1Q2010 National Debt Update

The pace of my blogging has dropped off substantially the last couple of weeks, for which I apologise. I've been busy in Sarawak for the past week, and will be in Dubai until next month, so normal posting will only resume from about the first week of May or thereabouts (depending on how I deal with the jet lag). This post will have to do for now.

I’ve noticed that I’m getting a lot of Google hits about Malaysia’s national debt position and fiscal deficit. Since I haven’t done an update in a while, what’s the position with government finance and Malaysia’s national debt right now?

Up to the end of last year the national debt reached RM362 billion compared to RM306 billion in 2008, with about half the increase due to planned expenditure under the 2008-2009 budget, and the other half coming from the combined stimulus packages:

That actually comes in about RM18b below my rough forecast, which isn’t bad at all. Up to 22nd April, a further net RM16.64 billion was borrowed, which was a little off the pace of last year and includes RM10.9 billion in redemptions (mostly in April). That puts total national debt to date at around RM378 billion, or a little over RM13,000 per capita.

I put my thoughts on the government’s debt position in a recent post and won’t repeat my comments on that here.

However, as an interesting side note, there was a very short and ill-publicised report that the government has already broken fiscal discipline to the tune of RM12 billion over and above the 2010 budget:

An additional allocation of RM12 billion will be approved for the 2010 Budget, said Second Finance Minister Datuk Seri Ahmad Husni Ahmad Hanadzlah.

He said the allocation was to implement the six National Key Result Areas (NKRA) under the 10th Malaysia Plan (10MP) and to cater for additional funds sought by various ministries.

That’s an additional 6.3% over the planned budget and almost wipes out the projected savings over the 2009 budget. The only saving grace with this is that the government has almost always underestimated its operational spending in its budget proposals – so this additional outlay is just par for the course (budget proposals against actual realisation, RM millions, 1998-2010):

To offset this profligacy somewhat, the Treasury has, apart from last year, also systematically underestimated revenue every year as well. I think revenue will again surprise on the upside this year – 6%-7% GDP growth is well within reach – which will help defray the additional expenditure.

Technical Notes:

1. Federal Government finance and public borrowing data from BNM's February 2010 Monthly Statistical Bulletin
2. March/April 2010 public borrowing data from BNM's FAST
3. Budget estimates from various copies of the Ministry of Finance Economic Report

Feb 2010 Industrial Production

Last week’s February production report showed output growth fell as expected on an unadjusted basis, but also a bit more than I’m comfortable with even after seasonal adjustment (log annual and monthly changes; seasonally adjusted):

I’m not overly concerned yet due to the short working month we had, as well as the fairly decent February trade numbers that were posted. The latter together with slowing output implies a run down in inventories, which suggests March will be catch-up time – watch for better numbers for the month just past.

Technical Notes:

February 2010 Industrial Production Report from the Department of Statistics

Hold On To Your Hats…

…it’ll be a better year than you think. Seems I’m not the only one who thinks GDP growth this year will be pretty good. HSBC thinks Malaysia will hit 7.3% in 2010, while JP Morgan forecasts a higher 7.8%.

Part of that is of course the sheer depth of the recession – GDP dropped a full RM70 billion in nominal terms – and the resulting base effect on this year’s output. I’ve already explained my reasoning in this post, but to summarise, I think a fairly full recovery in trade and consumption is in the offing, which means that the economy is likely to return to its previous growth path. That implies that growth this year will be much faster than normal at over 7%.

Having said that, don’t buy too much into this year’s growth as the start of a new trend – it isn’t.

Reassessing Macroeconomics

William White, Chairman of the Economic and Development Review Committee of the Organization for Economic Cooperation and Development and ex-Economic Advisor and Head of the Monetary and Economic Department at the Bank for International Settlements from 1995 to 2008, writes on what’s wrong with Macro analysis today:

Modern Macroeconomics is on the Wrong Track

"What do the above considerations imply for the future of macroeconomics? The simplifying assumptions of the New Classical and New Keynesian models do not make them obvious candidates for near-term guidance on how best to conduct macroeconomic policies.

