Report No. 20371 -MA Malaysia Malaysia Public Expenditures Managing the Crisis; Challenging the Future May 22, 2000 Poverty Reduction and Economic Management Sector Unit East Asia and Pacific Region Document of the World Bank CURRENCY EQUIVALENTS (as of May 2000) Currency Unit = Ringgit (RM) RM 1 = US$3.8 US$ 1 RM 0.26 MALAYSIA - FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS EPF - Employment Provident Fund EPU - Economic Planning Unit IDC - Infrastructure Development Corporation IDF - Infrastructure Development Fund ISO - Independent System Operator MAMPU - Malaysian Administrative Modernization and Management Planning Unit MBS - Modified Budgeting System MOH - Ministry of Health MTA - Metropolitan Transportation Authority NEP - New Economic Policy NERP - National Economic Recovery Plan NGO - Non-Governmental Organization NHI - National Heart Institute NDP - National Development Policy OECD - Organization for Economic Cooperation and Development PEA - Public Expenditure Analysis PKPA - Civil Service Improvement Circulars or Development Administrative Circulars PPRT - Development Program for the Hardcore Poor SPR - Structural Policy Review TBTA - Tri-borough Bridge and Tunnel Authority TIFIA - Transportation Infrastructure Financing and Innovation Act VAT - Value-Added Tax Regional Vice President: Mr. Jemal-ud-din Kassum, EAPVP Country Director: Ms. Ngozi Okonjo-Iweala, EACSM Chief Economist: Mr. Masahiro Kawai, EAPVP Sector Manager: Mr. Homi Kharas, EASPR Task Team Leader: Ms. Mona Haddad, EASPR MALAYSIA PUBLIC EXPENDITURES MANAGING THE CRISIS; CHALLENGING THE FUTURE TABLE OF CONTENTS EXECUTIVE SUMMARY ...................i 1. RESPONDING TO THE CRISIS .......................................... 1 A. The Fiscal Stimulus ..................2.......... ............2 B. Managing Contingent Liabilities in Infrastructure ............. .........5 C. The Social Impact of The Crisis.................................13 2. PUBLIC EXPENDITURE MANAGEMENT: HOW MALAYSIA PERFORMS 19 A. The Public Expenditure Management System ............... ......... 19 B. Extending Fiscal Planning and Performance Management to Off-Budget Expenditures ........................ ..........23 C. Strengthening Links between Cabinet Policymaking and the Budget Process .....29 D. Improving Performance Management ................................30 E. An Enhanced Public Reporting Framework .....................36 3. FUTURE CHALLENGES IN A MODERN ECONOMY: GOVERNMENT'S EVOLVING ROLE ...........................................38 A. Fiscal Patterns and the Role of Government ............ .............39 B. Health System for the Future: a Difficult Choice ......................44 C. Leading the Way in Higher Education ................... ..........55 D. Social Protection: Past and Future ........................... .....63 F. Pursuing Sustainability in Infrastructure ........................69 ACKNOWLEDGEMENTS This report was produced by a team led by Mona Haddad. The core team comprised Ashoka Mody (infrastructure), Louis Charles Viossat (health), Bruce Chapman (Australian National University; education), Vinod Ahuja (Indian Institute of Management, Ahmedabad, India; safety net), and Serif Sayin (consultant; public expenditure management). Ronald Hood and Thang- Long Ton brought the report up to date. Peer reviewers are: Jeffrey Hammer, Malcolm Holmes, and Vinaya Swaroop. Bert Hofinan provided overall advice. The report was prepared under the general guidance of Ijaz Nabi (Lead Economist), Homi Kharas and Ngozi Okonjo-Iweala. Production of the report was supported by Barbara Ossowicka (statistics) and David Bisbee (design and layout), Hedwig Abbey and Nancy Mensah (revision processing) and Bonita Brindley (editor). TABLES: Table 1.1: Federal Government Spending and Revenue, 1996-99 ...... ...........2 Table 1.2: Social Sector Budgets have been Largely Maintained ....... ..........15 Table 2.1: Steps to Control the Risk of Government Programs and Promises ........25 Table 3.1: Fiscal Summary of the Federal Government .......................40 Table 3.2: Consolidated Public Sector Finance ........... ..................41 Table 3.3: Fiscal Expenditures of the Federal Government by Sector..... ............43 Table 3.4: An Integral Approach for Social Risk Management ........ .............68 Table 3.5: Public and Private Financing for Infrastructure and Energy, 1991-2000 .....70 Table 3.6: Metro Performance in Selected World Cities .......................74 FIGURES: Figure 1.1: Contingent Liabilities in Infrastructure Before and After the Crisis, 7th Plan 5 Figure 1.2: Inequality May Level off After the Crisis .........................13 Figure 1.3: Most Retrenchments were in Urban Areas and for Low-Skill Workers (1998) .........................................14 Figure 3.1: Health Outcomes Have Leapt Since 1957 .........................44 Figure 3.2: Public Health Expenditures Have Held Steady .....................45 Figure 3.3: Participation by the Private Sector has Increased Dramatically ..............46 Figure 3.4: Do State Health Expenditures Go Where Incomes are Lowest? Not Quite ......................................... ..........47 Figure 3.5: Distribution of Health Expenditures 1990-1997 ....................48 Figure 3.6: Education Expenditures on the Rise, 1970-1999 ....................56 Figure 3.7A: Enrollment Rates in Public Institutions have Risen, 1970-1995 .............56 Figure 3.7B: Malaysia Lags in Tertiary Education Compared to the Region .............56 Figure 3.8: Higher Education Subsidies are Usually Regressive ........ .........57 Figure 3.9: Allocation to Tertiary Education are Increasing ....................58 Figure 3.10: The Cost of Tertiary Education is Rising ........................58 Figure 3.11: The Private Sector is Growing in University Education ..............58 Figure 3.12: The Distribution of Poor Across Malaysia, 1997 ........ ...........64 Figure 3.13: There is Some Discrepancy Between Social Allocation and Needs across States .........................................66 Figure 3.14: Growth of Infrastructure Stocks, 1965-1995 ......................69 Figure 3.15: Public and Private Investment in Infrastructure across the World, 1995 ... 72 BOXES: Box 1.1: From Fiscal Surplus to Fiscal Deficit .................................3 Box 1.2: When Does Fiscal Stimulus Become Ineffective? .....................4 Box 1.3: Contingent Government Liabilities: A Hidden Risk To Fiscal Stability ......7 Box 1.4: Estimating Exposure In Infrastructure Projects ..........................8 Box 1.5: A Risk Management Strategy for Contingent Liabilities ................12 Box 1.6: Protecting The Poor in a Crisis and Beyond .......... ...............17 Box 2.1: Malaysia's Modified Budgeting System - At the Forefront of Developing Countries ................................... 20 Box 2.2: Structure of Government, Budget, and Accounts .....................22 Box 3.1: Health Insurance Schemes - Concepts and Lessons from Other Countries .....53 Box 3.2: Australia's Income-Contingent Student Loan Scheme: Can it be Applied to Malaysia? ............................. 62 Box 3.3: Income Distribution Worsened in Many East Asian Countries ...... .....63 Box 3.4: The Malaysian Philosophy of Poverty Reduction .....................67 Box 3.5: Social Protection as Social Risk Management .......................68 Box 3.6: Malaysia and Chile: A Different Experience In Infrastructure Privatization .73 Box 3.7: The Benefits and Limits of The Malaysian Approach to Privatization - The Case of the National Sewerage Project ................ .........76 Box 3.8: Argentina May Well have the Most Competitive Power Industry in the World ................. ................................ 77 Box 3.9: Contracting - The Malaysian Approach .....................................................79 Box 3.10: Privatization of Port Klang: From Competitive to Direct Negotiations ........80 Box 3.11: Improving Transparency and Competitiveness in Infrastructure Concessions 83 ANNEXES: Annex 1: The Public Expenditure Management System Today ........ ......... 84 Annex 2: Accounts Structure and Public Accounts .............. .......... 87 Annex 3: Controlling Fiscal Risks .................................. 89 Annex 4: The Development Administration Circulars (PKPAs) ....... ..........91 Annex 5: Transfers to Nondepartmental Entities ......................96  EXECUTIVE SUMMARY 1. Like other countries in East Asia, Malaysia achieved unprecedented economic growth and dramatic poverty reduction in the two decades prior to 1997. During this period, the government's role evolved from being a main contributor to economic activity to a facilitator of private sector led growth. As a result, pressure on public expenditures was alleviated and when the regional financial crisis hit in 1997, the budget was in surplus-unusual for most countries- and public debt had fallen to around 30 percent of GDP. The fiscal and social impact of the crisis was cushioned by these favorable conditions. The government was able to loosen fiscal policy to stimulate demand without jeopardizing medium-term debt sustainability. Moreover, although growth was largely behind the reduction in poverty, the existing safety net-based on a comprehensive public health system, free basic education, and transfer and income generation schemes for the rural poor and vulnerable-proved resilient to the crisis. An important component of this safety net was the productivity-linked wage which allowed flexibility in the labor market and thus kept unemployment low-only 3.9 percent in 1998 and 3.4 percent in 1999. Repatriating migrant workers, who were largely employed in hard-hit sectors such as construction, also buffered the rise in unemployment and poverty. Moreover, the post-crisis devaluation cushioned the impact on the rural poor (which accounted for the majority of the pre- crisis poor) as it raised agricultural income. 2. But the crisis brought to the fore issues in public expenditure management that 'might have remained of less significance in a fast-growing economy: large and increasing off-budget liabilities that could undermine fiscal prudence, accountability and efficiency in the use of public resources. Malaysia has reformed its public expenditure management system and it is now largely on par with international best practice. However, the government's strategy of allowing greater private sector involvement in the provision and financing of public services, mainly infrastructure, has put new demands on contingent and off-budget public expenditure management. While this strategy has led to positive outcomes-infrastructure capacity doubled between 1985 and 1995-the government provided extensive financial support to private projects and corporatized entities and did not always foster sufficient competition in awarding contracts to maximize efficiency; this increased the government's direct and contingent liabilities. This public-private interface is also becoming more significant in tertiary education and health, where public universities and hospitals are being corporatized. Although it would improve decision making, performance, and the response to changing socio-economic needs, the resulting off-budget liabilities, if not adequately managed, would raise fiscal risk. 3. Malaysia also faces future challenges in achieving medium term outcomes that will determine whether it can sustain past achievements and move to a fully developed country as envisaged in the government's Vision 2020. The goal is "to transform the economy from investment-driven output growth to one that is productivity- and quality-driven; and to place greater efforts on ensuring equitable distribution of the nation's expansion in income and wealth." For that, the most important challenge ahead may well be in higher education. Although public expenditures in social sectors have led to impressive outcomes-health indicators now - 11 - compare favorably with upper-middle income countries, primary education is universal, and secondary education expanded rapidly-higher education has lagged. Malaysia's university enrollment at 11 percent falls behind other East Asian countries-60 percent in Korea and 35 percent in the Philippines. At the same time, over half of public spending on tertiary education goes to the better off. But there are other challenges; regional disparities in social indicators persist and inequality has been on the rise since 1990. Moreover, as typical in an increasingly modem and globalized economy, social protection and health care face new risks as income rises, population ages, and new disease patterns emerge. 