Alesson from the Asian crisis is that the effectiveness of Malaysia’s fiscal policy in demand management may benefit from greater flexibility. While Malaysia’s tradition of fiscal prudence provided a buffer against adverse shocks during the crisis, structural rigidities in public finances rendered fiscal policy less responsive to the changing economic environment. A key challenge to fiscal management is to make it flexible enough to function as an effective countercyclical tool within the framework dedicated to maintaining long-term fiscal sustainability.
Remedies for improving fiscal flexibility could include extension of the fiscal planning horizon to cover the course of the business cycle, to be supported by well-defined safeguards and escape clauses (for fiscal rules); more realistic economic-forecasts and revenue projections as the basis for setting fiscal targets; a structural fiscal balance concept; and greater use of automatic stabilizers and contingency measures in the budget.
Introduction and Recent Developments
During the 1980s, Malaysia experienced large fiscal deficits and high public debt-to-GDP ratios. Fiscal consofidation, begun in the mid-1980s, aimed at reducing imbalances with the support of strong government commitment to a rule-based fiscal policy, privatization, and reorientation of capital spending to basic infrastructure development and other productive sectors. During the period of fiscal consofidation (1992–97), fiscal policy was geared more toward achieving The medium-term development objectives and was used, to a lesser extent, as a tool for demand management (Figure 4.1).
Public programs were formulated within the frame work of five-year development plans aimed at promoting economic growth over the medium term through capacity expansion; improvements in productivity; and adequate provision of public intrastructure, utilities, and other modern services. The government played an important role in mobilizing public and private resources to finance its development programs, including through off-budget and quasi-fiscal activities. In support of the development strategy, fiscal consolidation was conducted mainly-through the lightening of the operating budget that led to current surpluses, which in turn helped to moderate overheating pressures on the economy arising from accelerated money and credit growth, together with a surge in capital inflows.
In the context of the consolidation. Malaysia’s fiscal conservatism was reflected in the rule of disallowing an “operating deficit” in the annual budget to help strengthen the financial position of the federal government. While revenue performance determined the level of recurrent spending, the capacity to raise nonbank financing determined the size of capital spending, thereby minimizing budgetary financing from the banking system. This rule, together with a tradition of conservative revenue projections, led to large operating–and overall–surpluses each year during 1990-97 (Figure 4.2). The strengthened fiscal position served the country well during the ensuing crisis, in that it provided substantial scope for a countercyclical fiscal policy and funding for financial sector restructuring.
Fiscal Budget and Actual Balance
(In percent of GDP)
Fiscal Budget and Actual Balance
(In percent of GDP)
Fiscal Budget and Actual Balance
(In percent of GDP)
At the outset of the crisis, Malaysia tightened macroeconomic policies to reduce vulnerability. The policy stance, together with a preemptive reform of the financial sector, was intended to help contain inflation and the current account deficit, reduce credit growth, and dampen the pressure on domestic demand. It was also expected to instill salutary effects on finances and market confidence. Eventually, the 1998 budget was revised to reflect a rebalancing of policies toward a smaller surplus.1 In anticipation of declining revenue in line with an economic downturn, the surplus was to result from lower current outlays and deferred infrastructure projects. These measures were also expected to help reduce imports and contain the high leverage of corporations.
Notwithstanding these policy initiatives, market confidence faltered markedly against broader adverse developments in the region, including concerns about financial system vulnerability. Economic activities also slowed much faster than anticipated, which proved to be a significant factor that further dampened market confidence. Against this background, the government readjusted its policy mix toward an expansionary policy and has maintained an expansionary stance since mid-1998 aimed at reactivating economic growth and, thereby, ensuring socioeconomic stability. A fiscal stimulus package was introduced that included a social safety net to mitigate the effects of economic adjustment on the most vulnerable groups, as well as large increases in capital spending, especially for infrastructure and other social sector projects.
The countercyclical fiscal policy has been delivered largely through discretionary measures. The fiscal stimulus package of 1998–2001 focused on selected capital projects designed to ensure maximum effect on economic growth, minimum leakage to imports, large export potential, and a short gestation period in terms of providing value-added to the economy. Large projects were restructured into smaller segments to facilitate financing. Beyond the budget, the government also provided fiscal impulse through off-budget operations, facilitated by the quasi-fiscal institutions. Existing credit schemes were expanded, and new specialized funds were set up to ensure continued access to credit at reasonable cost for priority sectors and projects.
