – a reduction in public debt results in an increase in private debt. The alternative is slower growth, and one unfortunate empirical finding of the Great Recession is that once lost, potential growth is never regained and the economy shifts down to a lower growth path.

So in any move towards absolute debt reduction, some thought must therefore be given to whether the Malaysian private sector has the wherewithal to take on more debt. And the answer to that question is mostly…no.

The corporate sector has been repairing its balance sheets since the Asian Financial Crisis, and while gearing ratios have risen in the past decade, there is little appetite for increasing leverage even more. In the slow growth world we are living in today, private investment in industrial capacity has been lukewarm and haphazard. Much of investment over the past decade has actually ended up in structures (aka office buildings and retail malls), of which we’re seeing a glut. What’s happening in the West today is corporates borrowing money to fund share buybacks – not exactly improving economic growth potential.

The household sector is in an even worse position. Debt levels remain elevated, despite 3-4 years of repair. Savings rates remain dismal at less than 2% of disposable income. Increasing household borrowing over present levels would be literally begging for a financial crisis, and one that would be even harder to resolve than a sovereign debt problem.

One last thing to add to my analysis here is that Malaysia still runs a current account surplus. That implies a continuing excess of savings over investment, and while there are a number of reasons for this, the inescapable conclusion is that running a fiscal deficit still remains a viable – indeed, in my view, obligatory – option. A fiscal deficit of less than 3% also meets the international standard for a “balanced” budget anyway.

Some people are bound to mention Malaysia’s last bout of debt reduction in the 1990s, which involved running a budget surplus. I’d argue the circumstances are different – at that point in time, the economy had a current account deficit, which implied that a budget surplus was not only useful, but necessary. Unless and until Malaysia’s current account falls into deficit, I will continue to advocate running a fiscal deficit.

So to repeat my conclusions, with the addition of the proviso mentioned above:

  1. As long as Malaysia has a current account surplus, the government should aim for a level of fiscal expenditure aimed at maximising potential growth, even if this means running a perpetual fiscal deficit;
  2. Ignore the level of debt – it’s not really important, and reducing it should not be a policy priority. Reducing it would place too great a burden on the private sector balance sheet.

Oh, and there’s no danger we’ll turn into Greece.

Monday, May 21, 2018

BR1M: Good Or Bad?

Loanstreet has an article on the pros and cons of BR1M (excerpt):

Will BR1M Destroy Malaysia from Within?

Since BR1M was implemented in 2012, it's been heavily criticised by many sections of the public. Many view it as nothing more than vote buying from the marginalised in society. Its harshest critics even claim that such careless use of public funds will run the country to ruin.

We believe that politics aside, the merits of BR1M should be assessed on its own. Is it really such terrible policy? Will it ruin the country as some claim?

Because we ourselves did not know how to feel about it, we decided to thoroughly examine the issues surrounding BR1M to find out if it is actually good policy, or one that could lead Malaysia to ruin.

The “road to ruin” narrative might be a little over the top, but the article covers most of the essential points. This came out before GE14, so a rebrand is probably apposite – my vote would be for Dividend Rakyat.

Two things I would add to the articles points are:

  1. Cash transfers actually do address the root causes of poverty - for the next generation. Poverty should be seen not just in terms of the current poor, but the impact that poverty has on the chances for social mobility of their children. Meritocracy only works under the unspoken assumption that initial conditions for all children are the same, which under most circumstances they are not. It's not enough to provide a good education, since this ignores the importance of for example social capital. Studies on child development also point to the importance of education in the 0-5 age range in terms of soft skills development, which even universal pre-school will not fully address.
  2. BR1M was explicitly funded by the savings from the reduction in petrol subsidies. In fact, initially, they even shared the same account code in the government's books. The way government finance works in Malaysia, BR1M would be classified as operating expenditure, so it can ONLY be funded by revenues, and not by borrowing.

Wednesday, May 16, 2018

The First 100 Days

I’ve had multiple requests to comment on this, but haven’t had the time. To be honest, I didn’t read either side’s political manifesto too closely, as most election promises are so hedged with operational realities that the likelihood of full implementation was never going to be very high, when political idealism meets unyielding economic realities. However, now that we have some clarity on the direction forward, it’s time to seriously assess Pakatan Harapan’s manifesto.

I won’t go over the whole thing, just the 10 items that were promised for the first 100 days, and even then only those that are economics related. So, no comment on investigating scandals or the stature of Sabah and Sarawak.

