Time For Independent Fiscal Assessment

I don’t see any of the papers or online media picking this up yet (maybe tomorrow?), so I will (quoted in full):

Academics call upon Barisan and Pakatan to declare policy positions on national finance and debt

Recent financial crises have visited economic calamity upon ordinary citizens in the countries of the East and West alike. Experience tells us that there can be no complacency about a nation's financial state.

Concerns voiced in various reports and the media call for special attention to Malaysia's finances and their management. These concerns are:

• A record-breaking capital flight out of Malaysia. Financial watchdog Global Financial Integrity (GFI) reported that a total of RM880 billion of funds were illegally transferred out of the country between 2001 and 2010.
• A sharply rising trend in government debt. This debt almost doubled from RM274 billion at the beginning of 2008 to RM502 billion at the end of 2012. International Monetary Fund (IMF) statistics expect it to grow by RM277 billion to RM779 billion in 2017.
• Incomplete information about the Malaysian government's full exposure to debt. The official figures for government debt exclude debts that are called contingent liabilities. These include off-balance-sheet borrowings and the debts of banks, government-linked companies and other private-sector enterprises that the government has guaranteed to pay off in the event that these entities default. One estimate of these hidden debts in 2011 placed it at RM117 billion.
• Rapid growth of the share of total government debt owed to foreign holders. This has soared from 0.1% in 2003 to 6.7% in 2006, 11.8% in 2009, and 26.8% in 2012. Although 97% of this debt remains Ringgit-denominated, this trend is a cause for concern, and compromises future policy autonomy as well as heightens exposure to capital flight in the event of financial panic.
• Possible massive losses by 1Malaysia Development Bhd. Recent revelations indicate that this strategic company, wholly owned by the government of Malaysia and tasked to lead in market driven initiatives to help transform the Malaysian economy, may have incurred losses of as much as RM4 billion through mispricing of its bond issue.
• Inconsistencies in Bank Negara reports regarding Malaysia's total debt. While one portion of Bank Negara's statistics tallies with the official total debt of RM695.4 billion for 2011 and RM737.6 billion for 2012, elsewhere in its reports it is implied that Malaysia's total debt is more than twice larger, at about RM2.025 trillion for 2011 and RM1.743 trillion for 2012. The latter would ordinarily be considered crisis-level figures.
• Fears of an imminent credit bubble in Malaysia and other East Asian countries. Households in Malaysia have amassed a consumer debt in excess of RM600 billion according to an IMF country report. Various financial analyses claim that Malaysia, Thailand, Singapore and Taiwan are at risk of a household debt crisis.
• The lack of sustainability of Malaysia's GDP growth. Rapid liquidations of natural capital such as petroleum and forests to finance deficit spending or to fulfill debt obligations have adverse economic and ecological implications for present and future generations. Moreover, unproductive investments and expenditures are recorded as positive GDP in the national accounts even if they yield returns that do not cover borrowing costs.
• A lack of discipline in adhering to Malaysia's statutory ceiling for debt. The ceiling has been raised on the debt limit from 40% of GDP set in 2003 to 45% in 2008 and subsequently to the present 55% in 2009.

The above details signal an alarming trend.

Decisive action is required to safeguard Malaysia's development potential and forestall a crisis situation such as in Greece.

In line with public interest, therefore, and as a first step towards democratising the management of government finances, we, the undersigned, call upon Barisan Nasional and Pakatan Rakyat, the main contenders for government in the 13th Malaysian general elections, to openly lay out detailed policy positions on how they intend to manage the nation's finances.

In their policy briefs on national finance and debt, the two political coalitions must provide the following minimum feedback:

1. Justify the projections for the borrowings that they anticipate making in the coming five years under their respective watch;

2. Spell out plans for tackling fiscal deficits and ballooning government and household debts;

3. Explain how their election manifesto promises on government spending will be consistent with sustainable debt and resource management;

4. Declare their commitment to investigating illegal financial outflows and repatriating these monies as prescribed by the United Nations Convention against Corruption;

5. State explicitly whether they will support the foundations of public transparency and accountability in our national finances by

(i) establishing a continuously updated 'debt register' that will be publicly available on the Internet, which records the stock of debts, the sources of these debts, interest/dividend payments made on these and details of the uses made of these borrowings;

(ii) establishing a multi-partisan parliamentary committee for debt oversight and approval;

(iii) holding public fora and referenda on spending or debt decisions of great import; and

(iv) other possible measures.

We urge the two major political coalitions to produce their national finance and debt policy briefs focusing on the proposals set out above as soon as possible.

The voters of this country deserve to go to the voting booths with better knowledge of what to expect in the management of Malaysia’s finance and debts from the new government in power.