The impact of the expansionary fiscal policy was initially weaker than expected and came with a significant lag (1998–99). Spending cuts implemented earlier could not be reversed easily. The fiscal rule of disallowing an operating deficit also limited the scope of using fiscal policy as a tool for demand management. In 1998 and 1999, the fiscal impulse, estimated at about 2 percent and 3 percent of GDP, respectively, was well below the budget targets (by 2 percent and 1 percent of GDP, respectively), which explained in part the slow turnaround in domestic demand (Box 4.1). Fiscal stimulus was enhanced in 2000 through both revenue and expenditure measures. The budget deficit of 4.3 percent of GDP, and possibly the lagged effects from projects initiated under previous years’ budgets, provided a strong impetus to the recovery in domestic demand.
Despite the larger fiscal deficit of the government, the overall financial position of the public sector was contained by the strengthened balance sheets of the nonfinancial public enterprises and benefited largely from banking and corporate restructuring, a significant turn around in economic activities, and high oil prices.
A key challenge is to ensure that fiscal policy in Malaysia can contribute to effective demand management. This would require greater flexibility in fiscal policy to respond to domestic and external macroeconomic shocks in an appropriate and timely way, while maintaining fiscal prudence to ensure medium-term fiscal sustainability and growth prospects. The remainder of this section reviews policy options that would provide such flexibility in the context of a medium-term fiscal strategy, and that explores operational guidelines to improve policy effectiveness.
Fiscal Policy in Malaysia, 1997–2000
Following the initial stage of tighter fiscal policy at the outset of the crisis, the government rebalanced its approach through policy easing in response to a sharp decline in domestic demand that became evident by mid-1998. Targeted budget surpluses were reduced, some previously announced cuts in social expenditures were reinstated, and additional capital spending was implemented. Off-budget spending, most notably through privatized infrastructure projects, also provided additional fiscal impetus.
However, the countercyclical fiscal policy was adopted later in Malaysia than in other Asian crisis countries. Fiscal policies, which had been contractionary at the eve of the crisis, were eased in Korea and Thailand and subsequently shifted to expansionary stances in late 1997 (in Thailand) and early 1998 (in Korea). In Malaysia, by contrast, the fiscal stance remained significantly contractionary throughout most of 1997 (i.e., a negative fiscal impulse of 1.3 percent of GDP); this was consistent with the advice of the IMF at that time. The shift in fiscal policy took place in mid-1998. Even then, the actual fiscal impulse was smaller than the budgetary target (by about 2 percent of GDP on average during 1998–99), owing in part to traditionally conservative revenue projections in the budget and insufficient flexibility in fiscal management (see figure, below).
Overall Fiscal Balances of Selected Asian Countries
(In percent of GDP)
Overall Fiscal Balances of Selected Asian Countries
(In percent of GDP)
Overall Fiscal Balances of Selected Asian Countries
(In percent of GDP)
Fiscal policy in Malaysia shifted to an expansionary stance in 1999 in support of economic recovery. The fiscal stimulus provided through the budget and off-budget operations helped to offset in part a continued decline in private demand. The fiscal impulse, including off-budget stimulus and estimated at about 3½ percent of GDP, was less than the budget target of 4½ percent of GDP and was backloaded to the second half of the year. On a cumulative basis, the fiscal impulse in Malaysia during 1997–99 became larger than in the other Asian crisis countries (see figure, below).1
Cumulative Fiscal Impulse of Selected Asian Countries
(In percent of GDP)
1The fiscal impulse for Thailand is calculated on a fiscal year basis (October - September).Cumulative Fiscal Impulse of Selected Asian Countries
(In percent of GDP)
1The fiscal impulse for Thailand is calculated on a fiscal year basis (October - September).Cumulative Fiscal Impulse of Selected Asian Countries
(In percent of GDP)
1The fiscal impulse for Thailand is calculated on a fiscal year basis (October - September).Still, the recovery in domestic demand in Malaysia remained weak in 1999, which prompted another fiscal stimulus in 2000. The budget deficit reached 4.3 percent of GDP. The economy responded with an impressive real growth of 8½ percent. Domestic demand also mounted a strong recovery, growing by more than 15 percent.
