There has been a spike of interest in the strategy of “debt monetization” especially after the Deputy Youth and Sports Minister Wan Ahmad Fayhsal supported the measure. There have been a chorus of voices for and against it. A Tan Sri in one of the WhatsApp groups I am in wrote “Printing money is irresponsible and destructive. We need to be more productive and sustainable”. This epitomises the stance of many nay-sayers who have not actually carefully considered the pros and cons of this strategy but feel it is morally reprehensible and that it will destroy the economy.
What is Debt Monetization?
We need to first talk about government bonds. Most governments raise funds to cover their budget deficit by floating bonds. Investors who buy these bonds get an interest payment annually (called a coupon rate) and these investors are paid back the total investment after a fixed period that varies from a year to 30 years or more.
Our government will need to float RM 90 billion worth of bonds in 2021 to cover the 6% deficit in the 2021 budget. This is in addition to the bonds that the government will have to float to “roll-over” the bonds that are due for full settlement in 2021. Federal Government debt is about RM 850 billion currently. Roughly about 10% of this amount will mature in 2021 and thus need to be paid back to the holders. The only way we can pay back the bonds that are maturing is by floating new bonds. So, our government will have to float bonds amounting to RM 175 billion in 2021. (The Federal Government has been rolling over maturing bonds for the past 20 years as we have always had a budget deficit over that period of time. The PH government floated bonds worth about RM 115 billion in 2019.)
The problem with all this borrowing is the interest we need to pay on the outstanding bonds. Currently the overall interest we are paying for our borrowings is about 4% of the total debt, approximately RM 35 billion a year. This is about 12% of the total federal budget and is more than the allocation for every ministry except for the Ministry of Education. The interest we have to pay to service our debt is a drain on our budget.
Debt monetization refers to the purchase of government bonds by the central bank of the country. So instead of selling all our new bonds to investors, we sell a portion of these bonds to Bank Negara but with a much lower coupon rate. So we get the money we need for resuscitating the economy but without pushing up our debt servicing burden by too much.
There are many who fear that large cash transfers to the families in need will lead to inflation as there will then be more money in the domestic economy chasing the same quantum of goods. This view, which is endorsed by “experts” such as the CEO of Centre for Market Education, is mistaken. We need to think in dynamic terms – extra money in the hands of the most affected families will see an increase in demand for basic items – food, simple repairs to the house, health care, etc – most of which can be produced by domestic producers. If 1 million families get a basic guaranteed income of RM 1000 per month, that would stimulate the production, processing and distribution of basic foods and other household needs and that in turn will generate business opportunities for thousands of SMEs and tens of thousands of workers – who are now languishing as aggregate demand has suffered because of the COVID-induced recession. There is more than enough latent capacity in our economy to meet the extra demand that will be created by additional spending enabled by debt monetization.
Pressure on the Ringgit?
There are many who fear that debt monetization will lead to a depreciation of the ringgit. Their concerns are not without basis. The relative value of a currency depends to a significant extent on the supply of and the demand for that currency in international financial markets. If there is a marked increase of that currency in the international financial market then the value of that currency will depreciate vis-a-vis other currencies.
For example, if Malaysia foolishly decides to procure all the RM 185 billion it requires in 2021 through debt monetization, that would mean that we pay out RM 85 billion to the bond investors whose bonds mature in 2021. The normal SOP would be to raise the RM 85 billion by selling bonds to a new set of investors. If the normal SOP is followed, there no net change in the supply of ringgit in the financial markets for though we pay out RM 85 billion to the old investors we at the same time receive RM 85 billion from the new set of investors. So the exercise does not increase the amount of ringgit in the financial markets.
This is why the PSM has suggested that the Federal Government should raise about RM 130 billion utilizing the normal SOP by selling to ordinary investors. This is about the sum we borrowed last year. We only use debt monetization for the extra amount – perhaps another 50 to 80 billion ringgit – that we need for handling the COVID crisis.
This is the bigger problem. Investors might be fearful that if the government overdoes this measure, the ringgit will depreciate and that would affect the value of their investments. They might therefore divest their holdings in Malaysian stocks and bonds and convert their ringgit to other currencies to invest elsewhere. That would increase the amount of Malaysian currency in the international financial markets and put downward pressure on the ringgit.
Investors -both domestic and foreign – might also be worried that the Malaysian government might be tempted to use this new source of funds to help GLCs and crony companies acquire equity in firms that are performing well. Given the perception that there is a pronounced rent-seeking culture among our political elite as well as a tendency to dip into the public till to enrich the elites, the fear that the augmented fiscal power of the government will be abused is understandable. This might lead to significant divestment. The outflow of capital will again increase the supply of ringgit in the international financial markets and push down the value of the ringgit.
If the value of the ringgit depreciates, then the cost of our imports will go up, and the prices of goods will go up. Inflation can occur in this scenario.
Need for Prudence, Transparency and Strict Guidelines.
If Malaysia decides to experiment with debt financing we need to be strict with ourselves. We should set clear limits as to the total quantum that can be borrowed from Bank Negara in a year – perhaps 5% of GDP. This works out to about RM 75 billion currently. We certainly should not borrow the entire amount in a large lump sum, but stagger it throughout the year, assessing the health of the ringgit as we go along.
We also need to agree how this fund can be used. It would be least controversial if this fund were used exclusively to provide support to families suffering a loss in household income because of the recession, easy credit to SMEs facing cash flow problems and to expand and strengthen our publlic healthcare system.
And transparency is a must! There must be legislation requiring the MOF to table reports in Parliament on how exactly the fund is used. We should also set definite time limits. For a start we should restrict this facility of Debt Monetization for the duration of the COVID Recession – for 2021 and 2022 only. After that we stop it and assess the impact it has had on our economy and currency.
The “New Normal” requires bold approaches.
The Federal Government needs a bit more of funds to do three important things. First is to make sure that vulnerable families are protected – that they have enough money in hand to get the basic food, shelter and health care that they need. Secondly, SMEs should not go under because of cash flow problems. They should be given loans that are interest free until the GDP moves into positive territory. And third, the Health Ministry budget should be augmented by another 5 or 6 billion. The KKM is doing a fairly good job and the extra money allocated to them will be put to good use.
We should not allow ill-defined fears and vague imaginings to keep us from utilising a strategy that will give the government the additional funds that it needs to do all of these crucially important things to protect everyone in these unusual times that we are now in.
Parti Sosialis Malaysia