We are left then with the Keynesian framework, with all the likely fuzziness and uncertainties implicit in the principal functional forms being subject to “animal spirits.” At the least, this implies appropriate skepticism of the forecasts generated by the available empirical models. Recent experience of very large forecast errors—not least by the IMF, the Organization for Economic Cooperation and Development, and other official bodies—only accentuates a tendency under way in most forecasting shops for many years. Conscious of the potential shortcomings of individual models, many institutions have begun to maintain a variety of such models. Judgments about policy requirements are based on an overview of them all, plus whatever intuition experienced policymakers are prone to add. This blend of art and science may be the best we can ever hope for.

White nicely summarises the developments in empirical macro over the past fifty years (in layman’s terms!), and also covers the contributions that Austrian theory and Hyman Minsky's insights have toward explaining the events of the past two years. He should know - White was one of the very few to correctly predict both the crisis and its proximate causes. With very few exceptions, most academic economists and central bankers got only one or the other right.

He identifies a few areas for future research to get macro analysis back on track:

1. Blending Austrian theory into the structure of Keynesian models, by identifying factors contributing to macro-imbalances
2. Investigate firm and household propensity to consume and invest, independently from the financial system and the supply of credit
3. Who should have regulatory responsibility for monitoring financial imbalances and “pressures”?
4. Urgently conduct research into the micro-foundations of the financial system
5. Due emphasis on research into non-efficient market/non-rational expectations hypotheses as the driver for agent behaviour
6. The impact of government intervention and safety nets needs to be investigated more thoroughly.

This research agenda is being echoed by many prominent economists (Krugman for one), and many central banks and multilateral institutions are scrambling to add financial accelerators and/or positive feedback loops into existing models (essentially putting old wine into new bottles).

The idea of adding Austrian insights into the existing macro-framework is a good one, a long as its not taken too far. The problem I have with Austrian economics is less about their analysis of the business cycle, which I think has validity – booms and busts driven by excessive credit creation – but because they have almost nothing to say about how to manage a bust beyond prescribing an economic system (money independent from discretionary authority e.g. the gold standard) that is many times worse than the present one. It’s like someone yelling fire, then trying to help put it out by telling everyone they shouldn’t be playing with the stuff. Absolutely correct – and absolutely useless.

H/T David Beckworth

Government Debt and the Potential For Crowding Out

Hoisted from comments:

Wenger J Khairy said...

Dear Hisham H,

I for one have not a clue what the NEM is neither is worthwhile even spending an iota even discussing it. Actually what business activity can the Government directly influence without incurring additional debt. That itself is going to be a self defeating point of view.

Lets put some facts on the table.

Nos 1 the myth that the Government somehow is responsible for some huge subsidy. 1MPM6 mentioned that the "subsidy" is RM 70 billion budgeted for 2010.

RM 70 billion subsidy? Who is he kidding. The actual subsidy to consumeres [sic] was 2 major items, the subsidy for fuel - RM 10 billion, to be shared with the glorious IPPs,allocation for MARA RM 2 billion and the subsidy for interest on the PTPN fund - about RM 1 billion.

The big ticket items lumped together in this transfer payments mistaken by the PM for subsidy was

RM 15 billion - interest on debt
RM 10 billion - Pensions
RM 6 billion - to the Unis (wonder why our students need to pay fees on top of this, and this is only the Op Budget)
RM 1 billion – KLIAB

The balance RM 15 billion was a hodge podge of various accounts with corpratization being a chief culprit.

So essentially the domestic economy is like a merry go round. Spend today like theres no tomorrow.

Unfortunately for the gomen, is that short term rates are now starting to spike up. Our debt duration which used to be very much in the long term during DSAI is now 50% in the short - medium term with massive refinancing of debt over the next 3 yes. The gomens weighted interest rate is 3.4ish %, imagine what the "subsidy" for Gomen debt will be in 2012 if interest rates were to spike to 5%, (of course triggered by some currency crisis / short term money flow out.)

Key thing is BNM's forex reserves. Thanks to the wisdom of Pak Lah we have a sizable cushion. However, for all our supposed current account surplus, the end inc in BNM foreign reserve position has been 0 for the last couple of months owing to the massive "reinvestment in overseas" phenomenon.

So where JPM fears to tread let I Wenger J Khairy put it succinctly.

A massive public deficit will reduce the cost of capital which means more and more of bank loanable funds will be used to prop up MGS and GII. 0 credit growth in all sectors except the household sector.