1 In general, the fiscal impulse is used for analyzing the fiscal stance under a stable economic environment; therefore, this information should be interpreted with care.Fiscal Policy Rules and Recent Experience
Malaysia follows an explicit fiscal policy rule that disallows an operating deficit in any given year. This rule aims at making a credible commitment to long-term fiscal sustainability by applying discipline to annual budgets. Other fiscal rules that have a longer time horizon are also at work and are predetermined in the medium-term framework of Malaysia’s five-year development plan to ensure broad consistency with the rule on the operating balance. These are
a balanced budget rule under the seventh five-year development plan (1996–2000), revised in mid-1998 in the context of the fiscal stimulus plan, that targets an overall federal government deficit of no more than 6 percent of GNP by the end of the plan period:
a spending rule that places an aggregate ceiling on capital expenditure during the seventh five-year plan period: and
a borrowing rule that sets a ceiling on the total outstanding stock of federal government debt during the seventh five-year plan, with a subceiling on external federal debt.
Overall, the rules are well defined as to the target variables and compliance criteria, which are approved by the parliament and are broadly enforceable. Internal consistencies of the fiscal rules with other macroeconomic policies—such as low inflation, sustainable government debt, and noninflationary financing—are safeguarded by the medium-term policy framework. Compliance with fiscal rules is enforced mostly through administrative means, although deviation from the rules requires parliamentary approval. There is no financial penalty for nonobservance. Nevertheless, a violation of the rules could entail loss of credibility of the government in the eyes of parliament and financial markets, as well as the public.
Notwithstanding fiscal discipline, the rules preclude the use of cyclical indicators and escape clauses, thereby constraining fiscal policy from becoming an effective countercyclical tool. Furthermore, the rules are assessed against fiscal targets that do not cover off-budget and quasi-fiscal operations, which lead to nontransparency in accounting and fiscal forecasting, as well as difficulty in assessing the total impact of fiscal policy and in estimating future government obligations.
While effective in imposing fiscal discipline, these rules have proved to be procyclical during the recent economic downturn. Conservative forecasting of tax revenues constrains the effectiveness of fiscal planning. Capital spending on projects tends to rely on discretionary measures, which can exert pressure on the implementation capacity. Procedural bottlenecks, insufficient financing, and long implementation periods for new projects also reduce the timeliness of the intended fiscal impact.
The government has made various adjustments to overcome these constraints during the course of the crisis. Monitoring of both revenue and expenditure in particular was stepped up through monthly meetings of the high-level Cash Flow Committee. In order to speed up spending, ministries were given the flexibility to move funds within the same economic categories. Contingency reserves were used for capital spending with the approval of the finance minister. The midterm review of the seventh five-year development plan (completed in mid-1998) was particularly timely in redirecting fiscal policy toward stimulating the economy in the wake of a sharp contraction.
The government also used off-budget operations and quasi-fiscal activities to reinforce the fiscal impetus. A specialized fund was established to provide financing to “privatized” infrastructure projects. During 1997–99, a total of 16 large projects (mostly for infrastructure development) were selected by the government for implementation through the Malaysia Infrastructure Development Bank. Additional loans were obtained mostly from quasi-government entities and bilateral external borrowing (under the Miyazawa initiative) with explicit guarantees from the government (Appendix I).
Enhancing Fiscal Policy Responsiveness to Business Cycles
Fiscal policy can be effective and countercyclical if the rules are so designed and institutional arrangements are in place to enforce them. The key issue in designing fiscal rules is the balance between the short-term need for growth and employment and the long-term desire for fiscal sustainability. To achieve an appropriate balance, flexibility is critical in the formulation and application of these rules, while clearly defined guidelines and escape clauses will safeguard the credibility of the authorities in pursuing fiscal prudence over the medium term.
Formulation of Fiscal Rules
Flexibility can be incorporated into fiscal rules by the following methods:
Expanding the horizon for budget formulation, including the application of fiscal rules, to cover the course of a business cycle would provide the economy with improved shock-absorptive capacity. For instance, the fiscal rule on the annual operating budget could be modified to allow an operating deficit during an economic downturn while observing the balance (on average) over the course of a business cycle. This would require a medium-term fiscal framework for planning, analysis, and forecasting (Box 4.2).