Thursday, May 3, 2018

GST, Exports, and the Ringgit

This is something I had to explain a few times as well over the past couple of weeks, so again, committing this to writing.

The Pakatan Harapan manifesto promises to abolish the Goods and Services Tax (GST) and bring back the old Sales and Services Tax (SST). Analysts expect this (along with the other spending plans in the manifesto) to result in a sell down of the stock market, and a drop in the Ringgit. Contrary what people may think, this has nothing to do with “investor sentiment”. There are fundamental reasons for thinking this will happen, though I’ll only touch on the SST/GST effect.

Wednesday, May 2, 2018

Fiscal Realities

A couple of things were raised last week that I want to address:

Issue 1: The Difference between Operating and Developing Expenditure

I’ve had to explain this at least twice over the last few days, so I thought I might as well spell it out. Malaysia is one of the very few countries that actually subdivides spending between operating and development expenditure – actually, I think Singapore is the only other country that does this. MOF keeps these accounts entirely separate (I’ll touch on how they intersect in a bit), whereas most other countries consolidate the two.

Wednesday, April 25, 2018

Rethinking the Macroeconomics of Resource Rich Countries

VoxEU has a new e-book out on the way forward for commodity producing economies (excerpt):

Rethinking the macroeconomics of resource-rich countries: A new eBook
Rabah Arezki, Raouf Boucekkine, Jeffrey Frankel, Mohammed Laksaci, Rick van der Ploeg 24 April 2018

After years of high commodity prices, a new era of lower ones, especially for oil, seems likely to persist. This will be challenging for resource-rich countries, which must cope with the decline in income that accompanies the lower prices and the potential widening of internal and external imbalances. This column presents a new VOXEU eBook in which leading economists from academia and the public and private sector examine the shifting landscape in commodity markets and look at the exchange rate, monetary, and fiscal options policymakers have, as well as the role of finance, including sovereign wealth funds, and diversification.

It’s a compilation of papers from a 2016 conference, and to be honest, doesn’t really present anything ground-shakingly new on the subject. However, it does provide a convenient entree for those not familiar with the conduct of macro-policy in commodity producing countries (i.e. most Malaysians).

The article itself provides a short precis of the e-book, which you can download here.

Thursday, April 12, 2018

Effective Exchange Rate Indexes: March 2018 Update

The NEER and REER page has been updated, as has the Google Docs version.

Summary

A late CPI release by Taiwan caused this update to be late, as well as an update to the trade weights, based on export-import data for 4Q17.

On contrast to the last few months, the Ringgit was largely stable for March 2018, though still tending to the upside.The nominal broad index was up 6.42% yoy, but just 0.05% on the month (REER: 6.23%, 0.06%). The picture for the sub-indexes was equally mixed, with the nominal broad index down –0.14% compared to February, but with the real index up 0.06%.

Still, gains were broad-based, with the Ringgit up against 11 currencies and down against just 4. The biggest gain was against the AUD (+1.52% mom), building further on gains since the middle of last year. The biggest decline was against the JPY (-1.58%), though this was after rising 5 out of the last 6 months.

01_indexes

Changelog:

  1. Indexes have been updated to March 2018
  2. CPI deflators and forecasts have been updated for Feburary/March 2018
  3. Trade weights were updated to December 2017. This required revisions to all the indexes from Jan-17 onwards

Thursday, April 5, 2018

Historical Revisionism Redux

P. Gunasegaran demonstrates – yet again – that he doesn’t understand exchange rates (excerpt):

How successive governments impoverished M'sians

A QUESTION OF BUSINESS | At least two ways - both very wrong in the longer term - were used to support the export sector in Malaysia in believing that growth through exports was the right thing for a developing country like Malaysia.

But even though there was economic growth, which means more wealth was created, there was impoverishment too. But how could that be? Basically, those who were rich got richer and those who were poor got poorer.

How did the government achieve export competitiveness over the years? Through two measures. First, they reduced the number of things Malaysians generally could buy by going for a policy which weakened the ringgit. And two, they imported poverty by allowing the uncontrolled import of cheap labour.

Tuesday, April 3, 2018

Stuck in the Middle

The Deputy PM thinks middlemen are the culprits for high prices (excerpt):

Zahid: Higher prices of goods and services the work of 'cartels', not GST

BAGAN DATUK: The rise of market prices were not caused by the Goods and Services Tax (GST) but the actions of middlemen and “cartels” who manipulated prices for their own gain.

