By Jason Loh Seong Wei, Head of Social, Law & Human Rights at EMIR Research.
Covid-19 has reignited that never-ending debate on the effectiveness of fiscal policy versus monetary policy in times of economic crises and doldrums. By extension, one of the burning issues arising from this is the level of the fiscal deficit which has to do with government spending as well as revenue such as tax receipts.
For most countries, including here in Malaysia, there is the settled recognition that fiscal policy – particularly in view of the looming Budget 2021 – has to do more even if fiscal consolidation (which means fiscal reduction) as the desirable goal still has to come in the medium-term.
Fiscal consolidation in general itself (let alone trying to target a specific figure) will be very difficult to achieve should – and let’s assume for the sake of argument that – the scenario of a bleak and gloomy economic outlook is to be on-going and persist.
The irony is that trying to achieve fiscal consolidation prematurely might result in having to postpone it to the long-term or until such time when circumstances are more propitious.
We are told that good fiscal practice dictates that the government reduces its fiscal deficit down to the three percent threshold of the GDP, e.g. 3.3%, at least as the target in the long-term.
Historically, by 1983, Malaysia’s fiscal deficit was the highest at 18% and reduced to 5% in 1988 and finally to 1.9% by the peak of the Asian Financial Crisis (1998) and then spiked to 6.6% in 2000 only to be brought down to 5.3% in 2002.
In 2007, the budget deficit was at 3.2% before hitting 7% in 2009 during the Global Financial Crisis/GFC (2008-2009). It was 2.9% of the GDP in 2017 before resetting to 3.7% in 2018. Our fiscal deficit was reduced to 3.4% of the GDP in 2019.
As it is, Finance Minister Tengku Zafrul Abdul Aziz has said that our fiscal deficit would hit 6% by end of the year.
It could be argued that the 3% fiscal rule has its origins in the Stability and Growth Pact (SGP) of the European Union (EU). In turn, the SGP which emerged out of the Maastricht Treaty 1992 enshrined two requirements: (a) a debt to GDP ratio below 60%, or converging towards it; and (b) a budget deficit below 3% of the GDP.
The 3% fiscal rule was imposed in order to fulfil those two “pre-conditions” and was to apply regardless of the context, i.e. the business cycles of member-states.
The context for the “prototype” of the 3% fiscal rule was the monetary union (eurozone) and the preoccupation with the need for very low inflation levels. However, the reason why 3% is the chosen number has neither been satisfactorily explained nor justified.
Intriguingly, leading member-states such as Germany (early 2000s) and France (late 2000s) have themselves been consistently guilty of breaching the fiscal rule – for the sake of their own economies, no less!
In the wake of the GFC (2008), Greece would stand out as the opposite example where a primary budget surplus was imposed (i.e. revenue before debt servicing is taken into account).
So, instead of a 3% budget deficit, Greece was expected to achieve a budget surplus which was 4.14% in 2019. So, no magic number here – of a fiscal deficit despite the need for some form because of the on-going economic conditions.
That is, of high and crippling private sector debt, currency misalignment whereby the Greek euro was overvalued and the nexus between private and public debt. Alongside that was, of course, austerity (internal devaluation) such as wage and pensions cuts. The result was economic contraction by 26% of real GDP in 2017 and high (especially youth) unemployment rates in double digits.
The inexorable logic here would be that – going by the empirical evidence – there couldn’t be a magic number. This is so since by definition the situation presupposes and implies that the 3% fiscal threshold and rule is the embodiment of economic and financial stability and growth.
In our own case, fiscal consolidation towards 3.4% saw the GDP for Q4 of 2019 grew by 3.6% below the annual of 4.3% and only 0.7% for the Q1 for this year. So, there’s much space for the threshold in terms of fiscal consolidation to be increased from 3.4%.
This is particularly in view of the need to prepare policy thinking for continuous budget deficits above the recommended 3 percent threshold and rule that we have been so accustomed in the past decades or so.
Furthermore, given the current Covid-19 epidemic’s impact on the economy, it’s hereby urged that the threshold of fiscal deficits should be regarded as neither good nor bad. That is, the threshold by itself says nothing as to the effectiveness and relevance of the fiscal deficit at this time of economic uncertainty and despair.
To quote from the late Keynesian economist, Gardner Ackley, who had proposed that fiscal and monetary policies must be mustered to fine-tune the market as it is not self-correcting:
“My own position on deficits has always been, and remains, that deficits, per se, are neither good nor bad. There are times when they are not only appropriate but even highly desirable, and there are times when they are inappropriate and dangerous. During a recession or a period of “stagflation”, deficits are nearly unavoidable, and are likely to be constructive rather than harmful”.
To add, higher fiscal deficits – even if understood as temporary, targeted and timely – can be justified in the name of the economics of empathy.