4. This is the first Public Expenditure Analysis (PEA) since 1992. Its objectives are to analyze fiscal issues arising from the crisis; gauge the government's public expenditure management system; and assess performance and future challenges in education, health, poverty reduction, and infrastructure. The PEA complements the Structural Policy Review (SPR) of 1999 which covers key challenges for short-term recovery and medium-term growth in the social sector, financial and corporate sector, governance, and macroeconomic policies, including a post-crisis debt sustainability analysis. Responding to the Crisis 5. The economic and social impact of the crisis deepened in 1998, although less than initially feared-the economy contracted by 7.5 percent and a quarter of a million people became newly poor. The financial and corporate sectors became vulnerable as non-performing loans rose. The crisis has also jeopardized the financial viability of many privatized infrastructure projects. The government has taken a proactive role in managing the crisis. Its National Economic Recovery Plan (July 1998) aimed for quick recovery through fiscal stimulus, plus loosening monetary policy to increase aggregate demand; fixing the exchange rate and imposing selective capital controls to stabilize the currency; providing social protection for vulnerable Malaysians; and restructuring corporate and banking sectors to restore business activity. The government is also reviving privatized infrastructure projects through the Infrastructure Development Fund. At the same time, prospects for the future are improving-growth reached 5.4 percent in 1999 and is expected to average 6 percent or more in the following two years. 6. The crisis and its remedies have immediate implications for fiscal management: Will the fiscal stimulus undermine medium term sustainability? How large are contingent liabilities arising from infrastructure projects (and financial restructuring) and what can be done about them? Is the existing safety net adequate to support the social impact of the crisis? 7. First, the fiscal stimulus was necessary to halt the contraction in aggregate demand-it may have represented the only significant positive stimulus to aggregate demand in 1998-and will not undermine medium term fiscal sustainability thanks to good initial conditions of fiscal surplus and low public debt (see SPR, 1999). Malaysia has correctly focused the fiscal stimulus on increasing public expenditures for infrastructure projects that have strong linkages with the economy and a short gestation period; and on reducing income taxes. However, despite stepped up development expenditures during 1998, the deficit of the federal government was smaller than planned-2.1 percent of GDP instead of 2.6 percent. This reflects higher-than-expected tax revenues and delays in project implementation. The appropriate mix of tax reductions and expenditure increases could therefore be revisited to maximize the efficiency of the stimulus. Moreover, the government may consider applying its balanced current budget rule over the - i1 - business cycle rather than yearly in order to allow greater flexibility during recessions without undermining fiscal discipline. In 1999, the budget deficit rose to 3.6 percent of GDP. 8. Second, the crisis has increased the likelihood that contingent liabilities from privatized infrastructure projects become actual liabilities. To reduce its financial exposure, the government has responded by deferring and scaling back some projects and by negotiating the workout and financial restructuring of others. The government's overall approach to manage contingent liabilities from infrastructure projects during the crisis is appropriate to restore confidence and vigor to the economy; however, its implications for the medium term must be recognized because it adds new contingent liabilities. Therefore, decisions to support specific projects could be better guided by two considerations-minimize the burden on the government and maximize efficiency. For that, the government's financial support of ailing projects needs to be rationed to projects that can reasonably achieve long-term self-sufficiency and made in the context of a long-term strategy for each sector that enhances competition, while ensuring network coordination and integrity. Some projects may never regain economic viability, even allowing for sunk cost, and may have to be completely re-appraised. 9. Third, Malaysia has managed to cope with the social impact of the crisis so far, in part because of good initial conditions and a strong built-in safety net mechanism. The solid foundations of the existing network of free health and basic education have remained virtually intact and helped cushion vulnerable groups. Price controls for selected food items-although inefficient as an income transfer-were strengthened, making basic foods more affordable. Flexible wages and repatriation of migrant workers buffered the social impact of the crisis by maintaining low unemployment. However, the scope of the public safety net programs could be further expanded during the crisis. The government took specific measures to mitigate the social impact of the crisis by enhancing income-earning opportunities (micro credit to urban and rural poor, and training to retrenched workers) while maintaining expenditures on health, education, and its existing safety net program. But these measures may not be sufficient because the number of poor has increased, the face of poverty has changed (the new poor are largely urban), micro credits typically do not work well in a recession and may not reach the needy, and international experience with training programs is generally disappointing. The crisis has caused greater hardship for the urban poor and safety net programs will need to be designed carefully in order to provide protection where it is most needed. Furthermore, income transfer programs would provide temporary relief whenever such crises recur. Public Expenditure Management 10. The Malaysian public expenditure management system performs on par with international best practice as exemplified in a few OECD countries. This is due to extraordinary efforts by central agencies to improve the system over the past 10 years through fiscal discipline, allocation of public resources to strategic priorities, effective and efficient use of public resources, and accountability for the use of public resources. The Modified Budgeting System (MBS), introduced in 1989 and recently implemented, provides greater managerial flexibility and accountability to the public management system, and is being used in some developing countries as a model. Malaysia is also undertaking a self-evaluation of the IMF fiscal transparency code. But Malaysia could further enhance its public management system by better integrating off-budget liabilities in the planning, performance, and budgeting process; and by improving performance management and strengthening links between Cabinet policymaking and the budget process. - 1v - 11. First, Malaysia could improve its off-budget public expenditure management through a more comprehensive fiscal planning and reporting system. Fiscal prudence is ensured through a balanced budget rule for operational expenditures, and top-down setting of spending targets that enables the Treasury to control aggregate spending effectively. But fiscal planning focuses on the cash flows of the central government-a framework that gives too little attention to the government's financial assets and contingent liabilities-and could be extended to the consolidated financial position of ministries, departments, statutory bodies, and corporatized public entities; it would also require a clear understanding of the contingent liabilities arising from guarantees issued by the government. Public accounting and financial and performance reporting systems are solid-Malaysia has an Accountant General's Department with adequate accounting standards and information systems, an Auditor General's Department that applies internationally accepted auditing standards, and a Public Accounts Committee that scrutinizes the Auditor General's reports to Parliament. But public accounts could be expanded to strengthen fiscal discipline by including: a consolidated financial position of ministries, departments, statutory bodies, and public corporations; a consolidated financial statement of all contingent liabilities of the federal government; and the full cost of transfers to statutory bodies and public corporations. Performance reporting systems, which cover the performance of ministries and departmental entities, could also be applied to statutory bodies and public corporations, and their performance could be covered in the strategic plan of their controlling ministry. 12. Second, Malaysia can achieve better resource allocation by forging a stronger link between the Cabinet's priority and the policies financed by the budget, through some changes in the budget process. The public expenditure management system includes procedures and incentives to ensure that ministries reflect national strategies in their policies and programs. However, chronic supplementary budgets necessitated by the Cabinet's introduction of policies during the fiscal year signal a weak link between the Cabinet's policymaking process and the budget process; the Cabinet does not guide the budget process until the very late stages. Introducing a procedure early in the budget process in which the Cabinet identifies its priorities and announces them publicly in a budget policy statement might help increase its ownership of the budget process. 13. Third, Malaysia can also deliver better public service for less money by enhancing the performance incentives of public sector and nondepartmental agencies. The Malaysian administration developed excellent initiatives for improving performance management by public sector entities-the Program Agreements under the MBS established between the Treasury and line ministries during the budget process to identify performance expectations, the Exception Reports prepared by the ministries to report variations in performance outcomes to the Treasury, and the Civil Service Improvement Circulars aim at promoting and enforcing various aspects of effectiveness and efficiency across government agencies. However, these initiatives are perceived by most public sector managers as regulations; their implementation could be improved by strengthening the strategic planning process in ministries and their departments. Future Challenges in a Modern Economy 14. Malaysia's outcomes in poverty, health, education, and infrastructure have been outstanding. The government is addressing remaining issues-such as regional disparity in social indicators and rising inequality. It is also preparing to meet the second-generation challenges ahead, arising largely from Malaysia's advanced level of development and its ambitious goals of Vision 2020. These entail a rethinking of the government's role in tertiary education, tertiary -V- health care, social protection against income risk, and infrastructure. In all these areas, there is a potential role for the private sector in provision and financing, and the government's role is gradually shifting from being a provider of these services to a financial supporter and a regulator. In this evolving public-private partnership, the goal of the government is to reduce the fiscal burden while ensuring equity in delivering public services and efficiency in allocating and using public resources. 15. The most advanced sector in this process is infrastructure, where "privatization" backed up by government support began a decade ago; but Malaysia could learn from international experience in infrastructure strategies that will improve the viability of projects. In tertiary education, there is a need to expand supply and corporatization of universities is underway; but this needs to be accompanied by a better financing system for students to ensure greater accessibility and equity. In health, the government has been contemplating for over a decade the corporatization of hospitals and the introduction of a national insurance scheme; this is a complex issue still debated among OECD countries and there is no perfect solution. In social protection, the role of the government as a guarantor of income risk is debatable; many countries like Malaysia do not support a Western type of social protection, such as unemployment insurance, and are looking for alternative mechanisms. 