I’ll return to the gist of the proposal a little later, but first, there are some factual errors in the statement:

1. The GFI numbers on capital outflows refer to “illicit” flows, not “illegal” flows. This is not a semantic difference. Trade mispricing constitute over 80% of these “flows”, and while you may certainly refer to these as unethical, unfair or inequitable and while they are certainly “hidden”, they are not unfortunately illegal under the current tax law. Nor are they really flows, but more a geographic shift in the accounting treatment of profit. That means trying to repatriate the monies won’t work, because no “money” actually “left”.
2. There is no “trend” in the doubling of the government debt level. What you actually have is a structural break in 2009-2010, when the government incurred a larger than expected deficit due to falling revenue – technically, a change in the intercept, not the slope. The actual “trend” is a lot more sedate.
3. Contingent liabilities are actually reported (much to my surprise). Granted, you do have to dig for the info, but it is publicly available. One thing that should be mentioned is that there are 4 categories of contingent liabilities – they are explicit or implicit, and direct or indirect. Reported and estimated contingent liabilities are only of the explicit-direct kind i.e. written government guarantees. Bailing out the financial system on the other hand would fall under the implicit-indirect category, while a government owned company with no explicit guarantee would be considered a implicit-direct liability. It should be noted here that one of the initiatives under the GTP is a switch to accrual accounting, as well as adoption of the latest government accounting standards. Two relevant outcomes should be expected out of this move – computation of a government balance sheet, from which a better assessment of public debt can be made, and secondly, heightened disclosure and risks involved with contingent liabilities.
4. Total debt calculations can be highly misleading, mainly due to offsetting obligations. There’s also the difference between external obligations and internal obligations which I think is the source of the discrepancy, but I’ll reserve judgement until I can verify the numbers for myself.
5. There’s still a lot of confusion over the statutory debt limit, mainly because the stat limit (which caps a subset of debt instruments) is the same as the administrative limit (which caps total debt). As far as I can tell, debt has yet to even exceed the stat limit for  2008 (45%) (again, to be confirmed).

Now as for the proposal, and given the commitments outlined in each coalition’s election manifestos, it’s certainly appropriate and one I’d agree with…

…except I don’t think it’s either practical or optimal. To expect political parties to provide reasonable non-partisan fiscal projections is expecting too much. They have neither the expertise nor the motivation to do so. Disclosure might be beneficial in terms of tempering some of the more excessive proposals via public criticism, but I don’t think its much of a deterrent to populist policies.

Second, only the Treasury would have the detailed data to make a reasonable stab at accurately defining the fiscal impact of individual policy proposals. But, since the Treasury is effectively under the control of the executive branch, that undermines the perception of its objectivity and hence the utility of using its resources.

Moving on to the specific proposals:

1. Since 80% of the government’s debt is in marketable instruments, most of the info is already publicly available either through market information terminals such as Bloomberg or via BondInfoHub. Given the scale and complexity of government borrowing I’m dubious about the need for anything more than this for public consumption. Also, since the funds raised are 1) fungible, and 2) goes directly into the government’s development account, asking for the details on the usage of funds is a little strange since spending priorities are already set out in the development budget every year (which, unlike the operational budget, rarely varies much) and preceded by the 5 Year Malaysia Plans. Moreover the funds are already segregated from the operational budget. Progress against the development budget is already available in an even more accessible form via the ETP/GTP, believe it or not.
2. A parliamentary committee to “approve” debt is a non-starter for me. Given the specific structure of the government’s debt issuance, as well as administrative and operational constraints, this would simply be rehashing the annual budget on a biweekly basis. To clarify – the government has since Independence adhered to the “golden rule” of fiscal policy i.e. only investment projects are funded by debt. Operationally, the government’s funding is segregated into two accounts, with government revenue going towards covering operational costs while borrowing is used to cover the development budget. Hence, any parliamentary debt oversight is effectively oversight over the development budget, which is set in advance through each 5 year Malaysia Plan. We’re not exactly talking about discretionary spending here.

Given the above, I’d much prefer another route, one I’ve brought up before – a non-partisan independent budget office, reporting to Parliament, or (for political economy reasons e.g. in the UK) reporting to the Treasury.

This has the advantage of concentrating tax, economic, and econometric expertise in a single body tasked with objective assessment of specific policy proposals, analysis of long term fiscal trends, and if we really want to go that far, responsibility for assessing fiscal debt sustainability.

I’d bet on the effectiveness of that structure more than I would the integrity of any fiscal proposals coming from political parties, or relying on either side to “police” the other. Even if a budget office would be reporting to Parliament, it would have no mandate to come up with its own fiscal proposals, only assess those made by others. The incentive structure makes better sense, and is more likely to be effective.