Subsidy :The Pro and Contra of it.

Malaysia: Subsidies or Bankruptcy?
MALAY MAIL
Wednesday, June 2nd, 2010 17:50:00
Dear Editor,

It was reported that subsidy cuts will be implemented from this month. The objective was to avoid bankruptcy due to accumulative debt caused by the subsidies. If not implemented immediately, the dooms day was predicted in 2019. If implemented now, a saving of RM103 billion within 5 years (2015) was forecasted.



The proposed cuts cover petrol, food items (sugar, flour and cooking oil), gas, toll rates, health care and education.



The intention is undoubtedly noble. Nobody wants the country goes to the drain. Therefore the subsidy schemes, currently stood at RM74 billion, should be revisited as they are largely expropriated by the undeserving rich people and big businesses. But the schemes ought to be continued for the deserving bottom 40percent whose monthly household incomes are below RM2,129.



But did Datuk Seri Idris Jala prudently choose the right word 'bankruptcy' and harshly put all the blame on subsidies? Does the mounting debt can only be tackled by cutting the subsidies? Did he give the government a comprehensive landscape and, hence, the right signal?



The sacred duty of any responsible government is to provide a better standard of living for its rakyat on a sustainable time frame. It should be achieved through prudent management of the economy. And 'prudent' does not necessarily means a balanced budget ALL the time.



The strengths (or weaknesses) of the government in managing the country's economy are measured by a few (basket of) indicators such as fiscal deficit, magnitude of debt, external debt service ratio and saving-investment gap.



The worst managed economy in the world is the US with debilitating budget, trade and balance of payments deficits. In the case of Malaysia, apart from a short period in the mid-1990s, the government has always run a fiscal deficit but nowhere close to that of the US. In fact, the government has managed to tame the fiscal deficit to 5.6 percent (as a percentage of GDP) in 2010, down from 7.4 percent in 2009.



At 5.6 percent, it is about half of that of UK's and Spain's and much lower than what Malaysia used to experience. In early 1980s, our fiscal deficit used to be at around 14 percent. And at the current rate the Prime Minister is driving the economy (10.1percent growth in first quarter), this year's GNP could be significantly above the target of RM499,690 million. Hence, the deficit in percentage terms would be reduced further.



Regarding the national debt that Idris was referring to, one has to look at its magnitude as well. It is normally measured as a percentage of GNP. In 2009, Malaysia's debt was 34.7 percent; about a fifth of what Japan is facing (192 percent) and 30 percent of Singapore (118 percent). Belgium and Italy used to experience about 180 percent.



Our country highest national debt ratio was in mid 1980s, at around 70 percent. What must be commended is that over the past few years, the Treasury has managed to pay almost all our foreign borrowings. This positive situation gives the government ample space to focus on tackling domestic borrowings which stood at RM321.5 billion in 2009; the lion share was government securities which constitute 7.1percent. It is important to note that domestic borrowings have negligible risk of impacting our foreign reserves. As at 14 May 2010 2010, it was RM314.2 billion and it can finance 8.3 months of retained imports.



Borrowing is one part of the equation; ability to pay is the other part. The later is normally measured in terms of external debt service ratio. In 2009, our debt service ratio stood at 6.5 percent; admittedly higher than the 2.6 percent recorded in the previous year.



Nevertheless, there is no reason to panic since our exports have shown a significant rebound of 31 percent during the first quarter this year. If the trend continues as forecasted, the percentage will definitely move south.



Additionally, by convention, the threshold is 20 percent; hence, we are much below that psychological line. Our worst case scenario was in 1986, when we had to service the debt at 18.9 percent.



Lastly let us look at the investment-saving gap. In 2009, our surplus was RM91.8 billion or 13.5 percent of GNP. It was higher than Germany's 10 percent saving rate, the biggest economy in the Euro Zone. Admittedly, it was lower than 2008 (18.1 percent). However, the surplus provided ample liquidity to finance domestic economic activities.



In terms of gross national savings, it was still at a comfortable level of 31.3 percent, albeit, 6.6 percentage point below the 2008 level. However, due to potentially strong economic recovery, it is projected that the savings will rebound to around 35 percent this year.



The above basket of economic indicators showed that Malaysia's economic structure is much stronger than it was in the 1980s and is comparatively better than some of those countries. Combined with its prudent and accomodative fiscal and monetary policies, the risk of being bankrupt is quite remote.



Such a possibility is further reduced when the government broadens its tax base through the introduction of GST and aggressively implementing high valued added economic paradigm. The resultant outcomes would be more taxable income and a wider taxable base.



Idris should also realise that our GDP can improve, and hence government revenue will rise, if corruption is effectively reduced. Leakages and evaporation will stop.



Additionally, a study showed that an increase of one point in the Corruption Perception Index (CPI) will attract FDI which is equivalent to 0.5percent of the GDP and pushed up the average income by 4 percent. Indeed the rakyat will benefit since the government is seen to be committed to fight corruption. The government revenue will increase accordingly.



Going back to subsidies cuts, before they are implemented, Idris should be reminded that the major economic factor contributed to the Alliance's big loss in 1969 was high unemployment rate (more than 8 percent). The main contributing economic factor to the 2008 political tsunami was inflation (5.4 percent).



Therefore, I believe the withdrawal plan would be judiciously implemented; less it may cost a government. Idris may win the battle (cut subsidies) but will lose the war (general election). From the violent reaction, I suspect Idris will be more tactful and politically sensitive in future.



He should have 100 percent confidence in the current government that it won't allow the country to go bankrupt. It has an excellent track record in effectively and efficiently managing it for the last 53 years.



Datuk Akbar Ali