Introduction

The 2001 budget will be presented to parliament on October 27. When this year's budget was announced in October 1999, a month before the General Election, it provided for a deficit of 12.97 billion ringgit -- or 4.4 percent of gross national product.

In a recent speech, the Prime Minister stated that Malaysia hopes to achieve a surplus budget for 2001 after a strong economic performance this year.

" I think we have done very well this year. Actually, we have earned sufficient money," the official Bernama news agency quoted him as saying. "So we hope we can achieve a surplus budget. If we can't it will not be too bad." The Prime Minister’s remarks made curious reading. Were these remarks made as part of the campaign of "spin" or were these remarks a reflection of his total lack of understanding of the realty of the economic circumstances confronting the country? In this article Observer takes a look at the underlying macro-economic situation that must be taken into account in the framing of the budget. The current policy frame-work is reviewed and the flawed policies questioned. In a follow up article, an attempt will be made to present an alternative set of policies more appropriate to the challenges facing the nation.

Retrospect

When Tun Daim presents the Federal Budget for the year 2001, he will be truly challenged in laying out a budget that is credible to markets, sustains recent growth and recovery and meets the confused political dictates of the Prime Minister. Daim is likely to opt for a budget to save the Prime Minister who is drowning in a sea of woes as he confronts the erosion of his political base while still bent upon pursuing massive bailouts of crony corporate friends. Mahathir’s irrevocable commitment to the ringgit peg and selective capital controls limits Daim’s ability to frame a realistic and transparent budget.

The budget under normal circumstances is an instrument and vehicle for presenting a coherent road map and strategy for the nation’s economy. It is more than just a retrospective accounting of trends in the economy; an exercise in seeking Parliamentary approval for raising revenue and seeking appropriations for funding the business of government. It sets out policy priorities and the direction in which the economy moves in the year ahead. It sends powerful signals to the private sector and the world at large.

The budget for the year 2000 first presented in October 1999 was clearly a feel good budget to enable the Barisan National to win the 1999 General Election. It gave away revenue through tax cuts, salary increases to public servants, increased provisions for bailouts and the expenditures on stalled mega projects. The budget projected a deficit over 4 percent of GDP, justified by the need to stimulate the economy. The fiscal stimulus was accompanied by a loose monetary policy. All in all the broad goals of policy were seemingly to encourage private consumption and encourage investment. It was in a sense a gamble that hinged upon a revival of investment and private consumption.

Critics of the budget had questioned the viability of the policy framework put in place. These critics questioned the need for large bailouts, the retention of capital controls and the currency peg, both of which were seen to deter foreign investment, and the absence of a coherent plan to encourage corporate restructuring.

Events in the past year have seen a recovery in growth to about 8 percent, largely due to a growth in exports built upon a combination of utilizing past excess capacity and favourable external market conditions. The fiscal deficit has also contributed to growth. However, private investment has not responded and private consumption remains anemic. Thus the gamble has not paid off More recent data shows a certain weakening in the property markets. Private foreign capital flows, both of FDI and portfolio capital, are a trickle. The stock market, despite early euphoria about the inclusion of KL stocks in the Morgan Stanley indices, remains in the doldrums as foreign fund managers continue to give Malaysia a wide berth because of political uncertainty, a further erosion of credibility in the institutions of government, especially the judiciary, and the absence of a serious effort to undertake corporate restructuring.

Backdrop for the Budget 2001

Daim’s gamble for creating a stable and sustainable economic environment has largely failed because the Government did not act in a number of critical areas. It has not pursued meaningful corporate reforms and to contain and check bailouts. It has not curbed mega projects, and not reined in corruption. Inaction is taking its toll and is manifested in the lower rating in the international Competitiveness Index, and a worsening of the country’s ranking in the Corruption Perception Index. The xenophobic statements of Mahathir, the singular failure of security as represented by the Grik arms heist and the kidnappings in Sabah, and the recent flaming of ethnic issues by the Prime Minister and UMNO Youth have not contributed to confidence building. All in all, the country faces major uncertainties, and the economic and investment climate has seen a steady deterioration.

Beyond these factors, it is important to look at the economic fundamentals, both domestic and international; that Daim must take account of in framing the budget for 2001. The grim facts cannot be dismissed.

In the months ahead, export growth is likely to slow as the US economy decelerates. Capacity constraints in the manufacturing sector will inhibit export growth. Lower commodity prices will impact on export earnings. Malaysia’s import bill will rise as oil prices remain at high levels, even though counterbalanced in part by higher oil export earnings. The extent to which the latter will be a factor is uncertain since Petronas may have sold forward at lower than current spot prices.