Setting fiscal targets on the basis of a structural balance concept would allow revenue and expenditure to adjust automatically for deviations in output. Given the authorities’ commitment to fiscal consolidation over the medium term, there is merit to considering the use of the aggregate budget deficit as a target variable, supplemented by a subceiling on the operating budget. The pace of fiscal consolidation should follow a carefully mapped convergence plan to a structural balance.
Enhancing the role of built-in stabilizers would help to strengthen the countercyclical influence of fiscal policy while limiting the use of discretionary measures.2 More realistic revenue projections can also facilitate assessment of the effects of built-in stabilizers. On the expenditure side, the introduction of a well-targeted social safety net and provision of unemployment benefits could greatly improve the responsiveness of fiscal policy.
Establishing safeguards and escape clauses would allow fiscal policy to respond to large unforeseen shocks. The choices of cyclical indicators and conditions that would invoke the escape clauses need to he defined in advance and as precisely as possible. The criteria should be transparent so that the timing for triggering the escape clauses are known to the public. Choices of cyclical indicators should be sensitive to the business cycle (such as the level of private investment) and should be able to be monitored. To be effective, the coverage of the budget should include all off-budget and quasi-fiscal operations.
Introducing contingency measures during the budget process, either to add stimulus or withdraw it as required, could include the elimination (or imposition) of a surtax and introduction of a stabilization fund. An across-the-board increase (or cut) in capital spending, although effective, should be used only as a last resort. These and other measures, specified in advance, can betriggered during budget execution if actual budget performance deviates significantly from the planned path.
Greater Flexibility in Fiscal Policy Management
Fiscal consolidation over the medium term will require a shift from fiscal stimulus to a significant scaling back of development expenditure. It is a challenge to withdraw the stimulus without major disruption to economic activities. Capacity for policy analysis and forecasting will need to be strengthened, taking into consideration the linkages between fiscal and monetary policies, desired rate of growth, inflation, and other macroeconomic variables that influence budget preparation and execution. Shifting gears with minimal disruption to The economy could involve several initiatives.
Developing a medium-term fiscal framework as an integral part of the macroeconomic framework. This fiscal framework should include an analysis of the budget sensitivity to exogenous shocks and help identify major fiscal vulnerabilities. It should also incorporate forward-looking estimates on resource constraints based on actual and projected macroeconomic variables. Cyclical indicators should be identified to reflect business cycle behavior. Contingency measures (e.g., increases in current and capital expenditures or tax measures) could be formulated in the context of this medium-term framework, which would be regularly updated and applied on an annual rolling basis.
Assessing the fiscal policy stance based on consolidated public accounts. Provision of fully consolidated details of off-budget and quasi-fiscal activities for both revenue and expenditures would greatly enhance transparency and allow the full impact of fiscal policy to be analyzed. The netting of certain expenditures should be replaced by transactions on a gross basis.
Improving the quality and reliability of revenue forecasts by adopting a more systematic, model-based approach. A simple structural model can be developed to cover as many different components of revenue as feasible, particularly the major taxes. In this connection, there are two basic forecasting methods: the effective tax rate method and the revenue elasticity method. Time series on various taxes, particularly income taxes for individuals and corporations, need to be updated with a view to developing a micro simulation model for income tax forecasting purposes.
Fiscal Policy Responses to the Business Cycle
There are two schools of thought, In line with the Keynesian theory, one group argues that the formulation of fiscal policy should be responsive and countercyclical. Hence, one would observe a positive correlation between tax revenues and output, but a negative correlation between government spending and output. During an economic slowdown, the government should lower taxes and increase spending to stimulate the economy. The Counterargument inspired by Barro (1979), however, says that fiscal policy should be neutral over the business cycle and respond only to unanticipated shocks that affect the government’s budget constraint.
