Investing infrastructure for the future

TO spend or not to spend on infrastructure bringing benefit to a country’s citizens, that is the dilemma of Governments facing slower economic growth and heavy debt burdens. In Malaysia’s case, growth as measured by gross domestic product (GDP) is likely to slow down further this year, and an indication of this was the cut to the benchmark overnight policy rate on July 13 with another rate-cut expected by a number of economists before the end of the year.

Weaker growth means lower revenue and that puts pressure on the Federal Government’s budget. The Government is struggling to balance the books and has a persistent fiscal deficit that is increasingly challenging to bring down given the low crude oil price and weaker tax revenue.

In recent years, that has given voice to concerns over the ballooning government debt situation. Debt-to-GDP level, which in Malaysia includes both domestic and external debt, stands at 54.5% or RM631bil as of end-2015, which is close to the 55% debt ceiling imposed by the Government Funding Act 1983.

Contingent liabilities, which are explicit guarantees, stand at 15.4% of GDP or RM178bil. Taken together, these debts come to just under 70% of GDP. There are no estimates for implicit guarantees except what has been made available to the public, which includes the portion of 1Malaysia Development Bhd debt that has not been explicitly guaranteed by the Government.

What is concerning to analysts is that with the slower growth, the Government will find it harder to allocate resources for spending that will bring future benefit to the country either in terms of boosting human capital or the economy by generating jobs through growth while at the same time trying to pare down debt.

With the heavier debt burden and not much leeway to pay down, should the Government be embarking on multi-billion ringgit projects, in which it will have to back by explicitly guaranteeing the loans taken by entities involved in such projects? This will mean that the contingent liabilities will rise, placing even more pressure on government finances, to say nothing of the implicit guarantees.

Examples of such projects include the 2,239km Pan Borneo highway straddling Sabah and Sarawak, with an estimated cost of RM29bil, the 350km Kuala Lumpur-Singapore High Speed Railway, widely estimated to cost between RM60bil and RM65bil and MRT Line two, with estimates of between RM28bil and RM30bil.

The International Monetary Fund’s (IMF) resident representative for Malaysia and Singapore, Geoffrey Heenan, believes there is some limited fiscal room in the near-term, and says the 55% ceiling is not absolute from an economic viewpoint. He points out in an e-mail to StarBizWeek that Malaysia has been able to finance its public sector deficits at a relatively low cost mainly because foreign investors are comfortable with holding Malaysian Government Securities (MGS).

“Foreign holdings of MGS have been remarkably stable, despite the fall in oil prices and other global financial shocks. We believe that this reflects investor confidence in Malaysia’s macroeconomic management, based on the prudent monetary policy of Bank Negara and major fiscal initiatives such as subsidy reform and the introduction of the goods and services tax (GST),” Heenan says.

He adds that a modest and temporary increase in debt levels will not have a major impact on investor confidence as long as the Government maintains its commitment to medium-term fiscal sustainability in a credible way. There are those who argue that with slower growth, classic Keynesian economics, which relies on government intervention during bad times, should be implemented. This intervention includes spending on infrastructure and interest-rate cuts. These measures should generate growth, and therefore jobs that will translate into consumption.

Heenan says the country will benefit from more infrastructure. “Effective public infrastructure investment has been shown not only to boost economic growth directly, but also attract new foreign direct investment. It has also been shown to reduce income inequality. This is particularly true when infrastructure improves the access of rural populations to economic opportunities, and health and education services,” he says.

In this context, Heenan, together with other economists, believes that the Pan Borneo highway will play a key role in the development of Sabah and Sarawak. “Well-designed public infrastructure projects can be positive for fiscal sustainability, if these result in higher economic growth. Borrowing to fund public infrastructure, especially in the current global environment of low growth and interest rates, could not only deliver a boost to long-term growth, but also help offset the impact of weak external demand that much of region is now experiencing,” he argues.

But Heenan cautions that there are issues of corporate governance in the public sector and that public investment efficiency can be improved in Malaysia. “Some methods identified by the IMF could be helpful in this regard. Specifically, a new diagnostic tool – the Public Investment Management Assessment (PIMA)– evaluates key public institutions in the planning, allocation and implementation phases of public investment projects,” he says.

Besides PIMA, the IMF has another tool called the Public-Private Partnerships Fiscal Risks Management Model (PFRAM) assessing the potential fiscal costs and risks arising from public-private partnership projects. Heenan says this tool can be relevant to Malaysia given its relatively high public debt level and significant contingent liabilities.

Even so, he says there may be some more scope to curb operational expenditures through efficiency gains. Economists have constantly decried Malaysia’s high operating expenditure stemming from its bloated civil service as well as subsidies.

Heenan says recent fiscal initiatives including the GST and subsidy reforms, have been both growth-friendly and helped support fiscal consolidation but recommends that exemptions and the number of zero-rated items in the GST list be reduced as a way to increase government revenues with minimal impact on growth.