(Petaling Jaya, Monday):
The Budget for the year ahead presented to Parliament on Friday has received mixed reactions. Corporate and financial market managers have expressed disappointment that corporate taxes were not lowered; foreign fund managers feel let down that although the levy on profits remitted will be removed, there is no relaxation of the one-year rule. The mainstream media and the sycophants have applauded Tun Daim and heaped praises.
In overall terms, the budget was at best "uninspiring" as one market commentator put it. This is a mild rebuke. A serious analysis of the underlying policy framework employed in crafting the budget reveals serious flaws that are likely to have medium-term consequences. The policy failings will contribute to a looming crisis that may well be more devastating than the crisis of 1997.
Deeper analysis of the underlying strategies and policies embedded in the budget raise fundamental questions about the credibility of the budget. Daim's speech and the accompanying Economic Report presented to Parliament reveal contradictions. The assumptions employed in arriving at the macro-economic framework are less than plausible. Even more disturbing is the fact that little has been done to make policy corrections without which the economy is likely to drift into a new crisis.
The fiscal policies incorporated in the budget make little sense at this phase of the economic cycle. Although Daim has correctly emphasized that the recovery must be sustained and the economy move towards becoming more competitive through diversification into technology-based industries, the specific policies outlined give little confidence that these goals can be attained.
Daim is gambling that the private sector will resume the role of being the engine of growth, backed up by sizable inflows of foreign direct investment. The prospects of that happening are clouded and must continue to remain speculative, given the state of the private corporate sector and the Government's stance on FDI.
Daim has singularly failed to address the most pressing problem concerning the private sector - that of corporate restructuring. In a recent report, the Asian Development Bank made the following observation : However, corporate issues remain unresolved. Many Malaysian firms remain heavily indebted and are unable to service their debt obligations. The Government continues to support firms which it considers strategically important. This is preventing an early resolution to corporate sector indebtedness. Restrictions on foreign ownership have also played a role in Malaysia's failure to benefit from the mergers and acquisitions that have become increasingly important as a source of regional FDI since the Asian financial crisis.
Economic Performance in 2000
Daim reported that the economy grew by 7.5% during the current year. Manufacturing was the most dynamic sector, recording a growth rate of 17.5 % in constant price terms. This contributed to an increase in exports of 14.7% in current terms. In real terms these were considerably less. The other major stimulus was provided by sharp rises in public spending. The deficit of 4.5% projected at the time of the budget for 2000 was exceeded and is now estimated to be 5.9%. Inflation, Daim claimed, remained at a low level of 1.9%. He took credit for these developments by alluding to the soundness of policies followed by the Government.
These claims need to be evaluated against the actual circumstances. The economy grew at over 10% in the first half of the year. Thus the outturn of 7.5% for the year as a whole is indicative of some slowing down in the last six months of the year. This is confirmed by slower manufacturing output and export growth reported in recent months.
It is somewhat disingenuous to claim that sound policies were responsible for growth. Malaysia, as an open economy, is dependent on external market conditions. In this particular instance, strong demand in the US for electronics (which have low value added for Malaysia) was the driving force. Coupled with this, excess capacity existed following the 1997 crisis. It was utilization of that capacity that enabled accelerated export growth. Had it not been for the strong fiscal stimulus, in part driven by the imperatives of election promises, growth would have been lower.
A word about the inflation figures that were highlighted. Daim cited the very modest rise in the Consumer Price Index - an index heavily weighted with price-controlled items. He failed to point out that the Producer Price Index - a more conventionally accepted measure of inflation - rose by no less than 4.4% (versus a decline of 3.3% in the previous year.) Thus the underlying inflation rate was considerably higher than acknowledged.
