Stitch in time

Malaysia's fiscal tightening is wise 'taper' cover

Malaysian Prime Minister Najib Razak is being wisely cautious. Although the US Federal Reserve may not begin unwinding its quantitative easing for some months, Najib is taking steps to ensure that Malaysian debt doesn't get trampled if bondholders stampede out of emerging markets.

In his annual budget unveiled on October 25, Najib announced the introduction of a six per cent goods and services tax from April 2015. Together with a 16 per cent cut in subsidies next year, the new consumption tax will lower the fiscal deficit to three per cent of GDP in 2015, from an estimated four per cent this year. The risk of capital flight is real. Foreigners own 27 percent of outstanding public debt, according to BNP Paribas. In the event that they all sell, half the country's foreign-currency reserves will vanish. Even a more limited selloff may cause an inflationary slide in the ringgit.

Malaysia is a creditor nation, but its government has been lazy about taxation - happy to rely on revenue from the country's depleting oil riches. Such benevolence towards citizens is no longer tenable. A dramatic narrowing of the trade surplus has raised the possibility that the nation will eventually be forced to rely on foreigners' savings to finance investment. That puts pressure on the government to rein in its budget to reassure creditors.

Bondholders are still jittery. Although the yield on 10-year Malaysian government bonds fell to a four-month low after Najib's speech, creditors' misgivings haven't been entirely dispelled. Since May, the cost of buying protection against a default on Malaysian state debt has shot up to levels similar to what investors need to pay to insure against a similar event in Thailand, even though that country's public debt has a lower rating.

Political compulsion may yet lead to belt-tightening deadlines being missed. Besides, GDP growth next year could fail to hit the government's target of 5 to 5.5 percent, putting Najib under pressure to delay austerity. Still, the prime minister has at least acknowledged the need to prepare for the post-QE world. Postponing even the intention to be fiscally cautious would have been costly.