16. Education. Malaysia has achieved universal primary education and doubled secondary enrollment, but despite recent increases tertiary education has lagged compared to other East Asian countries. The government intends to increase tertiary enrollment from its current level of 11 percent (excluding overseas students) to 40 percent by the year 2020. This presents a policy dilemma: while enrollments in higher education need to grow substantially if Malaysia is to remain competitive in world markets, costs of providing education are steep-up to RM18,500 ($5,000) per student per year depending on the subject-and the current subsidy goes disproportionately to the better off. The lags in tertiary education are partly due to insufficient qualified secondary education students and partly to insufficient supply of institutions. To resolve the first constraint, the quality of education is being revisited and additional emphasis is being placed on the sciences. To resolve the second constraint, supply of tertiary education needs to increase. Some of the expansion of tertiary education would come from private universities, but public universities will also need considerable expansion. Since a general tertiary education subsidy is inequitable and inefficient, financing becomes important. Malaysia could adopt progressive, fair and efficient reforms by raising university fees while expanding the grant and loan scheme to students. If Malaysia succeeds in implementing its reform agenda, it could become a world leader in education policy. 17. Health. Malaysia built a public healthcare system that is comprehensive, efficient, and inexpensive. Improvements in health indicators have soared since Independence, outperforming most developing countries-infant mortality dropped to 9 per 1,000 live births, from 75 in 1957; and maternal mortality is down to .0.2 per 1,000 live births, from 3.2 in 1957. These impressive outcomes have been achieved at low cost-national health expenditure is around 1.5 percent of GDP, lower than the average for middle-income countries. Increasingly, private healthcare serves the rich so that public expenditures on health are captured mainly by the poor. Despite these achievements, important challenges remain. There are regional disparities in health outcomes and health expenditures; new patterns of disease are emerging and would require more preventive care; and there is a shortage of public doctors. Moreover, Malaysia has, in common with the rest of East Asia, contemporary problems such as aging populations and increased chronic illnesses. Recognizing the need to enhance the efficiency of health services and retain - vi - qualified personnel, the government is undertaking the corporatization of hospitals, while further strengthening its regulatory and enforcement functions. 18. Social protection. Malaysia has an enviable record of poverty reduction but as it globalizes it is becoming more vulnerable to external shocks. The government's philosophy of social protection is to build human capital by providing universal basic education and healthcare, selectively grant low-cost housing, improve infrastructure (especially in rural areas), provide income-generating schemes to the poor, and limit income transfers to the hardcore poor or unemployable poor. Over the past 25 years, poverty shrank from over half of the population to about 8 percent (using the national poverty line, equivalent to $2.5 per day). Public interventions in Malaysia have largely focused on reducing the vulnerability of low-income households; but the recent crisis has shown that globalization increases income variability for all. This raises a new role for social protection: helping individuals better manage income risk-from unemployment, disability, sickness, and other shocks-through labor market policies and educational training, pension systems, and disability insurance. Malaysia has a productivity- linked wage system that provides flexibility in the labor market, retrenchment benefits, and a pension system that covers all employees in the formal sector, army, and civil service. The crisis has shown that, to a large extent, Malaysia's safety net is resilient to such shocks. However, safety net programs that grow automatically with a crisis-such as urban workfare programs and additional school meals-can be implemented to allow greater flexibility during crises. 19. Infrastructure. The quantum leap achieved in infrastructure expansion over the past decade came at a cost. The Malaysian strategy of rapid deployment with substantial government support had merit in the earlier phases of privatization when there was a need to quickly mobilize private capital. But it created structural inefficiencies-weak policy framework and planning process caused inefficiency in technical review and missed opportunities for system integration; lack of competitive elements likely increased project cost though allowed faster process; public- private risk allocation in concession provisions increased government exposure; lack of transparency in awarding concessions reduced public confidence; and lack of technical monitoring and feedback of government's exposure into decision-making at the macro- investment level and project selection level threatens long-term effectiveness of government's investments. As privatization has become a more pervasive feature of Malaysian infrastructure and the overall economy has matured, rapid speed in awarding contracts needs to be balanced against longer-term goals of ensuring project sustainability and minimizing cost to the government. For that, serious consideration should be given to the market structure and the possibilities of competition; a regulatory system that provides incentives for cost minimization and is credible to the public; and a contracting process that is transparent and efficient. Malaysia is gradually moving in this direction. In addition, the infrastructure provision and financing strategy could benefit from international experience (see Matrix). - Vii - POLICY MATRIX Objective Policy Measures Public Expenditure Management Maintain fiscal discipline * Extend fiscal planning to the consolidated financial position of central government, statutory bodie and public corporations; and to contingent liabilities. * Follow a multi-year balanced current budget rule. Ensure public accountability - Expand public accounts to include statutory bodies and public corporations, the cost of subsidie. for public resource use extended to them, and contingent liabilities to privatized entities. Allocate public resources to * Identify Cabinet priorities early in the budget process and reflect them in medium-term strategic plans strategic priorities of line ministries. Ensure effective and * Strengthen the strategic planning process in ministries and their departments and extend the efficient use of public performance management to nondepartmental public entities. resources Health Enhance resource allocation * Spend more on medical staff, broaden the scope of preventive care, and achieve better balance acros: states. 0 Raise resources by reassessing entitlements to free care, adjusting fees to better reflect costs, and introducing copayments. Improve the public-private . Promote and regulate the private sector. partnership 0 Reduce the cost of privatization: for outsourcing, revise the legal and financial framework of existinE contracts, and increase competition for new contracts; for corporatization, reduce the wage bill an review pricing for civil servants at the National Heart Institute. Education Increase the supply of * Provide loans to students with a potential to increase fees. higher education in a cost- * Expand the tertiary education system and improve secondary school retention rates. effective manner * Extend the availability of loans to private university students. * Encourage private banks to provide loans for university education by providing loan guarantees. Social protection Reduce rising trends in * Continue to allocate larger budgets to states that lag behind. inequality * Ensure that low-income people build adequate skills to participate in growing sectors. * Continue to use consumption-smoothing over the lifecycle for all households through labor marke policies and educational training, pension systems, and disability insurance. Manage social risk * Design income transfer schemes that can expand easily during crises and are more targeted to urbar areas. Infrastructure Improve financial viability * Consider alternatives to the Build-Operate-Transfer (BOT) toll road model, such as network-based of toll roads regional transport utilities. * Review toll formula provisions to provide for more stable and reasonable rate increases. Improve financial viability * Create an urban transport fund and finance it through securitization of new revenue sources, such a and investment efficiency of gasoline tax surcharge, area road pricing scheme, and parking taxes. urban transport . Create a Strategic Authority to strengthen multi-modal planning, implementation, and regulation. Improve the financial * Combine water and sanitation services. viability of sanitation a Split the concession area into distinct jurisdictions to promote competition. services a Use incentive regulation, such as price cap, to limit costs instead of guaranteeing rates of return. Increase competition and * Unbundle the sector into generation, transmission, and distribution; introduce a strong regulato efficiency in power supply framework; and allow free entry in power generation. 0 Create and operate an independent system operator. * Regulate distribution rates through a price cap formula. Strengthen the planning * Shift the planning process for project selection from quantitative targets to needs assessment. process 0 Rank projects based on realistic criteria for economic return, including consideration for risk exposure. a Increase the role of line ministries in project definition and concession negotiation. Move technical reviews forward in the review process to ensure adequate project evaluations and cos estimates.  1. RESPONDING TO THE CRISIS 1.1 After initial resistance to the regional shocks of 1997, the economic and social impact of the crisis deepened, although less than initially feared. During 1998, the economy contracted by 7.5 percent after more than a decade of 9 percent annual growth. Unemployment increased from 2.5 percent in 1997, technically a full employment level, to 3.4 percent by December 1998 and remained at this level in 1999. Inflation was contained at 5.4 percent in 1998. Poverty was on the rise-at least a quarter million people became poor in 1998, reversing two decades of continuous decline in poverty. The financial and corporate sectors became more vulnerable-non-performing loans reached 11 percent of total loans by August 1998 (by December 1999 non-performing loans stood at 11.1 percent on a 3-month basis, and 6.6 percent on a 6-month basis). The crisis also jeopardized the financial viability of many privatized infrastructure projects. 1.2 These events posed unprecedented challenges for the government of Malaysia. The government recognized the necessity of making fundamental shifts in policy and took a proactive role in managing the crisis. Its National Economic Recovery Plan (July 1998) aimed for quick recovery by using a fiscal stimulus plus loosening monetary policy to increase aggregate demand; fixing the exchange rate and imposing selective capital controls to stabilize the currency; providing social protection for vulnerable Malaysians; and restructuring corporate and banking sectors to revive businesses. The government is also reviving privatized infrastructure projects through the newly-established Infrastructure Development Fund. 1.3 The crisis and its remedies have serious implications for fiscal management. First, the fiscal stimulus strategy is necessary to help pull the economy out of recession but it carries some risks: it creates a higher government deficit and there is a risk that it might not work while the debt to GDP ratio builds up. Second, contingent and off-budget liabilities in infrastructure projects have complicated fiscal management. The crisis has lead to widespread liabilities for the government from infrastructure projects (estimated at around 4 percent of GDP, with an upper bound of 11 percent under a high-risk scenario) because their viability has deteriorated as a result of the crisis through costs rising and revenues plummeting. Implicit and explicit contingent liabilities arising from the financial sector restructuring (purchase of non-performing loans and recapitalization of banks) are also very large-estimated at around 10 percent of GDP, with an upper bound of 30 percent under a high-risk scenario (see SPR, 1999). Finally, the government is mitigating the social impact of the crisis. However, for the last 25 years or more, it has relied on growth to reduce poverty and it was unclear at the onset of the crisis whether the existing safety net could meet the new social needs. 