Daim's speech also highlighted the sharp rise in private investment. With regard to FDI flows, he said: "Inflows of foreign direct investment (FDI) have increased. Investment applications in the manufacturing sector to the Malaysian Industrial Development Authority (MIDA), increased significantly by 67.6 per cent valued at 17.5 billion ringgit in the first seven months of 2000. In the 2000 Budget, I announced the Pre-Packaged Incentives to encourage investment and business activities. To date, the Government has approved a total of seven projects valued at 11.25 billion ringgit. In addition, investments in high technology projects in MSC totaled 2.8 billion ringgit"
His statements were most disingenuous. The figures cited represent applications and approvals - not actual investment outlays. In effect, approvals have not translated into implemented projects. Indeed, these numbers are inconsistent with other evidence of private sector investment activity. For instance, loans extended by the banking system, for both consumer credit and investment, grew at the sluggish pace of 3.6% in the first eight months of the year. The 40% growth (in current terms) of imports of capital goods represented lumpy imports, including those by the Government. It is also pertinent to note that the balance of payments recorded inflows of total long-term capital of only RM 6.8 billion., a figure that included loans, portfolio and FDI flows. A decline of just under 50%, from the levels attained in 1999. Based on these indicators, it is hard to accept that private sector investment revived in the manner Daim implied.
As the current year ends, it is becoming clear that the macro-economic fundamentals in place raise concerns. Export growth is leveling off; the fiscal imbalance is out of skew; private investment remains sluggish largely because of inconsistent and contradictory policies resulting in a further loss of confidence; inflation is running at a much higher rate than admitted. The private sector remains in disarray with heavily debt-ridden balance sheets. Daim has apparently chosen to ignore these fundamental structural imbalances in crafting the budget for 2001.
Economic Prospects for 2001
Daim claimed that the outlook for the year ahead was favorable with growth to be sustained by a stronger performance of the private sector. However he proposes to follow a fiscal policy that would continue to be stimulative. In addition, he proposed measures that he claimed would enhance the competitive position and resilience of the economy.
While acknowledging that the US economy may slow down, he pinned hopes that growth in the European Union and Japan would provide Malaysia a favourable external environment to enable a growth of 7% to be achieved in the coming year. These are highly optimistic assumptions given that the sharp fall in the third quarter performance of the US economy, a weak Euro, and uncertainties about the Japanese economy give rise to larger concerns. Tensions in the Middle East, with accompanying high-energy costs, could adversely affect the global economy to a much larger extent.
Prudence would dictate that Daim take these negative factors into account in formulating his budget. His failure to do so is puzzling. Even assuming that that the external environment remains favourable, and that the measures taken do result in an effective response on the part of the domestic private sector, a growth of 7% is unlikely to be attained. Manufacturing growth of 12% is not on the cards given the capacity constraints now emerging. These will directly impact on export earnings, projected at 8.5% as against the 14.7% estimated for the current year. Daim has also pinned his hopes on a high rate of growth in private consumption along with an increase in private investment. The latter assumption is highly speculative given that there are no indications of any major policy changes that would induce and encourage private investment.
Were all of these assumptions played out in the manner Daim postulates, and the private sector re-emerges as the engine of growth, there would be no necessity for a major fiscal stimulus amounting to RM 16.1 billion or 4.4 % of GDP. The budgetary stance therefore constitutes a major contradiction to the scenario Daim is at pains to paint. It represents a dangerous gamble disturbing the macro-economic fundamentals.
Daim has dismissed the inflationary pressures that are building up in the economy by claiming that the CPI would only rise modestly while the PPP would be stable. No numbers are cited. This represents nothing more than a hope and prayer if account is taken of the fact that energy prices are likely to remain high in the early part of 2001; the recent removal of petroleum subsidies will have multiplier effects with electricity tariffs having to be adjusted upwards along side the inevitable rise in airfares. Taken as a whole, the 7% growth postulated is unlikely. The economy is more likely to grow at the slower rate recorded in the second half of 2000. Daim's double gamble is that the external environment will sustain growth, and that private investment will pick.
The fiscal policy adopted for the year ahead is essentially a continuation of the policies of the recent past - a sizable overall deficit which may turn out to be even larger if past performance is any guide. With the usual practice of supplementary provisions appropriated in the course of the year, the figure of RM 16.1 billion will be inevitably higher and put further strains on the fiscal framework with dangerous medium term consequences for macro-economic fundamentals.