Any decision by Uncle Sam to start to raise interest rates would put a pressure on BNM to do the same or else pummel the Ringgit.

Option A- Raise Interest rates
Public deficit continues to swell touching past RM 500 billion in 2012. This puts the soverign rating of the country at risk, not that local banks have a choice. In the end banks prop up the gomen and no new investment in the industry, which means declining international trade which means a potential decline in the BNM reserves which mean a downward bias on the ringgit (PPP fanboys be forewarned).

Option B- BNM continues to keep rates low, which means Ringgit gets pummelled on the forex market

So either way long term I see Soros prediction of 5 to the dollar becoming a reality and a massive inflation spike to hit the country in 2012.

SO says I Wenger J Khairy

Wenger paints a nightmare scenario, one I think has a low probability of happening, but he does have some highly pertinent points that bear examination.What he’s talking about is what’s called in economic terminology the “crowding out” of the private sector, as public sector demand on financial resources or the concomitant increase in the cost of capital reduces private consumption and investment. I don’t think that’s likely in Malaysia over the short term, though a failure to generate GDP growth over the next two years would certainly bring this factor potentially into play, as the government tries to pick up the slack in terms of deficient demand. It’s also a potential factor as we go through the latter half of the decade unless growth picks up, and the implementation of the NEM successfully shifts the burden of growth to the private sector.

In any case, my comments on Wenger’s post are as follows:

1. Subsidies – the breakdown of government operating and development expenditure by function is available in BNM’s Monthly Statistical Bulletin. Operating expenditure classified as subsidies were RM35.2 billion in 2008 and RM18.6 billion in 2009, nowhere near the RM70 billion quoted for 2010, so Wenger has a point – as far as it goes. It depends on whether you classify development expenditure as subsidies. If you do (and I’ll grant you it’s a bit of a stretch), then the RM70 billion figure is suddenly very plausible. Development expenditure was RM42.8 billion in 2008 and RM49.5 billion in 2009. (Technical Note: for those who are curious, the Malaysia Plans effectively lay out the government’s development expenditure over each 5yr Plan period).
   
2. Debt duration and interest burden – this is something I’ve noticed myself, as the bulk of issuance over the past couple of years has been in 3-year and 5-year maturities, rather than the 5-year and 10-year maturities that the Treasury usually favours. Effectively, that means the Treasury might have some trouble rolling over maturing debt in 2012-2014 when the bills come due, on top of the additional borrowing requirement for deficit financing over the next couple of years (Wenger’s estimate of RM500b sounds plausible to me, though I think it’s probably about 10% too high and one year too early).
   
   I honestly don’t think this will lead to crowding out of private investment or household financing over the medium term however, because Wenger missed one thing – the financial system is just sloshing with liquidity. Commercial bank holdings of MGS and GII are just 3.7% of their total assets, while loans comprise just 58.7%. As of February, commercial banks have RM187 billion on tap at the central bank – or nearly double the borrowing needs of the government for the next two years.
   
   But the spike in short term rates is real enough:
    
   I think this is a combination of a couple of things: BNM’s “normalisation” of interest rates which puts a floor under MGS yields, and (paradoxically) a reduction of investor uncertainty.
   
   The recession drove a big increase in demand for short term, risk-free securities against a relatively static supply in MGS maturing in less than one year, which drove down yields at the short end while widening the spread between maturities. Now that the recovery is well entrenched, the return of risk appetite should shift demand towards the longer end of the yield curve, while also converging yields across the maturity spectrum i.e. the yield curve is going to flatten.
   
   Note that under the current monetary regime which uses an interest rate target as the policy instrument, interest rate volatility should be relatively low compared to the volatility of the exchange rate or money supply (see the difference in MGS yield behaviour pre- and post-July 2005 in the chart above). If this thinking holds true then spreads over the past year or so were an aberration, and convergence should see spreads tightening again. In other words – don’t read too much into the spike in short term yields.
   