2 A. THE FISCAL STIMULUS A New Economic Reality in Malaysia 1.4 From a surplus of 1.9 percent in 1997, the federal budget was expected to show a deficit of about 2.1 percent of GDP in 1998 and 3.6 percent in 1999 (Table 1.1), excluding off-budgetary expenditures to recapitalize the financial sector and meet the government's liabilities in privatized infrastructure projects. The deficit would result from a decrease in revenue (about 14 percent between 1997 and 1998) and an increase in development spending (of about 15 percent between 1997 and 1998). Revenues would drop primarily because of the recession, but the fiscal stimulus would also contribute by reducing the corporate profits tax rate and other measures. Despite stepped up development expenditures during 1998, the deficit of the federal government was smaller than planned-only 2.1 percent of GDP-reflecting higher-than-expected tax revenues and delays in project implementation. The deficit will continue until the economy emerges from the recession and returns to growth of 4-5 percent. This may take a few years. The debt to GDP ratio may reach 50-60 percent by the year 2000 (including financial restructuring and contingent liabilities on privatized infrastructure projects), from 32 percent at end 1997. The rising debt will impose tradeoffs on policymakers- between the size of the stimulus and the size of the primary deficit, and between domestic and foreign debt financing. Therefore maximizing the effectiveness of the fiscal stimulus is crucial. Table 1.1: Federal Government Spending and Revenue, 1996-99 RM billion 1996 1997 1998 1999, Revenue 58.3 65.7 56.7 58.7 Direct taxes 25.9 30.4 30.0 27.2 Indirect taxes 21.4 23.2 15.3 18.1 Other 11.0 12.1 11.4 13.3 Expenditure 58.5 60.4 62.7 69.3 Current 43.9 44.7 44.6 46.7 Development 14.6 15.7 18.1 22.6 Surplus/Deficit -0.2 5.3 -6.0 -10.6 as % of GDP -0.1 1.9% -2.1 -3.6% Total Debt as a % of GDP 35.9% 32.6% 36.2% 37.3% Domestic Debt as a % of GDP 31.7% 27.9% 31.0% 31.3% Foreign Debt as a % of GDP 4.2% 4.7% 5.2% 6.1% 1. Preliminary. Source: Economic Report, MOF; Bank Negara. 3 Box 1.1: From Fiscal Surplus to Fiscal Deficit The successful fiscal adjusrtment stratcg% o%er Yhe past decade led to fiscal surpluses and sharp debt reduction (Figures I and 2) This is lke) to be rc% cried. however in the aftermah of the crisis Mien the 1998 budget was formulated in October 1997, economic growth was slaower but robust Then a maior concern u.s the continued deficit :n the current account position of the balance of pa,ments arising from insufficient national satings to tinance capital furnation. Aeaist this background. the fiscal stance had to be prudent to enlarge the stock of national sa%ngs. which the proi.re sector could then mobilize to finance its inestments and reduce is reliance on extcrnal resources Consistent with this obiective. a surplus of 3.2 percent of GNP was budgeted for :99S Restrictive fiscal polity atfirst.... In lizht of the impact and potential risk. of the financial crisis, the fiscal policy continued to aim at reducing the balance of paymcnis current account deficit which had been a drain on the country's external reserves Thi. required a cutback !n domestic demand. particularly goods with high import content. A se"ere drop in projected revenue for 1998 required a sharp cuiback in public expenditure to maintain a budgetary surplus. Consequently, in December 1997, the government innounced further e%penditure cuts in 1998 of at least IS percent, with in immediate 10 percent cutback cross the board on both operating and de'elopmcni expenditure, and 8 percent discretionar, cut: In March L198. to mninmi.-c the impact of the eConom.c crisis on the %ulnerable groups. the go.emment .llocated in addional R1 I billion for >.fety ne' projects ..then erpansionary. Hovecr. by the second quarter of 199S it was clear that the concems underlking fiscal restraint no longer pre%ailed-the current account position of the balance of pa,.ments recorded a surplus in 1998. partly due to impon reduction measures and part!R due to contracring domestic demand from the crisis Then the priority became re%itaizin domestic economic actmi.tics through fiscal stimulus In JulN 1998. the go,cmment announced an additional RM7 billion for development cxpendirurc (also to partly finance Danaharta. the new asset management companyt To pro%ide maimum stimulus to economic growth, the projects selected had to have strong linkages wi th the economs, minimum import content: short gestation period, and capacity to enhance the efficiency of the economy. Priory was gien to poterl alleiatnon projects, such as housing, rural declopmenr. and social sectors Mea:ures kere introduced to stimulate pn%atc sa%ing. including increased a deductions on the voluntar- contribution by employers to the EPF. and reduced corporate tax from 30 percent to 28 percent. F:gure i fotl debt to GDP rativ Fi ure 2 Prinar, deficit and is trend er't percent of GlJP 120 15 100 10 80 400 20 - 21 -20 1?'( #9q3 117 19q 1182 1385 138q? 1o31 134 199' Soure Bank Negara Fiscal Stimulus: Effectiveness and Risks 1.5 The fiscal stimulus strategy raises some critical questions for fiscal management: * Will the fiscal stimulus restore growth? * How can its effectiveness increase? * How will the fiscal stimulus affect fiscal and debt sustainability? * How will the deficit be financed? 4 1.6 First, easing fiscal policy is necessary to restore growth but not sufficient. The dangers of allowing the recession to continue argued for an expansive fiscal policy to stimulate demand. Large declines in private investment and consumption and little export growth during 1998, meant that the countercyclical measures were the only significant positive stimulus to aggregate demand in that year. The 3.6 percent fiscal deficit for 1999 provided a stronger fiscal impulse. Easing fiscal policy is thus crucial to halt the contraction in aggregate demand, although alone it cannot restore growth. 1.7 Second, Malaysia has correctly focused the fiscal stimulus on increasing public expenditures for infrastructure projects that have strong linkages with the economy and a short gestation period and on using tax cuts that have an intertemporal price effect (Box 1.2). The temporary cuts in expenditure taxes are more effective in raising aggregate demand than cuts in income taxes since they bring future expenditures into the present, by reducing the cost of current spending relative to those in the future. Malaysia used this phenomenon to advantage at the end of 1998-the temporary tax cuts on house and auto purchases provided a substantial stimulus for sales. Another example is the temporary investment credit used periodically in the United States-businesses purchasing new equipment subtract a fraction of its cost, the credit, directly from their profits tax bill, but only for a specified period. This reduces their tax bill-the income effect-but it also provides an incentive for moving future investment spending into the present. Box 1.2: %%hen Does Fiscal Stimulus Become Ineffective? A recent paper by Paul Knigman I o9 resusc:ates and moderni7es the idea of a hquidir. trap in which c%pansionarv moncrar- puic i:. ineffecuri L The core of his argument is thai if tht polic) is expected to be rc%crsed due to the Central Bank*s determination in inillation-fighng. it will not reduce real nteresi rates by creatim_ the expectaton of a penod of inflation. In that case, thc short- run poic w&ould be nef'ectue n stimulaung output KIrugman advances this arlaument Ln an analysis of Japanese nonetarN policy. His point is that the monetart expansion should be seen to be permanent. so the price lvtel is expected io rise .A similar point can be nde % ih respe.. t to iiscal epansi,n in Mala,sia. The public must percenc the new level of the debt to GDP ratio as sustanable If they anticipate that taxes %wIll be raised in the future to reduce the debt. their conSUrnpnon spending ind ie.tments would drop and the ta\ would go mainl into sa% iiS. 5,,urcc Paul Kr.iyman, Ir . eat . a ,'t.n.p and M/c Rcul,ern.- !.q.J:rn Trap Brookings Papers on Economic Act. .. I'% 1.8 During 1998, however, the fiscal deficit fell short of the target because of higher- than-expected tax revenues and delays in project implementation. To maximize the effectiveness of the stimulus, the appropriate mix between tax reductions and current or development expenditure increases could be re-assessed. Malaysia could also consider a more flexible rule of keeping its current budget balanced over a business cycle rather than on a yearly basis to better counter recessions. 5 1.9 Third, medium term fiscal sustainability can be achieved. The primary fiscal balance required to stabilize debt to GDP ratio at 60 percent depends on the gap between the real interest rate paid on debt and the real growth rate of the economy. Even if the real interest exceeds real GDP growth by 3 percent, Malaysia can stabilize its debt to GDP ratio at 60 percent by running a zero surplus on the primary fiscal balance, net of seignorage revenue (see SPR, 1999).1 1.10 Fourth, the authorities intend to finance two-thirds of the deficit locally. The deficit could partially be financed abroad at concessional rates (mainly from Japan). Excess liquidity in the banking system means that the balance can be financed domestically without any significant effect on interest rates. In the medium term, structural reforms in the financial sector, but also in infrastructure and human capital provision, would increase efficiency and growth, permit movement towards budget balance, and help reducing the debt to GDP ratio and its financial burden. B. MANAGING CONTINGENT LIABILITIES IN INFRASTRUCTURE 1.11 The crisis has brought to the fore the issue of contingent and off-budget liabilities, mainly arising from "privatized" infrastructure projects but also from financial restructuring. Over the past decade, the government has been highly successful in its strategy to mobilize private sector capital and skills to supply and operate infrastructure services with government support. However, direct and contingent liabilities (Box 1.3) to the government have remained large. The crisis has increased the likelihood that contingent liabilities in infrastructure projects materialize as their viability declined, and has complicated fiscal management. How Bad is it? Government Exposure After the Crisis 1.12 Weak demand (from the recession but also from over-optimistic projections), a growing reluctance to pay for services such as sanitation or toll roads, and financial Figure 1.1: Contingent liabilities in Infrastructure Before and After the Crisis, 7th Plan. Average expected cost * Before crisis gAfter crisis Unexpected cost Benchmarks: 1998 Health budget 1998 Infrastructure budget 0 6 12 18 RM billion Note: The figures are based on the average and unexpected cost to the government as the share of project cost estimated in figure 1.4 and applied to the total private investment in infrastructure (road and rail) during the 7th Plan. Source: World Bank staff calculations. 6 distress from higher debt burdens (due to Ringgit depreciation and higher interest rates) have caused serious difficulties in Malaysia's infrastructure projects. The nature of the existing private/public partnership caused a large share of the burden to become the government's liability. The government's financial exposure from existing privatized infrastructure projects, both contingent and realized, is substantial and has not been wholly evaluated or quantified. 1.13 Box 1.4 shows illustrative estimates of the government's exposure to two light rail projects, one toll road project, and one power project. The estimates are based on continually evolving assumptions on revenues and costs and so they need to be interpreted with caution. However, they do show that the crisis has had a significant impact in raising the government's obligations. If these projects are representative of other transport projects, the average expected costs from all such projects could be around RM7 billion (Figure 1.1); the unexpected cost could be around RM18 billion.2 If the government were to appropriate the full amount of its financial exposure (that is, 100 percent of its average expected cost) upfront, as is done in the U.S. in the form of a special fund, it would be equivalent to twice Malaysia's 1998 health budget. 