Revenue, Expenditure and Borrowings
Daim's budget proposal taken as a whole have been dubbed the Peoples' Budget. However, some critics have labeled the budget as a Contractors' Budget; yet others have described it as a "spend and spend" budget.
The 9.6% growth in revenue projected for 2001 is in part linked to the GDP growth during the past year. The tax rebates offered to low income earners have only a marginal impact as the revenue forgone is small. So too is the case with various corporate tax rebates.
Ordinary Operating Expenditure is projected to grow at 4.3%. This is likely to be an underestimate as in the course of the year supplementary appropriations will be sought. A significant reduction in the petroleum subsidy will contribute to slowing operating expenditure. Some part of the savings have been re-channeled to social spending and for politically correct expenditures. There are of course higher allocations for salaries and wages resulting from the pay increases given out in the last budget. Debt service will increase by 5.7% to just over RM 10 billion or one sixth (17%) of operating expenditure.
The Development budget allocations amount to RM25 billion encompassing a whole range of projects. These include the development of infrastructure for which a sum of RM 4.7 billion will be provided. The allocation covers the construction of roads and bridges, railways, ports and airports. Among the main road projects that will be constructed and continued are the East Coast Highway, Merotai and Kalabakan and Jalan Betong and Kayu Malam. Just over RM 1.0 billion will be provided for implementing transport projects, in particular projects involving railways, ports and airports. Among the projects that will be undertaken include the Rawang-Ipoh Double-Track, upgrading of Dermaga Merdeka Labuan Port as well as dredging works at the Kuala Perlis Port. New airports will be built in Tawau, Limbang and Bintulu in addition to upgrading works in Miri and Alor Setar airports. The allocation for the social services sector will increase significantly by 38.3% to RM10,934 million.Allocations for the social sectors, health and education, contain a large element of construction activity. Education and health facilities will be expanded. Four new universities will be built in Malacca, Negeri Sembilan, Pahang and Perlis. In brief, these programs represent a bonanza for BN linked contractors and construction companies. It is pertinent to observe that many of these infrastructure projects will be awarded without open and competitive bidding, in ways that are not transparent. The point at issue is whether the nation needs additional infrastructure, often not economically justifiable on the basis of cost-benefit analysis. In a sense the nation's future is being mortgaged.
The development budget will also make large transfers to various entities that are largely in the business of bailouts. In addition to the operating and development budgets there are any number of off budget agencies such as Khazanah, EPF, Dahnaharta, Tabong Haji etc that are expending substantial resources. Thus the overall operations of the Government are much larger than those accounted for by the budget. Additionally, the Government has over the years extended guarantees to various operators of privatized projects. These are undisclosed contingent liabilities of the Government best illustrated by the LRT systems, Indahwater and toll roads.. In the course of the year, Daim is more than likely to be called upon to honour many of these liabilities for which no provision appears to have been made in the budget. The overall deficit is thus likely to be much higher than indicated by the budget.
How does Daim intend to finance the deficit? It is noteworthy that that in his long address to the House no mention was made about financing the debt. The Economic Report is equally cryptic beyond stating that the Government "will rely largely on non-inflationary domestic sources." (page 89). However, in the KEY DATA AND FORECASTS table on page 7, we are told that some RM 5 billion will be borrowed from foreign sources. This represents five times the amount borrowed in 2000.
In the current year foreign borrowing amounted to just over RM 1 billion net Total disbursement of existing external loans is estimated at RM1,955 million, mainly from the World Bank (RM582 million), Islamic Development Bank (RM38 million) and Asian Development Bank (RM20 million). The disbursement of loans under the Miyazawa Programme, largely from the Japan Bank for International Cooperation (JBIC) amounted to RM712 million. In addition the global bond issue yielded US $350 million. The further point to note is that the Government has canceled loans from the World Bank as the Bank's terms for transparency in procurements could not be met. This was also the case with Japanese loans.
