Monday, January 26, 2015

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.


  1. Mmmm...I wonder, the US government debt to its GDP has been around 100% in the past three years (>85% & >95% in 2010 & 2011, respectively)...and yet it has not resorted to any austerity measures?


    1. @DS

      Actually they did. But the negative effects were offset by the Fed's QEIII

  2. I don't understand why you are getting so hot under your collar.

    Professional economists and analysts have different takes on the Malaysian economy.

    Time will tell who was right and who got it wrong.

    But I think that there is a general consensus that there is little point in having monetary easing or running fiscal deficits if the necessary structural reforms aren't instituted.

    Thus far I see precious little evidence that the government has the political will to implement structural reforms.

    They are just kicking the can further and further down the road!

    1. @anon 2.10

      Do we have to go through another Asian Financial Crisis to decide between different "takes"? That's an expensive way to figure out appropriate policy.

      As far as structural reforms go, who says there haven't been?

    2. Ok, Hisham....picking up the gauntlet, exactly what "structural reforms" have been implemented?

      Minimum wage? GST? Subsidy cutbacks? Cutting down on illegal immigrants? Moving away from labour-intensive manufacturing and agriculture to services? Employment based on "merit" (cue the catcalls and jeers)?

      And are you saying that another Asian Financial Crisis is on the cards? And that those who are "alarmist" are crying "wolf"?

      I guess that you aren't a fan of the "market" after all.

      Why am I not surprised?

    3. @hishamh

      Structural Reforms is open market, the best of the best gets the job regardless of race and religion.

      Open tender, the best contractor gets the job regardless of race and religion.

      I honestly believe in today's Global world, no country can succeed if they do not harness the best of the best.

    4. @anon 7.09

      Gee, how did you guess?

      As for the AFC, I wrote this in the blog post above:

      "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."

      Do we really need to undergo another crisis just relearn the policy mistakes of the past?

    5. @LatukBandar

      I think you need to read these:

  3. Bloomberg put out a report with the evocative heading "Sliding oil prices raise Malaysia's default risk" over the weekend.

    Unduly alarmist?

    The points made in the report:

    1. Malaysia's default risk is heading for the longest rising streak in a year.

    2. The cost of protecting sovereign debt against non-payment has leapt 21.5 basis points since Dec 31to 127.5 and is set for a third straight monthly advance (according to CMA). That's higher than for similar or lower-rated nations including Thailand at 105.5 basis points, the Philippines at 91.5 and Mexico at 114. The cost for Indonesia, ranked three steps lower, stood at 151. I take this to mean that the market thinks that there is a higher probability of Malaysia defaulting on it's sovereign debt than the Philippines, Thailand or Mexico.

    3. Anthony Chan, Hong Kong-based sovereign strategist at AllianceBernstein LP: "The sharp drop in the price of oil is clearly negative and we probably have yet to see the worst of the current-account deterioration. The risk of a further widening in sovereign and CDS spreads may persist for some time."

    4. The government derived 29% of its RM225 billion revenue in 2014 from crude, including a RM29 billion dividend from Petronas.

    5. Tumbling oil prices are turning the Ringgit into the biggest loser in Asia's forex market this year. It has fallen 2.7% against the US dollar this year, exceeding the 0.5% decline in Indonesia's Rupiah and the 0.3% drop in the Yuan.

    6. Victor Rodriguez, head of Asia-Pacific fixed income at Aberdeen Asset Management in Singapore: "With a lower currency (Ringgit), some of the exports like electronics and so forth can create some rebound... But we are quite pessimistic on the Ringgit."

    7. Investors are also watching Malaysia's current account as another gauge of its financial health. Fitch said on Jan 21 that the risks to Malaysia's current account surplus are to the downside. Should it fall into a deficit, the country will likely face greater volatility from capital flows and disruption to the economy.

    8. The yield on Malaysia's benchmark 10-year government bond has fallen to 3.946% from 4.145% on Dec 31.

    9. The impact of oil cannot be underestimated, according to Aaron Low, principal at emerging market fund Lumen Advisors LLC. Without mitigating measures such as budget consolidation, weaker crude prices would have caused a bigger dent to Malaysia, he said.