7 Box 1.3: Contingent Go,ernment Liabilities: a Hidden Risk to Fiscal StabilitY Recent cpecriences hate shown that major hidden ibcal risks are associated with contirgent giernmL nit liabillic- Therefore. fiscal adjustment that targets deficit and debt reduenon does not preent fiscal instabilit% All ourCe: 0I fiscal nsks must be addressed if gu%ermments are to ivoid sudden fiscal instabilr% and reali/c their '.'ng-ter' pulic-, objec,i% es There are fu,r r.pe of Lihabilities direct and continenr, each of w hich eiLher c %pli.it or MPlII Dir c liabduiN are obligations that will arie in an:. eent [he- .jrc predictable .according t. specific underlN i CIg c nm:c .a policN factors Contingent liabilities are obhations th.i are triggered b a pancular dILrete e.Cnl which ma-, rI may not occur The probabiliv, of conringenc to occur and the maeitude of The required public oulla., .arc clogenous ic g . the occurrence of a narwil disasteri or endogenous (e a implications of market inst.tut:ons arid of the design of go%emment programs on moral hawrd in the marketsi to govemment policies Explicit liabiiico Lrc specific go'ermient obligations defined by law or contract The go%emment is legalib mandated !o'.cuk .;ch an oblgaton when it becomes due implicit iabilities represent a moral obliganon or an expected burden of the,2 government not in the legal sense, but based on public expectations and political pressures Based on these charactertsucs, there are four t)pes of fiscal risk * Direct explicit liabilities are the main subject conventional fiscal anal.,sis The rep.mer.i Of sO.erCg. dLbi expenditures based on budget law in the current iscal year. and expenditures in the lon. tern :-or lcgallk mandated tems. such as ci%il ser.ice salaries and pensions. arid in some countncs c%.n ihL o%crall ioCra gecurity system * Direct implicit liabiluzics often arise as a presumed consequence of public ckpendiure poicies ir 1hL liri--r term Gi%-en their implicit nature. these obligations are not captured in g%emrnLnt balane hCts Tp:c..I.. Ehcy are h:gh for demographicall, dnisen cpenditurcs For example. n a publ:c p.\-ass;ou-zo Fhrie, ruturi, pensions constitute a direct impltctt liabilit\, the sie of which relects the expecied cencrosit. of and eli!ibili . for a benefit. and the future demographic and economic developments * Contingent explicit liabiliries are government legal obliation to make a pament ord if a particular cee kccurs Since their fiscal cost is insmible until the\ are triggered. the\ represent a hidden subidy., blur tical anal)sis and drain gosemiment finances in the future Therefore, stare griaranei and finarcin throu1h 5ucc- guiarLantc instuio.is. look politicall more artractisc than budgetarn support c'.en if thec, are more e\ptn-. later In the markets. continicni go%ernment obligations ma-, im mediatel> caC moral h.j.ard. pticularl. if ic os%ernment guaranCes the whole rather than a part . the underly. aSsets, and al risks rAher Lhin e,klJci p0ltITcal and'or commercial risks .S'! ittIranc SChILMO.% often co%cT unin%urable risks of ir.frequen uses that are enormous in total magnitude Thus. rather than financine chemnselli from feeU. tIcs redg.ribut wealth and relh on zo'ernent net financini * Contingent implicit liabilitires are not officially ricognized untit alhr a failure occurs The In..Len4 c. nt, the salue . nsk. and the required size of government outla% :are uncertain In mo.t couniic. 1.v fdit,niu! i'..Ii represents the most serious contingent implicit go'ernment liabL:it E%periences ha.e indicaced natr markcts expect the go% eminent to help financally far beond its IeLal obligation if stbiliry of thc financiu systern is at risk Fiscal authonries are often compelled also to co%er the unceered Incses and oblb.taioriE of the cenral bank, ge.-navn i w.*rrnmranS. stah-Mr.4J and large pril.. -crprOs, budg.ter and .ttrra-b.dgLtmn agn.ws. and an) other institutions of political significance Contingent habilities rise wih weakno,es in he macrocconomic framework, financial sector. regulator and supervisorN s:Stems and information d,sclsureI the markets HVuh pmate capital flo.s. for instance such v.e'aknesscs deate the nsks in assets valuation. interediation and borrow inz beha, tors in the markets Source HaLna Polackosa. Co.nungent Liabilries 1 Threa i,. bLI stabhi, World Bank Prem Nte . 8 Box 1.4: Estimating Government Exposure in Infrastructure Projects .i Jn m. : rL'01.1fnwt tj, . . h, i. p li ' r,j i. li,r . i. ,. t P rx , . n ,: ,i', K--ImIWm r tjhw PIh: finaln,wa: ro lm lcdb iri- ponaHii-i pr.iLl, gee.i ls r,i l,,, miar,:k, FirNt. in jpllmi-ýuek utl,Ook )n dkLopm.ni which diJ nm dect-ounL iir psibie Junide risks The recen cnomi :nJ financial Jon:urn thus LJ lo sdr Jeparture. lT'm oriiinil rin.mngirueure, .e they nere unhedged [o currenec, e\poxsre. charlLs in inr2.t r.lew md Jeeinc in &rnuind 'ecinJ. ier .pti ridership forca.-and hene. re enue force..e,t» -at h. iin n i .e pr;i.tL. riJer,hip øic'. rtel had t be rei.d e er pner l th.e cri., Fah dow% nw%arJ re, :z,n r[..c thjs m o t %cr:m nni b1,nt l Riders,hip dc,;1miwd :urthier stjh th.e eu Lrentec nmil, muon)l ---rescn! djJ.. r:J,r>hip sZaX I f or :.e li A rad ii, has i j,er.red aliui hall ihe break-esien lecl lhe geo..rnmr. bear i mv..ch o the .ir.cr adr,(4 indrc mmLrcI Tik :. n,iens Iit. abilii.. t termlate r. crtrained b-- guarantec. it prouJ.. ,in pnq[cc debt .ind. in >e - , in return un equt. rhe liIelihod and e-,t,n n f pre' e j.reulu. are h:-,h[-, sent e idrsh p and cTairic1.us which d,erne re%crue 1-ur liht rail proci ,umsurnn .ijrent riJerhip drwp to half ihe mosi recni g)o,ernmernt projecltions Junng the ihe gr,n graduail: imrrc, atte, Ihe Lr . th1, .2 age QL- to ihe ZsnMLe TI uld m.rca.:, frum 34 pLrkCn[iIt itbut i percell t,[ 1.1dl pr,je.c *. .,nih: r*il pr-jj.ct aid [røm 7 pLccn to 311 per,eiiut ofotal prt.eic eo :n anii,h,:r ihe 95' p,r.n,L,nn sho tht ih un,,pc,te:J co,t ILhat is. the ,-s ;ih 0lu prbabIIlht ol o.urr:nI i.wkh:h h.iLhlghf pteni; al suInerau.bu . aIlsI nS; suLitanuall "hc dediciied highuýay prejeci perrirn %e:ler th.:; ih. :ihi r-il prlx \arone 5i prereii le r ali, th!rn pr,-:,id h, [h, project and 12r:c re1 r .rek-. r . rr,. 1th : erau: -l th,: g', Crnm n i,ril h,e 3r,un.J ]in ner,en[ Ol ihe 1,11d prtleei- irirm a1 res : ee of ;ir, ri t.ø t. ris Government Epmisure in Seketed Transport Projects Under Three Reenue Scenarios Light Rail #1 100% of project revenue realized 70% of projected revenue realizedi 50% ofprojected revenue reaiized with ciradual recoverV Light Rail #2 100% of projected revenue realized N Cost at 95th percentile 70% of projected revenue * Cost at 50th percentile realized Mean cost to govement 50% of projected revenue feaized with qradual recovery Dedicated Highway Project 100% of projected realized 70% of projected revenue realized 50% of projeeled revenue rea[ized with radua recover -20 0 20 40 60 80 100 Govemment exposure as a percent of project cost Methodology: In estinating the govemrment's exposure, a Monte Carlo simulation approach was sed. The stochastic (uncertain) c:Lh k arL rL., prCIeeJ ni ih lu..urL Ie thuand l,nJ inc hundred jrn.; ; re run i'ndr IimL :cenr the p,r j 1.5 ec .r,nmicall jhk and n. -J:lult L.:cur-, 1'nder w..r .ndr.. th,: preject d-[f"lt .n l c ;-mmer. ial d,bt Lnd , lAken inr b, th. '.nmern ih, :umjted a%ced *nt I. [he *n.rnnant . te .uerag-: co.., ner .L thi -.enn u Th i 1 e. co1r. the SIrnmen¶ sal e ILp. t pak .,u[ ,n %; e:1. ..: Il seieral unt.r,abic ?actrs rc . e g Ian rider,h,p ard higher ihan Mr.tcpU- d CAL.. Lhen the p.a 1 n b'. l.i I h1, Jh l : .. unexpeckd li l dffned .u- ltk MunU pa.d Lut in thl 90 pef.rcenul : a l , there i, 1',.e pLr..cnl ..Jlnl-: Lie ILLh .L uI . i in ..ddii.n ku ti.:N %e :1 ur o "i .f pru.il .xaur the,, .,mmeru c..mni tte 4 u diJ, :ucjhj :,n isnr.i ral,,.jr., u.ich wOu]J need . he p d 9 The Response to the Crisis: Implications for Future Liabilities 1.14 As the contingent liabilities in infrastructure projects began to materialize, the government sought to inject new funds and facilitate financial restructuring in order to ease the immediate burden of debt repayment on concessionaires. The government's short-term strategy of rescuing these projects is driven by the aim of quickly restoring confidence and vigor in the economy and minimizing the fiscal burden from the contingent liabilities. However, the implications for the medium term must also be recognized-by extending its financial commitment to infrastructure projects, the government is taking on an increased financial burden, explicit or implicit. 1.15 To help finance ongoing projects, the Ministry of Finance has established the Infrastructure Development Corporation (IDC)-the infrastructure counterpart to financial sector entities Danaharta (purchasing/restructuring non-performing loans) and Danamodal (bank recapitalization). The goal for IDC is to secure up to RM1 1 billion in capital by 2000, although its funding targets are somewhat fluid as they depend on which projects are selected and their structuring approach. A RM1 billion has been raised to date through a short-term loan from Petronas (a public oil company). A RM3 billion loan from the Employers' Provident Fund (EPF) is being considered, part of which will be used to repay the Petronas loan. 1.16 It will be exceedingly difficult to access adequate levels of capital from non- government institutions, domestic or foreign, because revenue sources needed to service IDC's future debt obligations have not yet been established. Given the current economic situation and the nature of most infrastructure projects-which take time to generate significant levels of revenue-it is unlikely that cash flows generated from IDC's investments will suffice. Because of the difficulty in securing private capital, EPF and other government entities such as Khazanah, Petronas, and Tenaga will be an important source of funding. Since Danaharta and Danamodal are also likely to draw heavily upon the same government investment vehicles, the latter's risk profile will worsen measurably as their investments in troubled projects increase. This will raise the government's implicit contingent liabilities. 1.17 In addition to providing new funds for ongoing projects, the government is also scaling back and deferring certain projects, assisting with corporate workouts, and restructuring concessions and debt schedules to facilitate debt repayment over longer periods. The various financial restructuring options that the government is considering to support ailing projects are suitable but may increase its contingent liabilities. 1.18 First, the use of zero-coupon or other forms of deferred payment debt is aimed at providing near-term cash flow relief Although economic recovery would help repay the loans at a future date as project revenues ramp up, the approach also increases financial risk since the principal base grows considerably as deferred interest accrues, making future debt service more difficult. If the economy does not fully recover, the problem would worsen in the future. 1.19 Second, lengthening the concession term may also defer project financial obligations. However, in circumstances where long-term financial viability is in question, 10 the government will eventually either have to assume financial responsibility for the project or allow it to fail. 1.20 Third, another debt restructuring option involves the government forgiving all or a portion of its soft loans to a concessionaire in exchange for foregoing government guarantees of future price increases previously allowed under the concession agreement. Since this option involves trading future cash inflows (from repayments of soft loans) for a reduction in contingent liability exposure, the budgetary impact over the project's life would be neutral to positive. Such an approach provides the government with greater certainty about its liabilities while giving cash flow relief to concessionaires; but it should be undertaken in a balanced manner as it involves foregoing future revenue. Risk Management in a Crisis and Beyond 1.21 The government's overall approach to manage contingent liabilities from infrastructure projects during the crisis is appropriate; but because it adds new contingent liabilities decisions to support specific projects could be better guided by two considerations-minimize the burden on the government and maximize efficiency. 