Given these circumstances, it is highly unlikely that that external borrowing targets will be met in 2001 specially if bilateral and multilateral borrowings are foreclosed because of the unacceptability of the procurement conditions attached to such loans. Daim's only option then would be to go to international bond markets where he will be compelled to pay several basis points above LIBOR, thus making borrowings prohibitively expensive.
During the current year the Government borrowed RM 12 billion net from the domestic market through the issuance of Malaysian Government Securities (MGS) and Government Investment Issues (GIIs). The gross issue for these instruments are estimated at RM15,500 million and RM2,000 million, respectively. Taking into account domestic loan repayment of RM5,286 million, net domestic borrowing is estimated at RM12,214 million.
The principal dealers of MGS are commercial banks, finance companies and discount houses. As at end of 1999, the Employees Provident Fund (EPF) remains the major holder of MGS, accounting for 66% of MGS issued. For the coming year the Government will borrow at a minimum RM 11 billion domestically. Considering that, with large private bond and equity issues in the pipeline competing with Government borrowing requirements, the question arises as to whether the market can accommodate all borrowers. There is a clear danger that the private sector will be crowded out, and its role negated in assuming a key in pushing development.
The Budget 2001 afforded Daim with the opportunity to address the fundamental issue of rebuilding confidence. He has failed to meet that challenge. His speech made no reference to the need to check the cancer of corruption. Nor did he acknowledge that current non-transparency in decision-making was seriously impeding a revival of confidence and credibility. Also missing from his speech was an acknowledgement that the destruction of integrity in the judicial system was taking a heavy toll in overall business confidence.
Whilst implicitly acknowledging the importance of FDI in enabling the country to maintain a competitive edge through the move to a knowledge based economy, the incentives offered were meager and of limited consequence. Investors are looking for more than tax breaks. They seek a policy regime that is predictable and credible. The tinkering with the exit taxes is insufficient. The ringgit peg remains a sore issue. The absence of protection for minority shareholders makes the prospect of taking stakes in the likes of MAS, Telekoms, or TimeDotcom, an unattractive proposition for foreign investors. The establishment of a unit at the SEC to engage in a continuing dialogue with foreign Fund Managers does little to address their concerns. What they seek is clarity and consistency in policy. The continued emphasis on mega projects, and public and private investment in numerous white elephants, also sends strong signals that official policy is muddled.
The failure to seriously address corporate restructuring takes its own toll on business confidence. So too the case with corporate governance. Daim's remarks on the subject were rather curious. He said:
The measures Daim announced with regard to promoting a knowledge-based economy were meek and tentative. For example, allowing employees to withdraw savings from the EPF to buy PCs is not an attractive option until and unless other measures are taken to reduce Internet access charges. A venture capital fund to encourage innovation is a first step but needs to be supplemented by a reduction in bureaucracy. Inducements to get Malaysians back to their homeland are fine but have clearly not been thought through with sufficient care. For instance, are returnees willing to take a cut in earnings? Are they willing to disrupt the education of their children and put up with entry quotas into local universities? Has the Government considered other alternatives such as liberalizing work permits for skilled immigrants from India in a manner similar to the USA ?
Daim made much of the goal of establishing a caring society. The measures announced were piece meal. The Government has yet to seriously address the need for a comprehensive needs based, rather than a race based, safety net program. Daim made a mockery of his concern for the under-privileged in society. No programs were even mentioned with respect to the most marginalized groups in Malaysian society - the Indian plantation workers. Daim's speech did not mention even in passing the existence of over 1 million Malaysians who subsist on the equivalent of US 1 per day - the internationally accepted definition of absolute poverty. Labor related issues connected with the introduction of a minimum wage and a monthly wage system for plantation workers did not similarly merit even a passing reference.
The budget announced on Friday was in many senses a cynical exercise. Daim has clearly gambled with the long-term prosperity and well being of the nation.