3. Forex reserves – I think you’re off base with this one, Wenger. If BNM is allowing the Ringgit to float and only intervening during periods of high volatility, as I believe they are, then changes in reserves will not reflect flows of capital at all. I suggest you use this instead:
   
   (Change in Reserves) + (Change in commercial bank net foreign assets) - (Change in trade balance) = (Estimated Capital Flows)
   
   This doesn’t capture reinvestment, but yields a more realistic estimate of inflows or outflows of capital:
   
   
   But I agree with Wenger’s assessment that money is leaving (or staying) outside of the country.
   
4. A massive public deficit will reduce the cost of capital - I think this is a typo - shouldn't it be "raise" instead?
   
5. Any decision by Uncle Sam to start to raise interest rates would put a pressure on BNM to do the same or else pummel the Ringgit – I don’t think this will happen. US rate hikes might slow or halt the appreciation of the Ringgit, but on balance the fundamental story for the Ringgit will still be up. Even with the uncertainty over the trajectories of the two economies, this isn’t a tough call to make. It’s useful to think of it this way – what matters is the real interest rate differential, not just the interest rate difference (click on the pic for the larger version; shaded areas mark Ringgit appreciation relative to the USD): 
   
    
   It’s not a perfect match (note the initial drop in the real interest rate differential during the appreciation of the Ringgit post 2005), because the joker in the pack is the perceived risk premium, which is (i) unobservable, and (ii) time varying. In any case, we have a pretty long head start on tightening, and any US moves in that direction will have to cover a pretty significant gap in Malaysia’s favour. I find myself at odds with Soros – I think a sub RM3.00 to the USD rate a more likely outcome by 2012.
   
   Statistical Note: technically, because the exchange rate (I(1)) and the real interest rate (I(0)) are of different orders of integration, the relationship cannot be long term. Specifically, the real interest rate can only effect the rate of change in the exchange rate, but not its level.
   
6. This puts the soverign [sic] rating of the country at risk… – This is an interesting and valid point, and related to the risk premium I referred to in my previous point. Actual external debt is fairly low and dropping:
   
   
   But the real sensitivity of government debt to the sovereign risk rating, which on surface only directly affects non-Ringgit denominated government debt, is quite a bit higher than that. You have to add in foreign holders of domestic debt to the external debt numbers:
   
   
   …and probably take into account the external debt of NFPEs and the private sector as well, as these will also be affected by a rerating. On the other hand, I don’t think this will matter much at least over the near future because (i) the ratings agencies didn’t exactly get covered in glory the past couple of years, and (ii) the universe of alternative investments isn’t exactly that great. The thing is, while deficits matter for short term interest rates, long term it’s the debt to GDP ratio that investors look at. And on that score I think we’ll be fine:
   
   
   We’re still below the 60% level where investors start getting worried, and far below the 90% level where government borrowing starts impacting growth. Other countries in the region are on par or worse, and the advanced economics are far more at risk of seeing crowding out over the near term (many have damaged financial sectors as well). Malaysia’s total external debt position (public + private) isn’t all too bad either:
   
   
   Going forward, as long as the pace of government borrowing (i.e. the deficit) lags nominal GDP growth, as I expect it will this year, then the debt to GDP ratio should stabilise or retreat. Traditionally there are three ways for governments to reduce their debt burden. Higher taxation (works) or equivalently, reduced expenditure (which works even better – see this post) is what most people think of. The other two are inflation through monetary expansion or other means, and boosting economic growth directly which changes the denominator.
   
   I suspect all three are in play for Malaysia – the actual government debt level at the end of 2009 was a full RM18 billion below my estimate, suggesting that cuts in expenditure may have reduced the borrowing requirement below the projected range defined by the two stimulus packages and the original budget for 2009. In essence, the government traded off public consumption in favour of public investment.
   
   Second, inflation should return to its long term average later this year of around 2.5%-3.0%, which will have a small but measurable impact on the real debt burden (5% MGS yields notwithstanding – yes I think that’s distinctly possible as well, but primarily through higher inflation driven by faster growth).
   
   Third, trade growth is being driven by changes in the terms of trade through rising commodity prices, and not in volume of manufactured goods. The mining and agricultural sectors have never been big borrowers relative to the manufacturing industry, so would be less sensitive to crowding out by public borrowing (of course, their output and income are also more volatile). Another factor is that the manufacturing sector is suffering from massive over-capacity, so there is plenty of slack (and less financing required) to pick up output even in the absence of long term financing.
   

