Rebuild fiscal buffers for future shocks

Scarring impact: The unprecedented scale of the pandemic serves as a catalyst for the country to adopt a responsible fiscal approach.

DURING the Covid-19 pandemic in 2020, the federal government had a tight balance sheet and high debt level – unbroken 23 years of budget deficit since 1998; federal government debt of RM793bil or 48.7% of gross domestic product (GDP) at end-2019; and total debt and liabilities of RM1.169 trillion or 77.4% of GDP at end-2019.

A tight budget has forced the Finance Ministry to make some exemptions to the rules and discipline or specific clause of government financing and spending to undertake counter-cyclical measures to ease the pain of economic recession inflicted by the pandemic.

The Temporary Measures for Government Financing (Covid-19) 2020 Act was formulated to save human lives and the economy. The Act allows the government to obtain additional borrowing to finance measures under the economic stimulus packages and recovery plan.

Under the Act, the statutory limit of the federal government’s outstanding debt has been temporarily lifted from 55% to 60% of GDP, and only effective within three years until Dec 31,2022.

As at end-Dec 2020, the federal government debt stood at RM879.6bil or 58.0% of GDP, leaving a balance of 2% or equivalent to about RM30bil (based on the GDP nominal value of RM1.5 trillion).

The federal government’s total debt and liabilities stood at RM1.261 trillion or 89.2% of GDP at end-December 2020.

Following the crisis, the government had pumped about RM72.6bil direct fiscal injection through seven economic stimulus and recovery packages from 2020 to the first quarter of 2021.

This, together with a record budget allocation of RM322.5bil in Budget 2021, will result an increase in the outstanding debt of the federal government in 2021. However, the debt to GDP ratio may be lower due to the expanded nominal GDP.

The budget deficit had risen to 6.2% of GDP in 2020 from -3.4% of GDP in 2019. It will remain high at estimated 6% of GDP in 2021.

The elimination of the Covid-19 will take some time amid the ongoing national immunisation programme, albeit moving at a snail pace. But the economic pain is not over for citizens, businesses and the government’s balance sheet.

The Finance Ministry has set a medium-term fiscal framework that targets an overall fiscal deficit at an average 4.5% of GDP from 2021 to 2023 while the federal government debt is expected to increase, albeit at a manageable level.

Clearly, measures to continue containing the pandemic and restore the economy and business sustainability will need to be financed. As the scarring impact of Covid-19 may take some years to dissipate, the government has to start planning to rebuild fiscal and debt sustainability to deal with future shocks.

There are a number of reasons why the government has to use public sector balance sheet to manage its finances throughout the pandemic, paying attention to its net worth (total assets net of total liabilities).

This means a change in accounting methods from cash to accrual accounting.

First, the unprecedented scale of the pandemic serves as a catalyst for us to adopt a responsible fiscal approach, and be better-placed to deal with future serious economic shocks if the government’s balance sheet is strong. The crisis has demonstrated that the government’s limited budget has forced it to tap largely on non-direct fiscal funding to counteract the pandemic-inflicted economic downturn.

We need to rebuild strong government financial reserves buffer.

The political-economic aspect of the government is of paramount importance to safeguard our nation’s financial resources.

The federal government should adhere to strict financial discipline and prudent fiscal management to rebuild its financial reserves.

It only makes sense to fortify the government’s realisable financial reserves when our economy remains relatively strong, so that we will have sufficient and maybe, excess during the rainy days.Second, the government needs to restore its balance sheet and net worth to reduce the debt burden on future generations.

Being a responsible and caring government, it must look out for intergenerational equity.

Maintaining the buffer will be a huge challenge given more demanding public resources such as an ageing population, better healthcare coverage, comprehensive social protection and the expected large displacement of jobs in a digital world.

Hence, the government should plan, invest, manage and spend its resources wisely.

Third, maintaining a strong balance sheet and net worth position will benefit the government in terms of lower interest expenses, lower yields on the debt and more importantly, provides fiscal space and fiscal flexibility during the economic crisis.

Recent studies by the International Monetary Fund showed that countries that have strong net worth positions are more resilient to economic downturns and grow, on average, three times faster following a recession.

Finally, the Fiscal Responsibility Act (FRA), a special law to govern public finances, which will be enacted by end-2021, will make the Finance Ministry accountable for its commitment to maintaining a strong balance sheet.

The FRA must be formulated based on good principles and international best practices of fiscal management. Fiscal rules need to be simple, transparent, and easy to enforce.

It should be sufficiently binding, backed by strong political commitment, but also provide some flexibility to accommodate changing economic circumstances.

Lee Heng Guie is the executive director of the Socio-Economic Research Centre. The views expressed here are his own.

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