1.22 First, while continuing the government's soft loan and other financial support program is appropriate in this crisis context, its use should be rationed to projects that can reasonably achieve long-term self-sufficiency. Further, soft loans can be adjusted to incentive structures and management practices that reduce costs. For example, in the United States, a recently enacted infrastructure credit support program-the Transportation Infrastructure Financing and Innovation Act (TIFIA)-allows for subordinated federal loans, not unlike Malaysia's soft loans, loan guarantees, or lines of credit for public and private infrastructure projects of national significance. The TIFIA is limited to one-third of project costs and requires that the non-federally supported portion be financially viable, as demonstrated by an investment grade credit rating of a leading third party rating agency. Moreover, the government's participation must be budgeted. This approach is intended to encourage project development in cases where the private capital market is unable to do so on its own-because the project has a public good element and is not financially viable. 1.23 Second, new revenue sources could be raised. Increased petrol taxes represent a large and relatively inelastic potential revenue source, with positive transport policy ramifications. Malaysian petrol prices are among the lowest in the world and have contributed to the rapid rise of private automobile use. This, in turn, has necessitated huge infrastructure investments. The government has estimated that a modest ten sen per liter increase in the petrol consumption tax would result in about RM70 million per year. Other similar measures, such as higher vehicle registration fees and elimination of parking tax deductions for employers, could also be considered. 1.24 Third, as the government continues its efforts to reinvigorate the domestic economy, quantifying its direct and indirect obligations to privatized infrastructure projects is essential to calibrate and maximize the efficiency of the fiscal stimulus, and also to determine the extent of government borrowing or other financial assistance 11 needed to support existing on- or off-budget commitments. Full accounting of the government's support to infrastructure projects, should include direct and indirect obligations, direct and indirect guarantees, off-budget funding mechanisms, and existing system maintenance needs that need to be adequately budgeted for. A risk management strategy for the medium term could be developed (Box 1.5). 1.25 Finally, government decisions to support specific infrastructure projects need to be made in the context of a long-term strategy for each sector that enhances competition, while ensuring network coordination and integrity (see chapter 3). For stranded assets- assets that have been created or are under construction, and are not financially viable- such as some highway and urban rail projects, the government could assume all capital commitments and take over ownership of the fixed and operating assets, then issue new and improved concessions to operate them; while projects under construction need to be subject to more stringent oversight measures to avoid unnecessary costs or be completely re-appraised. 12 Box 1.5: A Risk Management Strategy for Contingent Liabilities \n m:lCeri:" r-k miarcn en pneiL t rrm t-r. r nne.pi i n.. orni /dentifing and L:ntroiiinr: the r kA.. \ I cate,: c t: ir ir i he \linisr r 3 f narc c-. ld bi mindaied t. record al , plic il iuiarartee, th.ir the Cee nT r ' : d - l rit tmg and ,i hi mi\ mnereel:, the ,,..rnml it'; debt IÉeue,ir. eir trpn,e~. ginea Ct J I f rid ifiminiJ. i riusmQ ,pranil 3r.J tni r 4.Qhj n oe,r.. : r scar:z ricu.urtin thh:ihest rk arei. im§ of earl:. - r nm. m .catnr,.:i'u .. i imp..rb..1r ,..'ld Le .ni ttd <' aro fo' r sarIr pri .nn '.' T.eaS..rc, Budg.ting and re.irting for contin.:enr habrit. Iie ir,t .tt. s mia.inn cn:me.n: Lhrbihue---th. probabilit that the i uarteit. kill hc ,aliJ ri the pr,m.ni r Nrcaron f,:hat happený The meauring rneihod can be jetuanal or econoimetri but the prelerncJ i; i the c,nL:r.gent cl.am, ana?st. uhich esien:ial', imulales differini sunfl.Uio' tia mi% anfold in , :uturi aid determiric, the p.:,inents required under th'e scenarius From this., thi esp.tc.c ind uepccted c.sr ar der.ed tie e\pected c')4t I uerage co- o. er ih: d:iferen: senariasi iiaure ihi lkeX pi..rin. thc kill imeur a-, sr, LeqU'ai .I t ih: subi, imph eI l- the ciance of the ;ruarante The unrtepei1ed cs r.prk..,rii ih, p l.mk.n e hl to be ineurred it the )' percinle iciose to the h:ghe;t pz; irint Hudee,nn i, r.s are iher , :e Frim pulic. pan: of i r'; thi e -pcteid '-1sa.stinmale can be u,ed i, iudge v.htther the n.rno.. ud :e w!nu th .ppar he p.:rileer ihr,uL. an equi.Aln cash, up front subl irJ. ELpa,t. J r. b i i ' * ..:d: ned n d;uz:: bLeker,.J [-r d ii.hu be nelued i.j r. te appr,opri ìnen rn.; L', iri contra: uns i ied ri ,: decl t:- bI. Pirnn a'de e ipital i- d a1 . it the c emn Budoutini ro: ,pat . I agu c. a..'.r . .deni ..aue Lcounii. .hien. i tu ir:ia:1 a mrd;u,rerr muin - .ear bude.t :rrnm..rn .rb-ba1 J h1.ien iici'.epr. wr'is ih. å: '*g.;a. opusre j..siciutcd .; ih canr suaintee. ni * iere ::aran:. prd.: and cec's pe' *rae 'etr. r fin ,elLcune one form cf fhanrieriL aSSsafCe o.er anoihen ikunder a cash-ba'ed :, icfni budettur. a I.rnmlir egate 1 ;hbudeerary coci o Ssum tin:ancial isIs:ance ; i' te -:. outi creaied b., the transaetrr in thi ,:urrent budget -,ear. thuQ. %khen i eo' ernment ;ssue.: j direct Ilr :he e. tre iae' .lu' ,: r th. luan ir h. date ih: lian -' isied is recordid as i oudgeiar. ct tih lan r.pantin:s recorJI..d a cash .nl-. in - .b;equen :,ear' ile loan 2uarine and insur:nce prgrar:m :re nt rc1..urdud ., -L,S anW i dlrmr made a: semt future unceridm date! The use of a prýeri .a!uc s mirequir: tih: riecordn. of t-e.penie and apprc.pruarung aar.ni . thi -\p,terd cost ofthe jeiaon at the ime :h :ransionur uenirt en i .ider this . it. ill aetienr le g . upfrent subsid. or lian .au rane: i rCClC iqui..aler.l cc A itr,tlriit ..r.d mus thi' ch ic. bkt-Len kirxi.us frm :f go. crnment *uppri L: in be mae .n ih, b. i c' heir ini men' ritlir ih J beiru dri en b- cecutring cor entii3 Uic of a presen r,lue n..,n . re t affec J1r din' i lh-baLCd etimiatCa of the zu% erprieni fistJ defic i. since the efIeet in the eeiic i n:, recirdid uii adtail ca, nt are ijibured rom the re-- enLe fund Adoption Of a presenrit --.-lue mine:hLid c.i urr. udg .nn . ,-irmp 1re' w ncie; ; 'et åA.:de reaurces up ir,r. lor the e%pected Io of'' :ihe gtudantee i4iued In addrien tI bd-gen br thi' rul? ..pcLd ýr;eni C eut co in. er:3ac r.n anrid urance prugram cevernmemt; neCd tto set :asde rk-er.e aat une--.pi..ed INt.e Pieparing ftr une,,peewd lossaý pre,.ents thv plieal ba,klash ir.uc:atcd.n r1direet:ng 'carce p.blic r,. 'urce3 c ez. r tie suddin neris:e i costs. oba iii the ned t'r policil batkli, U'e.r uddi:tunal findir.g aind 'imirua:es the pcrTepiiur. thai an; ,uddkr. mnrease in ,uss reprisenliý. pr.otrai m:.mraacg ment Ser.; up res1r,. :, proectdan-i rueh ekeri, cn rinicai ihese prrlbms b; reducin th nuiber c ee i i: w hh ihin e.iuiZI.i br3i .r n: adrii nr å..ne, needsi seeT addiwonal badeetar. r1. iJute.. t. co- .:r pr-M mi i an and b:. r,.-J 1.In.: thi :. -e i fl '...cear. rcques:. thi ari' made unce i c,i emni,.ni . i. is nsk 'nA ierarie ar :aaI2. i term, rf both w; hbIh roi..s and the .ese of l i is 4,ihn- 1- bear, i ::,n crb.i,h re-en Js., !ast unicp.:. J t. .< ri,. cipT ,' ii tih.n il eredit and inseranec pro ram; To du s r. hu,er, enert ::e, :j de:e:.re i,l iwhther ruees .I bie -.I Lased (in ih.: ,dieii' une..peelo p,;iSu.e c' eea 2uarron:: ,r .r , port~'he ...ue..:11.rk \ IR Approch t( .Ce-oknt for portIoho drr.erarticat,hn the .n'.esimernt pilhe. : the res:r..e. i.1 b1, oice th',, a:e eetablished, aind iheri the resenes sh"'utd reiJed .1itigarg riåks thrugh better poiie infarucure tre cu nni u reneiat n ih ihc eoncessrunatirc:z -J for ne,.. contr.a . anJ pie'..1 Lerm:· e: I' Ik,, er c ,Si her ... in - guarinte The difi"erence beitkee, thi c: of bu. thi con'rai. frm thi iuriint 'ray ci sprh,r, and the pri- recei,ed tr,nm new, bidJer; mat I: Le co-ridrable H [.ir har pr-ee ha. in effec:. te -e p', d in an cia.se TI~- G.joh emnment ma enoise co watn :i fe.. ,ca fur J,r.,z.d rO recer ,.mwh.at :i :t he net easti iht ,r...irniment i lo.ere How.ieer, rhe i,nger the war, the ereaher the .rli tnat -h t.cl rin ern the Go%crnnment ma', ccitinnue, Liht the hieh implied rat o' relurn tu 'the pra:t spo r. ari |nd,rs. the net enits acrualL ri,e thrrjun .airng AM o a be taken mio acckni are inC Lziien:. air, that nu. .:eru :e an ear:l. ni oe t) a f'i r inlperit&e St nem Sour, \\ :t. Binl 13 C. THE SOCIAL IMPACT OF THE CRISIS 1.26 The crisis has damaged the financial well being of Malaysian households and has temporarily closed the opportunity to use growth as a safety net. Declining stock and asset prices and lower returns to investments and savings have eroded personal wealth- in 1998 the KLSE plummeted by more than 50 percent. As domestic and foreign demand for goods fell and the economy began to contract, private sector real wages stagnated but unemployment remained low, unlike other crisis countries. Inflation was also kept under control; it increased to 5 percent but the price of basic necessities such as food and medicine shot up to over 8 percent. At the onset of the crisis, the social consequences seemed unclear: Who has been affected? How badly affected are they? And is the existing safety net adequate to address their needs? Gauging the Social Impact of the Crisis 1.27 The number of poor has increased by at least a quarter million (government estimate). Another estimate of the headcount index, obtained from the 1997 Household Income Survey by changing the sources of income for households during the crisis according to the aggregate changes in the economy,3 shows that around 400,000 individuals-2 percent of the population-could have fallen into poverty by 1999 as their income drops below RM98 per month or $2.5 per day. Of these, one-third would be hardcore poor, with income below RM44 per month. However, the Gini coefficient, an indicator of inequality, may stabilize as a result of the crisis, after deteriorating sharply in the early 1990s (Figure 1.2). 1.28 Repatriating migrant workers (from Indonesia, Philippines, Bangladesh) who were employed in shrinking sectors such as construction and manufacturing buffered the social impact of the crisis-since most of these workers earn little, losing their jobs would have plunged them into poverty which would have increased the headcount index. 1.29 The economic slowdown and the drop in business activity was felt more in urban areas-the newly poor are mainly urban self-employed. Income derived from the agriculture sector grew at a slightly faster rate in 1998 compared with 1997 owing to higher prices of palm oil, increased production of food crops in response to the higher costs of imports, and increased revenue from exports due to the devaluation and the low import content of agriculture products. Figure 1.2 : Inequality May Level off After the Crisis a) E 8 0.51 0.50 0.49 0.48 0.47 0.46 Souce Wr Bc CD -4 CK) to CD co W~ __J ro3 - CD Source: World Bank staff calculations based on HIS. 14 Figure 1.3: Most Retrenchments Were in Urban Areas and for Low-Skill Workers (1998) Across states Across major occupations Production and Sabah & Agriculture, Related Kedah & Labuan HAndal Workers, Sarawak Transport Perlis 5% Forestry Equipment 8% 5% Workers, Workers and Kuala Johor Perak Service Fisherm and Larrs Lumpur 8% 5% Workers 3% 13 o Others 6% 11% Sals Workers 4% Admnisra tie - Profesional, Clerical and Admiristrative Technicaland Related anMaaea Read Penang Selangor Workers Workersia 21% 24% 12% 8% Workers 15% Source: Manpower Department, Ministry of Human Resources. 1.30 Despite reduced economic activity, unemployment has remained low, rising from 2.7 percent in 1997 (technically full employment) to 3.5 percent in 1998. Given that GDP has dropped by 7 percent while employment has declined by less than 3 percent, the resulting drop in labor productivity is partly due to labor hoarding-firms working their employees less intensively but with the same hours of work, or maintaining the same number of employees on reduced hours. It could also signal a major increase in low labor productivity employment-for example, construction laborers who become petty traders to see themselves through the construction slowdown. 