In short I don’t think the crowding out scenario is credible just yet, though a double-dip in the world economy will guarantee we’ll have trouble. Also there’s no doubt that higher interest rates will eventually impact the private sector, but given we’re starting from a below-optimum point, I’m uncertain how much that effect will be or at what point it will kick in. On the other hand, I don’t think at this stage government borrowing will exhaust or impinge the capability of banks to finance business, given the existing excess liquidity situation we’re in.

In passing, I actually like the NEM, less because I think it will have much of an impact on Malaysia reaching high-income status (I think demographic factors and the exchange rate will take care of that), but because it sets the foundation for sustaining higher income growth in the future - as in 20-30 years from now. But one effect that the NEM will have right now is it’s market-orientation. If the government holds to this principle, then there’s a good chance private investment will flow again. More pragmatically, the sale of government owned companies and assets will help offset the need to borrow.

Sometimes Government Policy Does Work: Credit Card Edition

Back during the tabling of the 2010 budget, the Government proposed a RM50 levy on each principal credit card and RM25 on supplementary cards. I thought at the time and from the anecdotal evidence that the levy might have some effect on people “collecting” credit cards.

Boy, was I wrong (log annual and monthly changes):

The effect has instead been pretty dramatic – from an October 2009 peak of over 11.23 million cards (principal and supplementary), Malaysians have returned or cut up 1.15 million cards or just over 10% of the total. The sudden drop in card circulation has also skewed metrics based on card numbers – a definite structural break for those interested in statistically analysing the local credit card market. That’s probably cold comfort to the hoards of credit card sales agents across the country, but the impact must be pretty gratifying to policymakers at BNM and the Treasury.

On a side note, it also appears from the data that consumers are spending again:

The first chart above shows the percentage of current balances outstanding as a percentage of the credit line extended – card users are rolling over approximately 22% of their credit limits, which isn’t bad compared with many other countries, though it makes the whole business much less profitable for banks. The second chart shows that people are also swiping their cards more often, which bodes well for GDP growth in 1Q2010 – I think the economy will likely surprise quite a few people this year.

Technical Notes:

Data from Bank Negara Malaysia’s Feb 2010 Monthly Statistical Bulletin

Feb 2010 Monetary Policy Update

A little late this month, but better late than never as they say.

As ever when faced with a major festival, currency in circulation (and hence M1) jumped in February, while M2 growth fell back a bit as people converted deposits into cash (log annual and monthly changes; seasonally adjusted):

I expect the reverse to happen in March, with M1 growth dropping and M2 growth rising again, as cash gets reconverted to bank deposits.

The big story of the past month of course is not on the money supply front but on interest rates, with the 25bp bump in the OPR causing a chain-reaction across the whole range of interest bearing instruments and bank lending rates, not to mention the Ringgit. Some of the February data reflected expectations of the hike in the OPR, but none quite so dramatic as MGS yields:

Note the very sharp rise at the short end, which effectively flattened the yield curve – the bulk of the increase happened right at the end of the month in the run up to the Monetary Policy Committee (MPC) meeting. Incoming supply wasn’t a factor, as only RM3.5 billion was tendered in February and that was for a 5 year tenure (and was also 100% oversubscribed). Current MGS yields show some softening across the board, so the market is probably factoring in just another 25bp hike this year and no more.

I think that might be a little optimistic, as I’m expecting at least another 50bp increase by November. There’s so far little hard data to support that view as the stock market has been fairly settled and loan growth is running at a decent, if slightly frothy clip – no nascent asset bubbles in evidence. But I have this feeling…

Technical Notes:

Data from Bank Negara Malaysia’s Feb 2010 Monthly Statistical Bulletin

Singapore: The Future Has Grey Hairs

In exact counterpoint to my analysis of Malaysia’s demographics, Morgan Stanley (again! I love these guys) covers Singapore’s ageing work force, and the implications for economic growth in our southern neighbours:

Can Mr. Productivity Fight the ‘Silver Tsunami'?

