Fiscal Rules: Does Credibility Matter?

On December 14, 2021, Lee Heng Guie of SERC wrote an interesting treatise on the above subject.

A credible set of fiscal rules is needed to reduce fiscal deficits and debt-to-gross domestic product (GDP) ratios to sustainable level, promote inclusive economic growth, mitigate room for fiscal manipulation and encourage politicians to prioritise among the many demands on the annual budget.

Source:https://www.propelnonprofits.org

The government’s massive fiscal support that has salvaged the Malaysian economy and businesses by saving lives and jobs has worsened both the budget deficit and public debt since 2020. The statutory debt ceiling was raised twice from 55% of GDP in 2019 to 60% in 2020 and further to 65% in 2021. Malaysia’s budget deficit has widened from 3.4% of GDP in 2019 to 6.2% in 2020 and 6.5% in 2021. This is targeted to reduce to 6.0% of GDP in 2022. Public debt to GDP has reached RM969.3bil or 64% of GDP at end-September 2021 (end-2020: RM880bil or 62.1% of GDP; end-2019: RM793bil or 52.4% of GDP).

While it is expected that the budget deficit will improve and debt will decrease marginally in the next few years as the economy recovers, these developments raise questions about how deficit can be lowered and high debt can go without being disruptive.

Any loosening of fiscal discipline and unsustainable debt could bode ill for the country’s credit ratings. Malaysia needs to fix its tight fiscal space to build economic resilience for buffering against future adverse shocks.

In the Medium-Term Fiscal Framework, the average fiscal deficit is expected to reach around 5% of GDP in 2022-2024, and in the 12th Malaysia Plan (2021-2025), the fiscal deficit will reduce to between 3% and 3.5% of GDP in 2025.

A robust set of budgetary rules and fiscal institution is needed to achieve goals of ensuring fiscal stability and debt sustainability. Fiscal rules must be made simple, flexible and enforceable in the face of changing economic circumstances.

Lee Heng Guie argues that the government will enact the Fiscal Responsibility Act (FRA) in 2022, which aims at improving governance, accountability and transparency in fiscal management.

The government’s commitment and credibility to well-managed public finances can reassure financial markets and investors that our country’s sovereign credit rating is in good shape and lower the risk of credit default.

As he sees it, the following principles are needed to enhance the effectiveness of fiscal rules:

Fiscal structure

Revenue strategy that strengthens revenue collection and efficiency, including the predictability and stability of tax rates. Broadening of the narrow tax base and plugging tax leakages.

There must also be expenditure rationalisation and optimisation, which is outcome-based and meets expenditure efficiency rule to minimise wastage.

Fiscal discipline

Fiscal policy is only used for counter-cyclical or to mitigate adverse shocks-induced economic recession. The government should save money in good economic times and prevent large expenditure increases, which can absorb all revenue windfalls.

Achieve and maintain prudent public debt levels

Ceilings on public debt are a common feature of rule-based fiscal frameworks. Higher debt increases vulnerability to shocks and can undermine market confidence and lead to fiscal distress.

Contingent liabilities

Fiscal surveillance framework requires risk awareness and close monitoring of contingent liabilities. The government’s contingent liabilities have increased by 13.3% per annum to RM375.3bil at end-June 2021 (end-Dec 2015: RM177.7bil).

Escape clause to accommodate unexpected shocks/events

Precise exceptions are allowed under a well-defined fiscal surveillance framework. A limited and clearly defined set of events can trigger the exception.

Good communication, timely and regular fiscal updates

The International Monetary Fund research shows that a country’s commitment to budget discipline and clear communication of policy priorities, backed by transparency on government spending and revenues, will pay off.

All of the above are good principles to follow. But it is in the execution or implementation that we are sorely lacking. Accountability, transparency and authority are three pillars that are weak in Malaysia. No one wants to be accountable and no heads will roll for failures! No one will take responsibility as committees are the mode for execution. Even if one has authority, it is seldom exercised because that’s how the civil service is set-up.

Amidst all the above, if the bi-partisan Public Accounts Committee takes a more central role then it may force some movement to a more responsible implementation of the fiscal framework. Otherwise, we will have good pronouncements with no accountability.

Reference:

Fiscal rules: Credibility matters, Lee Heng Guie, Starbiz, December 14, 2021