A study by Vegh and Talvi (2000) finds that fiscal policy in Malaysia follows neither the counter cyclical nor the neutral-response views. In fact, based on a sample of 56 countries (1977–94), the study shows that in developing countries (including Malaysia) government spending and taxes are highly procyclical. The authors consider this as the outcome of the variability of the tax base. They find that the tax base fluctuations along with the business cycle are much larger in Developing countries than in the G-7 countries. This would imply that, if the Barro prescription were followed, full tax smoothing would resull in large budget surpluses in a boom and large budget deficits in a bust. Vegh and Talvi argue, however, that the political economy could make it costly to run large fiscal surpluses, owing to the pressure to increase public spending in particular on government consumption and nonproductive investments. Thus, Developing countries may choose pro-cyclical fiscal policy as their optimal fiscal response to favorable shocks in their tax base. Their argument is in contrast with the standard explanation for procyclical fiscal policy in Developing countries that builds on the imperfect access to international credit markets during unfavorable times. They suggest that it is the inability of the government to generate large enough surpluses during expansion that forces it to borrow less during recession (see figure, upper right-hand side).
The study suggested that in Malaysia the budget revenue, government consumption, and private consumption are procyclical.1 Their correlation coefficients with output are estimated at 0.64, 0.54, and 0.77, respectively (corresponding averages for the Asian crisis countries were 0.66, 0.56, and 0.62, respectively). The procyclical nature of fiscal policy is also found in other Developing countries in the sample, although the degrees of correlation are nonhomogenous. Evidence shows that in Malaysia economic expansion during 1991–97 led to real increases in government revenue, but these grew at slower paces than real GDP. Higher revenue exerted pressure for larger government spending. To minimize such pressure, the government developed a tendency to underestimate revenues in the budget. The procyclical nature of the fiscal policy was reversed in 1998–99 through the provision of ad hoc countercyclical fiscal stimulus (see figure, lower right-hand side).
Adopting a forward-looking approach to fiscal management by incorporating fiscal monitoring with forecasting. This would help identify possible deviations in fiscal policy stance from the intended path. Tax and expenditure policy options should be reviewed and updated on a timely basis, excluding windfall revenues and nonrecurring expenditures, while taking into account medium-term macroeconomic constraints. It would also be helpful to initiate procedures to review regularly the sources of errors between actual outcome and the quarterly forecast for major budgetary components. Errors could then be analyzed against possible attributes to changes in policies, revisions in macroeconomic assumptions, and/or technical pitfalls in the forecasting model.
Developing mechanisms for identifying the most and least efficient and effective spending programs, based on economic and social criteria. Results could be disseminated to line ministries as potential candidates for expenditure adjustments. In this connection, high value-added and quick-yielding programs might be identified and targeted according to expenditure policy priorities; this is particularly important where there is a need for additional spending.
Allowing expenditure switching among sectors or ministries, such as increases in social sector expenditure or public maintenance, together with reductions in less productive spending. Avoiding across-the-board increases (or reductions) as much us possible will limit adverse economic and social impact and the loss of efficiency. Contingent reserves may also be used, with the amount adjusted on an annual rolling basis, to serve as a buffer against unexpected shocks in the future.
Conclusions
Experience in recent years suggests that greater flexibility in fiscal management will help reduce the economic and social costs of a crisis through timely adjustments. This flexibility must be guided by well-defined fiscal rules that aim at enhancing the counter cyclical nature of fiscal policy. Specifically, greater flexibility can be achieved through a rules-based framework, with the horizon extended to the medium term. This framework should have a well-defined fiscal target (i.e., a structurally adjusted balance). Temporary deviations from the target will be permitted, however, under clearly defined guidelines to accommodate unforeseen adverse shocks. Political support is critical, as well as institutional arrangements for budget implementation. Fiscal flexibility would also be enhanced by the effective use of safeguards and escape clauses, realistic revenue projections, and a greater role for automatic stabilizers and contingency measures.
Fiscal flexibility needs to go hand-in-hand with greater transparency. This can be achieved by requiring the government to be explicit about its objectives, ensuring thereby that short-term fiscal policies are consistent with long-term macroeconomic goals. Greater flexibility and transparency will require timely updating of forecasts that highlight the changes in external and domestic conditions. Consolidation of off-budget and quasi-fiscal operations are also important.