...The Singapore economy is ageing and the pace of population greying will take on a new meaning in the coming decades (see factbox below for more details). Indeed, the dependency ratio (ratio of dependents to working-age population) has reached a historical low of 34.7% in 2010 amid a growing population base, implying that the economy is now in its final phase of reaping the ‘demographic dividend'. The current total fertility rate (TFR) has sunk as low as Japan's 1.27. This has been below the replacement rate of 2.1 since 1975. Ironically, the stark decline in TFR post 1950s and the sub-replacement fertility rate had helped to engineer an improvement in the dependency ratio via lower child dependency. Yet, the flip-side should soon rear its ugly head as the current working population grows old without replacement, leading to rising old-age dependency, arguably the more inferior sort of dependency.

They think that Singapore will eventually lose 1% of its growth potential over the next five years, a trend that I think will get worse as the population ages further. The greying of East Asia’s workforce will also likely slow growth in Taiwan, South Korea, and Hong Kong as well, with the only possible exception being China due to its still sub-optimal capital-labour ratio.

Malaysia has of course the opposite problem – our dependency ratio is high but mostly due to a higher proportion below the working age threshold. Which means over the next few decades, we’ll probably see a 1%-2% rise in our growth potential, provided of course that we have the right policies in place to harvest the “demographic dividend” of a rapidly increasing work force.

Morgan Stanley’s Reaction To The NEM

Malaysia's New Economic Model: Making the Right Noise

The market's and our expectations for the NEM have been low. However, what surprised us was that the NEM report had by far the most candid and comprehensive outline of impediments faced by the economy. We think that policymakers have properly outlined all the problems. The next step would be effective implementation. We suspect that market participants may want to see more tangible and orchestrated change before believing that a structural turnaround is for real. The fact that general elections are due by 2013 suggests that some measures may be politically difficult to implement. Yet, we think education reforms would be one area that would address the root problem in Malaysia without being politically charged. We would watch out for the extent of change on that front as an important signpost for Malaysia's structural inflexion point.

You can read the rest here.

Feb 2010 Trade: Better Than Expected

The Department of Statistics released a preliminary assessment of February’s trade data last Friday, which is another unexpectedly new move on their part. One can hope that this is a sign of better things to come, in terms of our statistical capacity and capabilities – for an emerging market, Malaysia’s stats record is pretty decent, but any improvement helps improve our knowledge and ability to track and monitor the economy. Matrade will issue a more complete report next week, per the usual schedule.

The data itself is a little schizophrenic. Although unadjusted exports fell 11.3% on the month, seasonally adjusted data shows a 2.7% improvement – you can see the effect that CNY had on volume. In any case, both unadjusted and adjusted series beat last month’s point forecasts, though still within the 2 standard error bands (log annual and monthly changes; seasonally adjusted):

The electronics sector continues to stagnate, with most of the growth on the margin being driven by other tradables such as commodities. Next month’s model forecasts show a jump back to over RM50 billion in both seasonally adjusted and non-seasonally adjusted series, though given the performance of the last few months, I fully expect actual realisation to stay in the upper range of the forecast interval:

Seasonally adjusted model

Point forecast:RM52,143m, Range forecast:RM58,648m-45,639m

Seasonal difference model

Point forecast:RM51,762m, Range forecast:RM59,029m-44,496m

Technical Notes:

Preliminary February 2010 External Trade Report from the Department of Statistics

More Thoughts on the NEM

Random musings, in no particular order:

1. Changing education from “rote learning to creative and critical thinking” – I don’t think this will be a big factor in getting Malaysia across to high income status, though it will be vital in maintaining it. This type of transformation will take a generation to complete, because you have to start from the beginning (pre-school, primary). Just applying change at all levels won’t have the desired effects, because you’re talking about not only changes to the syllabus, but also reskilling/retraining the teachers/lecturers, building the facilities, and reforming the mindset of both parents and children. It’s already mostly too late for the present crop of university and secondary school students i.e. the ones entering the work force during the next ten years. An unrelated issue is the requirement for capacity, because we have increasing sizes of age cohorts entering the school system over the next 20-30 years, plus the need increase college level education enrolment to at least match developed countries. Malaysia’s present level of sub-30% enrolment rates is way off from the 60%-80% that developed countries achieve – that means doubling the student capacity of universities in the next ten years, a tall order. I am however very happy with the proposed emphasis on vocational and technical training, as this offers a way out from the almost purely academic approach of our universities, which hasn’t proven to be nimble enough to meet the technical, skills and knowledge demands of the private sector.
   