    1. @anon

      Yes, unduly alarmist. Which means CDS, yields, and the Ringgit are overshooting their fundamentally justified values. Which means the smart money right now is surreptitiously buying.

      On oil, read my notes.

    2. That's misleading. The smart money is/was selling, or was already selling way back in august/september.

      There is no way leveraged/hedge funds can stomach these losses, if they were to go "long" on these local assets...over the last few weeks..

    3. @Misleading

      Oh right, of course. That's why the last two MGS/GII auctions saw so much action.

    4. Really, Hisham?

      What, then, is the "fundamentally justified value" of the Ringgit? On par with the Singapore Dollar at 1:1? Or on par with the Aussie Dollar at 1:1 too?

      Oh, wait - how about 1.3-something against the US Dollar, seeing as how the Fed has amassed monumental debts in the name of QE?

      If analysts and economists and the rakyat are being "unduly alarmist", it's because they have refused to subscribe to Pollyanna-ish views about Malaysian government finances and the Malaysian economy.

      Unless, of course, you are invoking the spirit of "patriotism" to claim that everything is A-ok and hunky-dory with the Malaysian economy?

      Like I said - seriously?

    5. @Hisham, C'mon, you know who tendered for the MGS/GII in that auctions.... (at least please check that out).

    6. @anon 6.33

      Yes, seriously. I don't know if I want to get into opening that particular can of worms yet. You might want to read this post though.

    7. @Misleading

      I was going by what my Treasury colleagues are telling me, but I will, thanks.

  4. Misleading,

    I think you are misleading. Please check as of today, the 10 years MGS yield has dropped to 3.89%

    Come on today is already about a month from 31/12/14. And indeed I agree with Hishamh, the smart money is buying.

    Zuo De

    1. Seriously?

      Why should MGS yield be 3.89% when the comparable 10 years US Treasuries yield is what?

      If the US government finances are in deep s**t, then 10 years MGS and US Treasuries should have identical yields.

      Go peddle that theory to the fund managers, international bond investors and bond hedge funds!

    2. @Zuo De. Sorry, i may not know you but i think we may have to differ on some thoughts here, particularly the term "smart money".

      I define smart money as hedge funds, because we are very short-term-minded and literally borrow money (very short term) to bet against market movements, resulting in very quick gains over a very short period (and getting out of the markets with similar pace). sharp movements in the markets are usually triggered by these movements of smart money because of the huge transaction volume.

      Going back to 3.89% from 4ish, reasonable, but nothing interesting there...

      Nonetheless, you may have your definition of what "smart money" is, and you may be right because someone was, indeed, bidding at that yield.

    3. @Misleading

      I don't define "smart money" as hedge funds. Given the performance of hedge funds over the past few years (present company excepted of course), it would be a bit of an oxymoron.

  5. Misleading, I have the same definition as hishamh on smart money. It is ok, we can differ. Now I do not know how to produce the time chart for MSG (10years) yield but if you have access to Star Biz saturday, you will see the surge in yield around end nov 14 to 4.25% or 4.3% and it stay there for about a month, then there is a sharp drop around the beginning of this year back to about 4% and now 3.89 ehis%. It is clear the rush out came to a complete stop and then suddenly a rush back in, that is my interpretation from a lay-person. Sorry I am not as descriptive as Warrior.

    Now having gone thru 1998 and especially 2008, I really have no trust for the hedge funds as they together with the rating agencies (western) caused all these sad episodes and impoverished millions of people just for their own greed. I mean why speculate on oil if you do not operate a refinery? What value add to the oil industry? Same for all the other commodities.

    I can hear anon 6:33 ( put a name lah so easier to follow) cringing there, but heck you stick to your dogma and I will stick to mine as I do not trust this people that caused all this hardship 1998 / 2008, period. So all this people are just spewing out whatever just so they can make a quick buck. As if they care about Malaysia or Malaysian.

    My other dogma - six months down the road, boom time.

    Have a nice day all.

    Zuo De

  6. Zuo De, what did you mean by boom time?