Debt monetisation: Don’t let its novelty scare you off!

Such fear should not stop us from using a strategy that will give the government the additional funds it needs to protect everyone during these unusual times, Jeyakumar Devaraj writes.

There has been a spike of interest in the strategy of “debt monetisation” especially after Deputy Youth and Sports Minister Wan Ahmad Fayhsal supported the measure.

A chorus of voices for and against it have been heard. 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 naysayers, 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 monetisation?

We need to first talk about government bonds. Most governments raise funds to cover their budget deficits 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 RM90bn worth of bonds in 2021 to cover the 6% deficit in Budget 2021. 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 RM850bn currently. Roughly about 10% of this amount [RM85bn] 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, the government will have to float bonds amounting to RM175bn [RM90bn plus RM85bn] 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 RM115bn 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, about RM35bn 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 monetisation: Debt monetisation 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 to resuscitate the economy but without pushing up the debt servicing burden too much.

Inflation?

Many fear large cash transfers to 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 the 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, healthcare, etc – most of which can be produced by domestic producers.

If one million families get a basic guaranteed income of RM1,000 per month, that would stimulate the production, processing and distribution of basic foodstuffs and other household needs.

That in turn will generate business opportunities for thousands of small and medium-sized enterprises (SMEs) and tens of thousands of workers – who are now languishing as aggregate demand has suffered because of the Covid-19-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 monetisation.

Pressure on the ringgit?

Many fear that debt monetisation 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 against other currencies.

For example, if Malaysia foolishly decides to procure all the RM185bn it requires in 2021 through debt monetisation, that would mean that we pay out RM85bn to the bond investors whose bonds mature in 2021.

The normal standard procedure would be to raise the RM85bn by selling bonds to a new set of investors. If the normal procedure is followed, there no net change in the supply of ringgit in the financial markets for, though we pay out RM85bn to the old investors, we at the same time receive RM85bn from the new set of investors. So the exercise does not increase the amount of ringgit in the financial markets.

This is why the Socialist Party of Malaysia (PSM) has suggested that the federal government should raise about RM130bn using the normal standard procedures by selling to ordinary investors. This is about the sum we borrowed last year. We only use debt monetisation for the extra amount – perhaps another RM50bn to RM80bn – that we need for handling the Covid-19 crisis.

Investor confidence

This is the bigger problem. Investors might be fearful that if the government overdoes this measure, the ringgit would 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 government-linked companies and crony companies to 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 would be abused is understandable.

This might lead to significant divestment. The outflow of capital would 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 would rise, 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 to the total quantum that can be borrowed from Bank Negara in a year – perhaps 5% of gross domestic product (GDP). This works out to about RM75bn 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 was used exclusively to provide support to families suffering a loss in household income because of the recession, to provide easy credit to SMEs facing cashflow problems, and to expand and strengthen our publlic healthcare system.

And transparency is a must! There must be legislation requiring the Ministry of Finance 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 monetisation for the duration of the Covid-19 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 funds to do three important things.

• It must make sure vulnerable families are protected – that they have enough money in hand to get the basic food, shelter and healthcare they need
• SMEs should not go under because of cash flowproblems. They should be given loans that are interest-free until the GDP moves into positive territory
• The Ministry of Health’s budget should be augmented by another RM5bn to RM6bn. The ministry is doing a fairly good job and the extra money allocated to it will be put to good use.

We should not allow ill-defined fears and vague imaginings to keep us from using a strategy that will give the government the additional funds it needs to do all these crucial things to protect everyone in these unusual times.

The views expressed in Aliran's media statements and the NGO statements we have endorsed reflect Aliran's official stand. Views and opinions expressed in other pieces published here do not necessarily reflect Aliran's official position.

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