2. Helping palm oil small holders (included under Appendix I of the NEM and reported on here) – I think this is a bad idea, and won’t be an effective policy. Small holders will probably benefit from better-yielding stocks, but they still suffer from diseconomies of scale. A better idea would be to encourage corporatisation of small-holders, or outright takeovers by the bigger players like Sime Darby or IOI. That’s obviously political suicide, but makes better economic sense and should also apply to the fishing, rice, and vegetable industries. Our agricultural policy has been badly designed since the 1980s, and perpetuating inefficiencies isn’t going to be effective in raising rural incomes, nor help us achieve food self-sufficiency.
   
3. Financing SMEs – From my own experience in the banking industry, lending to SMEs is quite frankly a bloody risky business – you’re probably better off buying junk bonds. That’s the real reason behind banks’ reluctance to lend to small companies. Note that bank lending to the SME sector largely consists of working capital and trade finance, which have the benefit of being collateralised and don’t require much capital charge. Hence the importance of agencies such as CGC, and the various BNM-run loans and guarantee schemes to grease the wheels of SME finance. I’m unsure whether the NEM will bring about any substantive change in this area. On a separate note, I’m happy that a review of bankruptcy laws is on the table, as under the current framework Malaysian bankruptcy protection is largely afforded to creditors, not debtors. This approach needs to be turned on its head. The research literature suggests that it takes an entrepreneur at least three tries before actually being able to run a business successfully, which means that we need to reduce the penalties of failure and facilitate “on-the-job” training. The current disincentives means that budding entrepreneurs have to give up too soon because the penalties against bankrupts are just too severe. We need to have “Chapter 11” style debtor protection so entrepreneurs have the chance to succeed and keep trying (maybe three strikes before you’re out?). The banks won’t be happy.
   
4. R&D – I don’t like the idea of a “technology research powerhouse”, commercially run or not. I had a chance to review the research literature on science parks over the last month, and the empirical evidence is not very encouraging. Clustering benefits from science parks/tech parks are short ranged for SMEs i.e. distance matters. I would rather use a scatter approach to this issue, rather than a centralised national approach – each public university must have an associated science park/research lab/tech park for collaboration with local industry. A centralised approach will only benefit the bigger companies not SMEs, but the bigger companies can afford to run their own R&D programs. However, I’m pretty happy with the rest of the R&D proposals – I had to draft a speech for my boss on university-industry collaboration recently, and I’m gratified that my own thinking is reflected in the NEM. About the only thing I would add is to increase the tax deduction to triple, rather than double as it is now, and broaden the coverage to support research in some of the social sciences like management, business and marketing, rather than just the “hard” sciences.
   
5. Minimum wage – I’m not that much against the idea as the NEAC is, with the proviso that any national minimum wage scheme be designed to limit employer abuses. It’s just not an effective tool for poverty alleviation, nor for raising wages generally. The unemployment effects and impact on “disadvantaged” groups are very real, except when the minimum wage is close to the market clearing wage. The trick is to find the market level in the absence of market information, and handle the differences between regions and between rural and urban areas – one rate is not going to get it done. Also, we need to be wary of union support for the minimum wage – their members will gain most of the wage and employment benefits, to the detriment of the poor and the inexperienced.
   
6. High-income=high-cost economy – There is no way we’re going to get away from this. Higher wages=higher input costs=higher price level=higher inflation. That’s why I believe the proposed social safety net and transformation fund are imperative, not optional, because the impact is going to fall the most on the poor and lower income groups. Having said that, a more nuanced view would be that material goods (especially imports) will become relatively cheaper, but costs of intangibles like healthcare and education will be more expensive. That’s a consequence of (a) a stronger emphasis on skills and knowledge, and (b) a higher internal exchange rate (tradables against non-tradables) which in turn drives a higher external exchange rate (the Ringgit). I don’t think this cost increase will necessarily turn up in the CPI, as you have the disinflationary effect of cheaper imports against the inflationary effect of higher services prices – the breakdown by components bears watching from now on. If it does however, BNM would likely raise interest rates which would induce a faster appreciation in the Ringgit, and balance out domestic-led cost-push inflation with even cheaper imports. Yes, a higher Ringgit is on the cards, if the NEM is effectively implemented.