Appendix 1. Off-Budget and Quasi-Fiscal Operations
For the past few years, the Malaysian government has influenced overall public sector finances through off-budget and quasi-fiscal operations. These activities are often carried out by semi-government entities and other public financial institutions. The framework for these activities has developed as a result of significant government involvement in the past that was essential for achieving the social objectives of rebalancing the ownership structure of the economy. The nature of off-budget and quasi-fiscal operations in Malaysia is mostly related to the government’s role, including that of Bank Negara Malaysia, as planner of the economy and regulator of the financial system. The government entrusts the central bank and other semi-government institutions to provide loans for strategic investment plans and to finance large infrastructure projects, financial and corporate sector restructuring, and operations of the informal social safety net.
Despite their potentially significant macroeconomic and financial impact, as well as allocative effects on the economy, off-budget and quasi-fiscal operations are currently outside the consolidated fiscal accounts of the public sector. Contingent liabilities associated with these operations are nonetheless moderate, based on identified information.
Major off-budget and quasi-fiscal operations in Malaysia include the Following:3
provision of concessional lending for privatized infrastructure projects through the operation of the Infrastructure Development Fund, a fund established in 1998 to provide off-budget fiscal stimulus through the implemenmiion of huge infrastructure projects:
activities of Khazanah—an entity initially created with the capital from privatization proceeds of public enterprises—that acts as an investment arm of the government for strategic Development projects and other activities of national interest; 4
financial restructuring of banks, which commenced in 1998, through the operations of Danaharta (to acquire nonperforming loans) and Danamodal (to recapitalize banks);
provision of explicit government guarantees of loans extended by the Employees’ Provident Fund, a public pension fund, and various state-owned trust funds to nonfinancial public enterprises and some privatized projects: bonds issued by Khazanah (up to KM 10 billion): and obligations of Danaharta:
provision of explicit government guarantees of external loans undertaken by major nonfinancial public enterprises that involve large projects of national interest, and other bilateral and multilateral external loans to public entities, including the state-owned financial institutions (e.g., Malaysia Infrastructure Development Bank);
extension of subsidized loans by Bank Negara Malaysia for the operation of the informal social safety net, including low-cost housing; and
potential government burden sharing in resolving the financial troubles of certain privatized projects as well as other quasi-fiscal operations associated with the activities of financial public enterprises.
Among the above-mentioned operations, financial information is mostly available on (i) the operations of Danaharta and Danamodal; (ii) explicit government guarantees of the external loans of major non-financial public enterprises undertaking large national projects; (iii) explicit government guarantees of domestic loans extended by the Emptoyees’ Provident Fund (and other trust funds) to major nonfinancial public enterprises; and (iv) Bank Negara Malaysia operations associated with the informal social safety net. Information related to the operations of Infrastructure Development Fund and Khazanah, however, is partial, and information of implicit government guarantees, and thus implicit contingent government liability related to certain privatized projects, is very limited.
Privatized Infrastructure Projects
Most off-budget operations were associated with the implementation of large privatized infrastructure projects. Sixty-eight such projects were implemented during 1996–98, with a total cost of RM 67 billion. Financial support from the federal government in terms of advances for land and loans was provided for major infrasiructure projects.5 Initial seed capital was provided from the budget for these projects to help secure long-term commercial loans at favorable terms,6 with the objectives of improving operating efficiency, saving budgetary resources, reducing administrative burden, and promoting private sector participation in the economy. These projects involved mainly the construction of highways, mass-transit systems, sewage systems, and other utilities for social sector development.
The Infrastructure Development fund was established in 1998 and was aimed at assisting with the financing of those privatized infrastructure projects whose implementation was significantly delayed in the aftermath of the crisis. The Infrastructure Development Fund had an initial capital of RM 1 billion and is managed by the Malaysia Infrastructure Development Bank. The government provided explicit guarantees for both domestic and external loans undertaken by the Malaysia Infrastructure Development Bank, which amounted to nearly RM 6 billion in 1999. Most of these loans are from the Employees’ Provident Fund (RM 4.5 billion 1 and bilateral sources (RM 1.3 million, under the Miyazawa initiative).