1.31 More than half of the retrenched workers are in construction; more than half are in the largely urban states of Selangor, Pinang and Kuala Lumpur; and more than half are unskilled (Figure 1.3). However, it was migrant workers who took the real brunt of the unemployment burden. In 1998, about 400,000 registered foreign workers were repatriated-which absorbed about 40 percent of that year's reduction in employment. Is the Existing Safety Net Adequate to Mitigate the Crisis? 1.32 The government took specific measures to mitigate the social impact of the crisis. The thrust of the government's program is to enhance income-earning opportunities while maintaining expenditures on health, education, and its existing safety net program (Table 1.2). This practice is consistent with Malaysia's underlying philosophy of providing the poor with the means to improve their livelihoods rather than giving them cash transfers. The program includes four main measures. 1.33 First, protecting social assistance spending. The government has protected recurrent expenditures on social assistance programs for needy children, the handicapped, the elderly and the hardcore poor. Among the measures were: (i) retaining the original 1998 15 budget allocation for the Development Program for the Hardcore Poor (PPRT); and (ii) making smaller cuts to the 1998 budgets of ministries involved in the provision of social programs, rural development, and agriculture programs which are mainly targeted for the poor and low-income group as well ensuring that the budget for 1999 is sufficient to meet program objectives. 1.34 Second, promoting income-earning activities. Following its philosophy of promoting income-generating opportunities for those who can work, the government allocated funds to targeted schemes for different groups that cover the hardcore poor and groups made vulnerable by the crisis. These allocations include (i) an additional RM100 million to Amanah Ikhtiar Malaysia for the provision of interest free loans to more hardcore poor; and (ii) RM200 million for a new micro credit scheme to provide assistance to petty traders and hawkers in urban areas. 1.35 Third, safeguarding employment. Since cost-cutting is essential during the economic slowdown, the government has urged employers to use retrenchment as a last resort and instead to consider alternatives such as training, retraining, pay cuts or reduced working hours. In August 1998, the government introduced a new amendment of the Employment Act that require prior notification of the Manpower Department by employers who plan to implement pay cuts and temporary lay-offs. Moreover, the Ministry of Human Resources launched a RM5 million Retraining of Retrenched Workers Scheme in May 1998. 1.36 Fourth, protecting health and education budgets. The health and education budgets were largely restored in 1998.4 In health, remaining cuts were concentrated to management programs and support services, and in education they were mainly in assets (e.g., office equipment and vehicles) and service and supplies (e.g., training, transport allowance). Since the 1999 budget restored the pre-crisis trends, these cuts should not have lasting effects. However new budgetary strain has emerged. In health, there was a substantial price increase for imported products used by health facilities (such as drugs and medical equipment). The MOH adjusted to the unexpected cost increase in drugs by Table 1.2 Social Sector Budgets Have Been Largely Maintained RM million 1994 1995 1996 1997 1998 1999/p Total Social 14826 15654 18808 19970 20845 23548 Development 3285 3513 3984 4919 5783 6936 Recurrent 11541 12141 14824 15051 15062 16612 Education 10108 10603 12489 12881 13443 15323 Development 2010 2044 2091 2521 2915 3865 Recurrent 8098 8559 10398 10360 10528 11458 Health 2529 2772 3474 3727 4047 4461 Development 354 388 459 449 716 835 Recurrent 2175 2384 3015 3278 3331 3626 p. preliminary. Source: Economic Report, MOF, 1999. 16 reducing quantity and prices-tighter prescriptions and shift to cheaper, local drugs-and postponed the import of equipment whenever feasible. Moreover, more people used public health facilities, putting greater demands on public resources. In education, government-sponsored overseas study programs for university students were suspended due to the depreciation of the ringgit, although students who were already studying overseas were allowed to continue. A larger share of university students had to be absorbed by domestic universities, increasing the 1999 recurrent budget for tertiary education. 1.37 To a large extent the Malaysian social protection mechanisms proved resilient to the crisis, although the scope of the public safety net programs could be further expanded during the crisis. 1.38 So far, Malaysia has managed to cope with the crisis, in part because of good initial conditions and a strong built-in safety net mechanism. The strong foundations of the existing network of free health and basic education have remained virtually,intact and helped cushion vulnerable groups. Price controls for selected food items, such as rice, flour, cooking oil, and sugar-although inefficient as an income transfer-were strengthened, making basic foods more affordable. Traditional values such as strong family ties and a solid commitment between employers and employees in the private sector has provided a private safety net that is often more important than that of the government, although private transfers are likely to decline during the crisis. An important component of this safety net was the productivity-linked wage which allowed flexibility in the labor market and thus kept unemployment low. Moreover, employers are legally obligated to pay layoff benefits or compensation to retrenched workers. This built-in safety mechanism has complemented the role of the government in mitigating the crisis. 1.39 However, the scope of safety net programs could be further expanded during the crisis. The government has largely aimed at maintaining the social sector budgets at their initial levels, when in fact the number of poor and the depth of poverty have increased. Moreover, the government has kept the same safety net programs when in fact the face of poverty has changed. Although the existing programs are well targeted to the new rural poor (70 percent of the pre-crisis poor were rural), they do not benefit the new urban poor. Existing programs for the urban poor-such as the grant program for secondary school children and the micro-credit program for female headed households-are now insufficient. The new programs-the micro credit for urban petty traders and the training programs for retrenched workers-are not optimally designed. Training for retrenched workers may not be useful in the new economic context since job loss was caused by a cyclical economic downturn and not by a structural mismatch of skills, plus many workers would rather be under-employed but earn income than participate in retraining. The micro-credit program for petty traders has disbursed very little because it appears that people are not willing to borrow and invest under such economic conditions. Furthermore, it is often hard to prevent the gains in credit from being captured by the nonpoor. 1.40 The government is reluctant to introduce new poverty programs for a temporary crisis because they may be difficult to reverse later, and in any case go against Malaysia's 17 traditional strategy for poverty alleviation which relies more on income generation rather than income transfer. Moreover, if growth picks up quickly, as the government is expecting, many of the social problems will be overcome. But the crisis has raised a new class of social problems for Malaysia and other countries-more urban and shock-related. To the extent possible, the government could rethink its safety net programs in light of the need to provide additional income transfers on a temporary basis, but keep their amount modest to minimize incentive costs, rely on self-targeting, and allow them to automatically grow during a crisis (Box 1.6). Box 1.6: Prorecting the Puor in a Crisis and Be-ond A mo-pronged :pproQ ch io' pr'l.ci :he poi: and .ln rib:i durir: a cr.w4 ould -in.i:ti * designtng %%orkt.are procrarn: or the unernplowd in urban .are±. * c-pardin- c\icing ptlir; proerams in rural dre. Lrnd 'Ircn%nhcning przrain; in arian area If oAfare program% hm.e na . mo autri.wI'e fLjur!; fjr ar economic %ris.--ihc pro'd i k and In,. automatic:!. Jwindle .L the cconoirn rc cr . Herkf3re prO.rm.M AL .. b:L Cu.aranIeLow i.-ake onrk on communitN-.nini.ted proiec:s-thjc ;ekin- rcl.. rniu,: '.urk to Lbt.n sLppcrt .and the .ork c&* clop; needed pub.ic work' uch s, nfr.'iru,turc:.r hou'in. :c.r the po..- ;ace - 1.uld noi C' Led the un,kille. w.v YL .o,d ri'n ino, en,ure It r.*lin b' :t':;os, n red nd 'raintain ThL ;re.nr. e to Iakc up rc:.uar .Ork -.hkn .iniab L aork should be piriued Dni o,n tichnicii1% liribridc prv-.,ii proposd ' bLun rt cummunin droup4 It help in,,ure that ihL rclif eflorT resporn-L t' the r. o.d i 1aL c. mm u ct and \.nuil contracTor.. PFrrposi!; %Ould be subrmucd to . central xicre. :h.a rim .!.hca.zc .khe:her the project qiulific under :he nJles of rhe Saife, net procrair.. 'A . it .i pnn Lli,.c lL;urL CompLemtarl Ira n, -fjerv in Cash or fod ac also necdcd To rL.i:h ihoe h. Crnnoi ir :ould no: p.rr.c.pate in rcliel I%Lrk-n0abl% lder .,r Tuder: For :hti th, uI%ernm niT :.u.d K.ild 'in Ii cxwing priograis in orJcr a Imo the L.%pJnsl-r '0 tE Juration of inc LTriI ii CULId pre-innouncc tha: a prokrran cipansion is for one %car n v tC ..oLid fuLtri 1pL Li . .A2ari .'ii l ecini pOogri1am d T0,Ld [rrr.4fLr, arz O'Ad ii-.A tci for ..-parn::cr -L c-d raner, en LL urci t1n..r. l:-I.rerIn. m. chani;iri, tuch a: pr..di4 io -qualt.l TILL O Ji' ribuiin l in puor ncichhvrh,.oJ.. rhLiC ran -iLr .' ern . .-.ill need TO h: .lili-:CILJ jdmin trat' l J Tr and Turn ] Ii 10u a'c.rdir..2 t.W ind...arors of .r.; 1 hi J.riind for r.J L .%.rk c in pro Ide a u.clul iizn.il !cr II' purpi c -t., lrirn P*aa ;on 1':1 r!'-.'l I-..r. . ri ri , i** , 3 .. V,or.d . i.i'1 PrmLri %LL. .Lanuar 1. % 18 The dynamics of the increase in the debt depend on the initial debt/GDP ratio d, the effective real interest rate at which the debt is financed r, the growth rate of GDP g, the primary surplus p, and the money- financed proportion of the deficit s (for seignorage). The basic relationship is as follows (terms on the right- hand side of the equation are all period t variables): d(t+1) - d(t) = (r - g)d - (p + s) With a total private financing of RM17.5 billion in roads during the 7 Plan, the total expected cost to the government could be RM3.7 billion, assuming 50 percent less traffic than initially projected. For rail, with a total private financing of RM10.6 billion during the 7' Plan, the total expected cost to the government could be RM9.4 billion, assuming 50 percent less revenue than the latest government projections. The estimations are based on 1997 Household Income Survey. The official poverty line of RM 545 per household per month is used, equivalent to RM 98 per capita per month. The hardcore poverty line is half of that. The assumptions for changes in real income during 1998 and 1999 (respectively, in percent) are: wages 0; 0; agriculture self-employment -6; 3.9; non-agriculture self-employment -9; 0; capital -30;-20; private transfers -20; -10; social transfers -12; 0; rent -20;-10. A more detailed explanation is provided in Annex 1. 4 Although at the beginning of 1998, as part of its austerity program, the government cut health and education budgets across the board (by 12 percent on the development side and 2 percent on the current side), cuts were gradually lifted during the year as the government switched to the fiscal stimulus strategy and reinforced its commitment to safeguard the social sectors. In health, final 1998 allocations represented 96 percent of initial allocations for operating expenditures and 94 percent for development expenditures. In education, final cuts in the recurrent budget for primary and secondary education were limited to 11 percent and were concentrated to a large extent in least disruptive areas (such as office equipment and vehicle purchase, minor repairs, etc.). 