Net export earnings are therefore unlikely to provide the thrust for sustaining growth. The bottom line is that exports will not be the dynamic factor contributing to GDP growth in the way they have for the past two years.

There is no evidence to indicate that there will be a sharp rise in private consumption in real terms. The contrary may be true if the economy begins to show signs of slowing down and faces higher levels of inflation.

The stimulus provided by public spending over the past two years will in all likelihood be not a strong factor in the coming year. The overall fiscal deficit, which has provided stimulus, is not sustainable. At current levels of almost 4 percent of GDP, the deficit introduces major distortions.

Given current economic policies, with severe rigidities and the overall economic and political climate, there is likely to be no sharp rise in investment particularly if FDI flows remain at low levels.

Taking these factors into account the growth prospects for the year ahead are somewhat bleak. Faced with these realities, Daim has little room to maneuver. Revenue will be less than buoyant. Raising tax rates to obtain additional revenues to curtail the current deficit is not an option. Any tax increases on consumption will adversely affect private consumption. He is also constrained in raising corporate taxes; such a move will further hurt the already weak investment climate.

To balance the current budget, he will need to cut back the ordinary expenditure of the Federal Government. However the scope for cutting ordinary expenditure is limited when account is taken of the fact that debt service accounts for well over 20 percent of expenditure and the salary, wage and pension bills take up a very sizable amount of the remainder. Further borrowings, recently announced (RM 5 billion domestically and US$ 350million internationally) will add to debt servicing costs.

The decision to cut back on the oil subsidies should be seen against this background. Such a scaling back will contribute to reduced recurrent expenditures and ease the strain on the deficit, but at a price. That price will be reflected in a higher inflation rate with its own social costs as the energy price increases (including an inevitable rise in the electricity tariff) are passed through the economic system.

Most analysts have seen the decision to withdraw petroleum royalty payments to Trengganu purely in political terms, namely to deny the PAS controlled state government the resources that it needs in order to run Terengganu. These analysts have missed a more fundamental aspect of the exercise, which will result in a re-channeling of over RM 1 billion into the Federal coffers. This maneuver thus has a dual goal – punishing PAS and filling the gapping holes in the Federal budget.

Taken together, the additional resources will help Daim’s dire need for more resources, that he needs to fund bailouts, mega projects to be executed by crony corporations hungry for projects, meeting contingent liabilities arising from past privatization programs, and for payouts for reverse privatizations. To this end the development budget will be boosted sharply. Daim will therefore need to borrow huge amounts. Much of the borrowings are likely to be from the domestic market. Such borrowings will crowd out the private sector and its need for investment funds are not likely to be met. Daim’s strategy is likely to backfire and private investment will continue to be sluggish. Large scale foreign borrowing is not a viable option for several reasons. With rising interest rates in international capital markets, and poor ratings, Daim will have to pay prohibitively high rates above LIBOR, to raise foreign funds. Bilateral project loans, Yen credits in particular, are unlikely to be forthcoming for the simple reason that conditions attached e.g. international competitive bidding for all procurements, are anathema to the prevailing culture in which projects are handed to cronies without bidding in a non-transparent manner. For much the same reasons, Daim is not in a position to borrow from the international financial institutions. Indeed, World Bank loans negotiated in 1999 are being canceled or pre-paid as the Government is unable and unwilling to accept terms that demand open bidding and full transparency.

The nation now faces a new crisis- lower growth, declining investment, higher inflation, a crippled private sector with a large debt overhang and an unsustainable budget scenario. These are the ingredients for a new crisis. While it is true that the external environment has darkened and will contribute negatively, poor and ill-conceived domestic policies of the recent past are the major contributing factors. Selective capital controls and the pegging of the ringgit, accompanied by the shrill xenophobic statements of the Prime Minister, are in part responsible for a drying up of FDI and portfolio flows. The failure to mount a credible restructuring of the corporate sector, despite billions poured in the form of bailouts, has left a weakened private sector unable to act as an engine of growth. Domestic political uncertainties along with a systematic erosion of the rule of law have led to some acceleration in capital flight as reflected in the large errors and omissions figures recorded in the nation’s balance of payments.

Based on past budget presentations, it is more than likely that the upcoming budget will be clothed in soothing and upbeat generalities. The real issues that he economy faces are likely to go unaddressed. With the present mix of policies in remain in place, there will be severe consequences in the medium term. In the meanwhile, the Prime Minister is likely to continue to remain in denial and decry any calls for a shift in policies.