Policy Analysis Isn’t For The Faint Of Heart

I read what I considered really bizarre articles in the Star last Saturday.

First, from Tan Sri Lin See Yan on the current turmoil in the currency and commodity markets. After noting the similarities with the 1990s and the divergent moves by central banks trying to restart growth, he says (excerpt; emphasis added):

A dismal world where oil and currencies are causing havoc

...Still, currency markets remain in turmoil. The recent abrupt move by Switzerland to remove the cap on its franc peg to the euro sent global markets reeling. This prompted the Wall Street Journal’s leader: “Murder in Zurich.” The Swiss franc had since revalued 20% against the euro.

Pressure is now on the Danish krone peg. It signals an end to stable money and a setback for growth. It blew a hole in Japan’s quantative easing (QE) strategy by undermining the credibility of central banks. So, the Swiss National Bank had to move or get run over. Currency market tumult harms. How will China respond to the challenge posed by a much weaker euro, yen and won? If Beijing caves-in and adopts the already in vogue beggar-thy-neighbour stance, ripples can become tidal waves. As I see it, the world has little choice but to go for a globally managed exchange regime.

I expected more from a seasoned ex-central banker. Managed/dirty floats were one of the primary reasons behind the Asian Financial Crisis. Unspoken here also is that the only way such a system can be successful is to simultaneously impose global capital controls.

Second, M Shanmugam talks about fiscal discipline (excerpt):

Current volatility a good check-and-balance mechanism for M’sia

…But the best reason to be optimistic of the falling crude oil prices and weakening ringgit is that it has – hopefully – forced the Government to instil some discipline into how it handles public finances….

…The contribution from Petroliam Nasional Bhd (Petronas) and the O&G segment towards Government coffers has been rising to almost one-third of its revenue – thanks to the high oil prices. However, there has been persistent deficit in the Federal Government budget, something that would not go unpunished in times of economic volatility.

That is what a macro-economic check-and-balance mechanism is all about.

Now, the biggest concern for investors on Malaysia is the possibility of the ringgit weakening further and its impact on foreigners holding Government debt papers….

…However, the problem arises because according to the data, foreigners were holding close to 47% of the debt papers as at the end of the third quarter of last year.

…Now, when they see signs of Malaysia’s economic fundamentals weakening due to the drop in oil revenue, they are taking the money out again.

They will only stop when they start to see some improvements in the economic fundamentals. A key indicator is the trade numbers that will be reflected in the balance of payment accounts. The weaker ringgit must translate into higher exports and imports must be checked….

…The Government cannot afford to keep on issuing debt papers like how it is used to. It has to make every ringgit count. Leakages must be plugged or else, the foreigners will keep selling the ringgit.

That’s the beauty of public finance. If it is abused, it will not go unpunished.

A few things here:

1. The contribution of oil & gas to public finances hasn’t been “rising”. It’s actually dropped for five straight years, despite high average oil prices.
2. Despite being net sellers over the past year, foreign investors haven’t exited the MGS market in any significant numbers. Unlike equity investors, fixed income investors tend to hedge their currency exposure, so wouldn’t have been panicked by the drop in the Ringgit.
3. Foreign holdings of MGS is very high, but not taken as a proportion of total government debt. If you take the later, it’s less than 30%.
4. If you followed the market action over the past couple of weeks, you’ll know the foreigners are back in again.

So much for bond vigilantes.

Lastly, Jagdev Singh Sidhu thinks the government should operate more like a private company (excerpt):

Government has to operate like a private company

THERE are big differences between how the private and public sectors operate. One of a Government’s main objectives is the welfare of people whereas the bottomline of a private company is just that, profit….

…For Governments, the debt crisis in Europe has been a lesson in fiscal responsibility. Governments no longer run up big deficits in perpetuity as the price it will pay is manifested through the loss of investor confidence and the economy as debt becomes too large and unsustainable.

Hence, with prudence being the buzzword with more governments these days, the trimming of deficits with an eye towards budget surpluses makes the public sector behave like private companies when it comes to financial discipline….

…In that 11 years, the Government’s operating expenditure has grown by a compounded annual rate of 7.31% compared with by a 6.96% growth in revenue.

The one area that has seen the biggest growth in the Government’s operating expenditure was the salaries and wages it pays to civil servants….

…Coming back to the issue of expenditure, what could have happened if the Government had mirrored what private companies do when it was sitting on huge increases in revenue?

Most companies would have invested their money (i.e. increase development expenditure) and possibly declared higher dividends (i.e. reduce the fiscal deficit).

There would have been increases in costs by paying their employees better but not to the extent seen in government….

…Cost rationalisation has to be a big focus of the Government as it is now with many companies worldwide including Malaysia.

Mr Jagdev:

1. The real lesson in Europe is not the dangers of fiscal irresponsibility, but the failure of monetary policy and the importance of institutional arrangements in the face of asymmetric shocks.
2. Budget surpluses or deficits should never be taken in isolation – which would be the preferred policy depends entirely on the flows in the other sectors in the economy. Financial discipline should never be a priority over public welfare.
3. Despite the growth of operating expenditure, during the last 11 years the government has actually run an operating surplus. In fact, despite running a fiscal deficit in all but 5 years since 1970, the operating balance has been in surplus in all but three (count’em, three) years.
4. Given that Malaysia has run a persistent current account surplus tells you all you need to know about what private companies are actually doing, given that the government runs a permanent deficit and households have been leveraging up. Are companies investing? No. Are they rewarding workers? The wage to GDP ratio in Malaysia has only just begun to rise very recently, helped along by the minimum wage. Prior to that, the ratio has barely budged since 1970, so the answer here is also “No”. Pay out dividends? You’ve got to be kidding me. What private companies have actually done in Malaysia is compile a whole hoard of cash. Gearing ratios on the KLCI declined throughout the 2000s, and only recently began climbing again. The current account surplus began declining at around the same time. Coincidence? No, just economic identities.