Off-budget capital spending was stepped up in 1999 to provide additional fiscal stimulus to the economy. The government handpicked 16 major projects (mainly in infrastructure, utilities, and social services), amounting to about RM 9 billion (3 percent of GDP), to be financed by the Malaysia Infrastructure Development Bank as part of the off-budget fiscal stimulus. Two-thirds have been finalized, and about RM 1 billion is expected to be disbursed annually during 1999–2001.
More recently, some of these large projects are facing financial difficulties that may have implicalions to the budget. The issue has caught the attention of the public, who has questioned the viability of these projects, as well as the governance issue related to government subsidies (both explicit or implicit) in the form of budget spending or soft loans.
There are no explicit government guarantees associated with these projects. Given the nature of these projects, however, the government has indicated that it may consider some form of financial support, depending on the merit of each case. Modalities could include a third-party takeover, buy back at discounts, and/or a rescue operation through cash injection. In the event of a government takeover, outstanding loans of the government would be automatically converted to equity holding in the project. Liquidation is not likely, as these projects involve national infrastructure and social services. The manner in which the government handles these projects, including the extent to which best practices are followed, is likely to have significant implications for public finances and Development programs in the future.
The government is working on improving the framework within which privatized projects are regulated particularly with respect to operating standards and quality of services, to ensure adherence to terms and conditions stipulated in the privatization agreements. One proposal is to establish sectoral regulatory bodies, initially to cover energy and gas. transportation, telecommunications, and water supply and sewerage systems. Under such a framework, the emphasis will be on penalties for noncompliance with the terms and conditions of the agreements.
Contingent Liabilities of the Government
Provisions of explicit guarantees to off-budget capital spending and operations of Danaharta have raised government contingent liabilities7 in recent years. Although data on these activities are not systematically reported in a consolidated manner, some information has been identified (Table 4.1.).
Quasi-Fiscal Contingent Liabilities
(Outstanding stock at end of period, in percent of GDP)
Excluding Danamodal bond issue of RM 7.7 billion (about 2½ percent of GDP) as of February 15, 2000.
Quasi-Fiscal Contingent Liabilities
(Outstanding stock at end of period, in percent of GDP)
| 1997 | 1998 | 1999 | |||
|---|---|---|---|---|---|
| Federal government guaranteed loans | 8.3 | 11.6 | 16.8 | ||
| Domestic | 5.0 | 7.1 | 8.3 | ||
| Foreign | 3.2 | 3.4 | 3.7 | ||
| Additional identified debt guaranteed by the government1 | 0.1 | 1.1 | 4.8 | ||
| Guaranteed loans for the Malaysia Infrastructure Development Bank | 0.1 | 0.2 | 0.5 | ||
| Guaranteed loans for Danaharta and Permodatan Nasional Bhd. | … | 0.9 | 3.6 | ||
| Guaranteed loans for Petrofiam Nasional Bhd. | … | … | 0.7 | ||
Excluding Danamodal bond issue of RM 7.7 billion (about 2½ percent of GDP) as of February 15, 2000.
Quasi-Fiscal Contingent Liabilities
(Outstanding stock at end of period, in percent of GDP)
| 1997 | 1998 | 1999 | |||
|---|---|---|---|---|---|
| Federal government guaranteed loans | 8.3 | 11.6 | 16.8 | ||
| Domestic | 5.0 | 7.1 | 8.3 | ||
| Foreign | 3.2 | 3.4 | 3.7 | ||
| Additional identified debt guaranteed by the government1 | 0.1 | 1.1 | 4.8 | ||
| Guaranteed loans for the Malaysia Infrastructure Development Bank | 0.1 | 0.2 | 0.5 | ||
| Guaranteed loans for Danaharta and Permodatan Nasional Bhd. | … | 0.9 | 3.6 | ||
| Guaranteed loans for Petrofiam Nasional Bhd. | … | … | 0.7 | ||
Excluding Danamodal bond issue of RM 7.7 billion (about 2½ percent of GDP) as of February 15, 2000.
Appendix II. Fiscal Measurement: Methodology Note
Definition of Cyclically Neutral Balance, Fiscal Stance, and Fiscal Impulse
Cyclically neutral balance measures the fiscal position relative to a base year; it is defined as the difference between the cyclically neutral revenue and expenditure. Cyclically neutral revenue represents a constant revenue-to-nominal-GDP ratio, while cyclically neutral expenditure represents a constant expenditure-to-potential-GDP ratio (excluding unemployment benefits), both relative to the base year.