Deputy Prime Minister Datuk Seri Dr Ahmad Zahid Hamidi, who is also chairman of the National Cost of Living Action Council, said these middlemen and cartels also made things worse by accusing the government of raising the prices of goods and services when it was they who were the ones responsible.

“They blame GST as the main cause, but these cartels and middlemen are the ones who, before this, avoided paying the Sales and Service Tax (SST). It is because of these people that the government decided to (do away with SST and) implement GST….

…Zahid said it was true that there had been an increase in production, import, foreign exchange costs at one time, but this was due to the fact that the ringgit had fallen against the dollar.

However, he said, the ringgit had now risen against the Greenback but the prices of goods had yet to come down.

Despite the “cartels/middlemen” explanation being a fairly widespread belief, I’d like to see some evidence for it first. While the DPM might be using this to deflect the perfectly valid point that GST is not wholly and certainly not primarily responsible for higher prices, I don’t see it reflected in any of the (patchy) census data on distributive trade. If this was true, profits (value-added, less wages) in the wholesale/retail sector should be rising. Instead, margins have been declining, largely due to higher wage bills.

That last point is mostly wrong too. Based on the interaction between prices and the exchange rate, there has been very little passthrough of exchange rate movements into domestic prices, which implies margins shrank when the Ringgit declined, and just reverted to “normal” as the Ringgit regained value. This isn’t to say that there hasn’t been isolated cases of direct passthrough into prices (I’m looking at you, Apple), but there hasn’t been a general wave in that direction. Moreover, the exchange rate should be completely irrelevant for prices of services.

What disturbs me most about this, however, is that the last two times I’ve heard this sentiment being publically aired by a top government official was in Zimbabwe and Venezuela. Both were cases of hyperinflationary environments, and governments who’d prefer to scapegoat rather than address the real causes of price increases.

Would addressing distributional inefficiencies and monopolies/oligopolies reduce prices? If they exist, quite possibly. However, any such improvement would be a temporary one-off reduction in the price level, and won’t change underlying inflation.

Monday, April 2, 2018

More on Seafood Prices

Nobody can deny inflation in food prices, and seafood is a major contributor to that. The biggest reason behind seafood price inflation is a supply-demand mismatch – the world as a whole is eating more than the seas can provide, with obvious long term consequences unless this is managed. But China is a major factor behind that mismatch (excerpt):

China's Real Offshore Disaster
There isn't much left for a million tons of light oil to kill.

Last Sunday's sinking of an Iranian oil tanker 180 miles off the coast of Shanghai certainly looks like an environmental disaster. Depending on how many of the ship's 1 million barrels of condensate were released into the ocean and not burned off, the accident could end up being one of the biggest oil spills in half a century. The irony? Even that wouldn't represent the biggest disaster to befall the area.

The fact is, thanks to massive overfishing in China's territorial waters, there isn't much marine life left to kill in the disaster zone. According to He Pemin of Shanghai Ocean University, those waters have been so denuded over the last three decades that fishermen "normally bypass the area and go further afield for a bigger catch."

It's a dark twist to an accident that has the potential to send oil drifting to the California coast. And it should encourage the Chinese government to rethink how it manages its marine environment. The need is urgent: China's hunger for seafood is fast outstripping its domestic resources. Consequences already loom, including food inflation, a depleted environment for the hundreds of millions of Chinese who live along the coast, and rising international tensions.

Chinese fishermen traditionally concentrated on inland and coastal waters. But as the economy opened up in the late 1970s and private fishing fleets grew in size, those areas were quickly fished out.

Seeing the industry as a jobs creator, local officials were loath to restrain it. The national government didn't do much better. Instead of crafting policies to sustain inshore fishing (by controlling catches and combating massive coastal pollution, for starters), authorities offered subsidies and technical support to help fishermen venture further offshore into the East China Sea. (The money also supported other "blue economy" industries such as shipbuilding and offshore drilling.) In 1985, just 10 percent of China's catch was netted in those far-flung fishing grounds; by 2000, it was 35 percent.

The shift was driven by a massive jump in China's seafood consumption as its population has become more affluent. Growth has averaged 7.9 percent annually since the late 1970s. Chinese seafood consumption increased 50 percent in just the last decade, to 62 million tons annually. That accounts for nearly two-thirds of global growth.

Lesson 1: Unless we do something to manage fisheries on a sustainable basis, the situation will only get worse.

Lesson 2: Politicians can say what they like, but no amount of fiddling with taxes or the local economy will make a difference. This is a global problem and needs a global solution.