Fiscal stance measures the difference between the actual balance and the cyclically neutral balance. A positive fiscal stance (i.e., a situation where the actual deficit is larger than the cyclically neutral deficit) indicates that fiscal policy is adding stimulus to the economy.
Fiscal impulse is defined as the change in the fiscal stance; it provides a sense of direction and the magnitude of the new fiscal stimulus to the economy. While the fiscal stance depends critically on the neutral balance and, thus, the selection of the base year, the fiscal impulse is not sensitive to this problem, which makes it a more useful indicator than the fiscal stance.
Calculation of Cyclically Neutral Balance, Fiscal Stance, and Fiscal Impulse
Selecting the base year t0; R(t0)-E(t0) is the cyclically neutral balance in year t0:
where R(t0) clically neutral revenue in year t0; where R(t0) = cyclically neutral revenue in year t0;
E(t0) = cyclically neutral expenditure in year t0.
Calculating the cyclically neutral revenue for current year t:
Neutral Revenue = Y(t)*r,
where Y(t) = nominal GDP in year t; r = the GDP share of revenue in the base year t0.
Calculating the cyclically neutral expenditure for current year t:
where P(t) = potential nominal GDP in year t; y(t0) = nominal GDP in year t0; AE(t0) = actual expenditure in t0 UB(t0) = unemployment benefit in t0.
Calculating the fiscal stance, S(t), in year t:
S(t) = [R(t0) – E(t0)] – [rY(t) – eP(t)],
where R(t0)-E(t0)the cyclically neutral balance in year t0; rY(t) - eP(t) = the cyclically neutral balance in year t; e = the GDP share of expenditure in the base year t0.
Calculating the fiscal impulse, I(t), in year t:
I(t) = [S(t)/Y(t)] – [S(t-1)/Y(t-1)].
Definition of Structural Fiscal Balance
Structural fiscal balance is the difference between the structural revenue and structural expenditure. The structural revenue measures the actual revenue adjusted for the lagged impact in ctosing the output gap. The structural expenditure measures the actual expenditure adjusted for the provision of unemployment benefits for cyclical unemployment (rather than the structural unemployment).
Calculation of Structural Fiscal Balance
Calculating the structural revenue, SR(t), in year t:
where AR(t) = actual revenue in year t; Output gap = (potential output)/(actual output); α = revenue elasticity (weighted average) in time t; β = revenue elasticity (weighted average) in time t-1.
Calculating the structural expenditure, SE(t), in year t:
where AE(t) = actual expenditure in year t; UB(t) = unemployment benefits in year t.
Calculating the structural balance, SB(t), in year t:
SB(t) = SR(t)-SE(t).
The structural balance is often measured in terms of potential GDP.
References
Alesina, Alberto, and Tamim Bayoumi, 1996, “The Cosls and Benefits of Fiscal Rules: Evidence from U.S. States,” NBER Working Paper No. 5614 (Cambridge. Massachusetts: National Bureau of Economic Research).
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Bank Negara Malaysia, Annual Report 1999 (Kuala Lumpur).
Barro, Robert, 1979,“Second Thoughts on KeynesianEconomics.” American Economic Review. vol, 69(May), pp. 54–59.
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This degree of fiscal easing, which was supported by the IMF, turned out to be insufficient.
Although Malaysia recently took measures to enhance the stabilizers on the revenue side by shifting to eurrenl year income tax assessment, stabilisers On the expenditure side remain absent.
In addition, the government’s contingent liabilities arise from the provision of bank deposit guarantees, which were made explicit in January 1998.
As of end-1999, Khazanah’s portfolio included its interests in Tenaga (36 percent of equity 1. Telekom Malaysia (37 percent): Malaysia Airports Holdings Bhd, (23 percent): and Putrajaya Holdings Sdn Bhd. (40 percent).
Most the new and major projects were privatized through the build-operate-transfer method.
Interest rates were in the range of 6-8 percent with an average grace period of 6 years and a repayment period of 15-18 years. These are in line with the terms of the government loans for these projects.
Information on contingent liabilities of the government associated with the provision of implicit guarantees is yet to be compiled and consolidated.