19 2. PUBLIC EXPENDITURE MANAGEMENT: HOW MALAYSIA PERFORMS 2.1 Malaysia has been at the forefront of public expenditure management reform among developing countries. Over the past ten years, central agencies devoted extraordinary efforts to improve the system through better fiscal discipline and improved effectiveness, efficiency, and accountability in the use of public resources. Malaysia had to adapt and customize reforms before achieving a successful public expenditure management system, as no best practice was available from developing countries. The Modified Budgeting System (MBS), introduced in 1989 and gradually implemented, provides greater managerial flexibility and accountability to the public management system. It performs on par with international best practice and is being used in some developing countries as a model. The MBS could be refined, however, especially in establishing strategic linkages between the budget reform and institutional changes that improve performance and between the budget process and Cabinet's policymaking process. 2.2 The crisis brought to the fore issues in public expenditure management that might have remained of less significance in a fast-growing economy: large and increasing off- budget liabilities that could undermine fiscal prudence, accountability and efficiency in the use of public resources. The government's strategy of allowing greater private sector involvement in the provision and financing of public services-mainly in infrastructure, but increasingly in health and education as well-has put new demands on contingent and off-budget public expenditure management as the government provided extensive financial support to private projects and corporatized entities. The fiscal planning framework, which currently focuses only on the cash flows of the central government, could therefore be expanded to cover contingent and off-budget liabilities. A. THE PUBLIC EXPENDITURE MANAGEMENT SYSTEM 2.3 Malaysia has been a leader of public administration reform among developing countries. In the late 1960s, it moved from a traditional budget system-which relies on line item budgeting and detailed line item control, and is highly centralized-to a program performance budgeting system-which uses program and activity structures, performance measurement elements, and performance evaluation. In the 1990s, it shifted to an output and outcome-based budgeting system, the Modified Budget System (MBS), which focuses on outputs and impacts, performance measurement, and evaluation (Box 2.1). The implementation of the MBS across federal agencies was spread over a period of five years. It was piloted in 1990 in three agencies-Health, Public Works, and Welfare Ministries-to introduce and cultivate familiarity with the new system among select Ministries. The number of agencies adopting the MBS gradually increased and by 1995, the MBS was operational through all federal ministries and departments. The MBS 20 focuses only on the operating budget, which forms about 70 percent of the total budget. The budget reform did little to integrate the operating and development budget, but the preparation and examination of these budgets are undertaken at the same time, although in separate exercises, and tabled before Parliament together. Box 2.1 11alvia's Modified Budgeting SNsteni--ir the Forefront of Developing Countries The tradat.inil Provram and Pcrfc,n r.XB11. Sudot:ne stem in 11.ila, a replaicJ b.. *hc Mhdified Budetini. System i!BS1 irn 19E9 io introduce greaer manaecriail f1eih:ir, and ccounrabill, Ic. the public mranagemcn 5.) stem Main objecti%es: * Promote a raial at!catwn 1i rC%(i1rLC to a.'emment programs b ;mposin; fiscal limits upn agcncies and forging a link bet-%een inputs and outputs * Impro%V JciphnL and rai1on2ill nl..) ii' hu,:ei proces In explicial, quantifNIre a hindint expenditure limit for each agencN. -hifting from line iem budgeting to perforance-bacd budgetrn. and producing output- oneniLd prugram structures * improe program ni amn by adoptirq ber manjgmeni practices. includni cncouraping grcaicr delegation olawhor:. from Treasur, W aQercie nJ Lhirn on to line mir.Lgeri * i .h ..co .4 Icc'untability on issues of program efficiency and effectiveness, by measuring performance against predetermined targets, evaluating programs and activities according to their impact and rele% ance and matching accountability and authority by holding managers accountable for performance Main features: * An Erpeadaure Target is provided to each Ministry/Department at the start off the budget process to which e%isting pohic budget submissions must comply. * A P, ograi Agreement is signed between the Treasury and the line ministry which determines the level of performance that can be achieved for a budget year with the allocation approved. At the end of the fiscal year, an EL,ttPe.1 Report is prepared by the line ministries regarding the performance of activities which do not reach the eels specified in the program agreemenr * l-','E,it i han.-w ijkes p,ljce for each acii. it.. at lea;t orice ei er, 1-i%e :.ar * .C Gencr,_aLj iprc.t t EipirtJaurc ( li adopled %.hich cnable; the Trca_zur, to lihten the conrrol§ of o%erall e,pendirLie and delegates the conrotl oc r details to line ministrie,. Nource John -nthon% \aicr. Bud-., R r.,,n-the1aua,;o Epranc. 1996 2.4 Understanding the public expenditure management system in Malaysia requires first understanding the structure of the federal government, the budget, and the accounts. This is described in Box 2.2 and in Annex 1 and Annex 2. A public expenditure management system has four functions: providing fiscal discipline, allocating public resources to strategic priorities, ensuring efficient and effective use of public resources, and ensuring public accountability for the use of public resources. In all four areas the Malaysian public expenditure system performs on par with international best practice, although it could be further refined. 2.5 First, the government has always been fiscally prudent. It has a balanced budget rule for operational expenditures and has had an overall budget surplus for the past several years. It has systems to ensure fiscal discipline, and a prudent central administration that uses the systems effectively. Top-down setting of spending targets enables the Treasury to effectively control aggregate spending. But fiscal planning 21 focuses on the cash flows of the central government, and framework that gives too little attention tot he government's financial assets and contingent liabilities. 2.6 Second, sound systems are in place to ensure that public resources are allocated to strategic priorities. Several documents set out the long- and medium-term national strategies for development, most notably the Look East Policy, Vision 2020, and the National Development Plans. Cabinet decisions are geared toward implementing these national strategies. The public expenditure management system includes procedures and incentives to ensure that ministries reflect national strategies in their policies, though they many not be very well structured or systematic. Chronic supplementary budgets necessitated by the Cabinet's introduction of policies during the fiscal year signal a missing link between Cabinet's decision-making and the budget process. 2.7 Third, the Malaysian administration developed two excellent initiatives for improving performance management by public sector entities: (i) the Program Agreements under the MBS established between the Treasury and line ministries during the budget process to identify performance expectations, and the Exception Reports prepared by the ministries to report variations in performance outcomes to the Treasury at the end of the fiscal year; and (ii) the Civil Service Improvement Circulars aimed at promoting and enforcing various aspects of effectiveness and efficiency across government agencies. However, these initiatives are not fully integrated into a coherent performance management framework. 2.8 Fourth, Malaysia has solid public accounting and financial reporting systems: an Accountant General's Department with adequate accounting standards and information systems, and Auditor General's Department that applies internationally accepted auditing standards, and a Public Accounts Committee that scrutinizes the Auditor General's reports to Parliament. Malaysia also has sound performance reporting systems covering the performance of ministries and departmental entities. Program Agreements are submitted to Treasury for review and scrutiny. For the purpose of Parliamentary review, the Treasury prepares and submits a comprehensive Program and performance Budget Estimate as a supplement to the government's budget request. Exception Reports are internal to the Treasury. The public accounts and the performance reporting are not integrated enough to include nondepartmental public entities. 2.9 The most important challenge ahead for public expenditure management in Malaysia is the integration of off-budget liabilities in the planning, performance, and budgeting process. Moreover, improving performance management and strengthening links between Cabinet policymaking and the budget process would further refine the public expenditure management system in Malaysia. These issues are revisited in the following sections. 22 Box 2.2: Structure of Goernment. Budget, and Accounts Structure of tie federal government. The IalIassiarn Parl:ament is bicameral. consisting of :he Sonate and the House of Repre&nra:ises The Parlirnieni i assisted in its o.Lorsiiht of the e,ecul,ic brar.ih by three .autonomous acencte. which receIe rhe.r authort., from the Constitution The Audior General audits the final accounts of the federal o%crnmenit aid is enriies and reports to Parliament A parliamentar subcorMILLL. the Public Accounts Commirtcc. re'.ts the audit reports. questions Offletak about an' .rongdoinr or shortcoming. and reports its recommendation. rr Parliament The Public Ser% ices Commission sets principles and standards for managing pubbe service, .A go%emment is formed upon recei ing a ma;ority wte of confidence from both Houses Policy implementation is generallN the respun :bilr of sector ministres. The budget .oing structure and the expendirure manaCement sl stem zive miniStries the :1exibilwr. needed to control the rcsources under their charge To ensure proper managemeni of resource;. the Cinance minister appoints controllinL officers %i,h that responsibiit%. iencralls the secretar general ofa rnini'.tr) ur the head of a department or agency Their activuties in this area are coemed by such li.s iand revulitions . the Financ:.l Procedure Act and the Treasurs instructions and circulars A seerng conimince led by the controlling officer is responsibli for the policymaking. planning, and budgeiog b% each m:nistr\ Sector ministries implement policies through agencies-the departmental enttiies, swtutor\ bodie,. and public corporations under their purtewk Performance standards such as impact, output. and cost are determined in a progran agreement between the minisir.'s steenne committee and the program manager responsible for deli.cr% of the ser%ices The program agreements establish the basis for budaect negotiations \ ith the Treasur and are scrutiniued by central agencies Budget srructure The expenditure budge consists of tmu par.;, the operating budger and the de%elopment budget. which are voted separately The Treasurn has pnmar, responstbilir for preparing the operating budget. and the Economic Planning Unit primary responsibihry for preparing the development budget. The goverment has a balanced budget pnnciple it borro %; only to tirance *e.clopment expenditure The operating budget coecrs two rypeq of ependiture charced and supplk Charged expenditure. w6hich is proided for b:. lass. is for obligaior\ p.sments such as royal allo%%ances and settlement of public debt Supply expenditure i; for routine expenditures maintained by annual %ote of Parliament. such as salaries and other administratise expenses of gosemment agencies The deselopment budget is based on protects that .a%e becn approved under the National Five-Year Development Plan Budger process. Aided bs the Treasury and the Economic Planning Unit, the CabineL decides on the overall Fiscal ceilings The Treasur issues l.rgars for the operatinL e%penditures of ministries and departments based on the previous year's allocaions %ah allow%ances for new% policies introduced b% Cabinet dunng the tiscal ycar In each ministry. a steenng committee headed b the Secretary General cames out annual plann:ng and budget formulation The conmece detemines the mini,tr.'s pnonnes and strategies, reLw.%s procrams, and introduces new policies Each agene. prepares a budci based on th. cipendirure targets Lach ministry eamines the budget of the agences under as puric.w. establishes the program agreements .%ith program managers, and submits them to the Treasury The min.str. also decides on transfers to starutor bodies and public corporations Once the budget submissions for indixidual agencies are %cited by the respecti%e budget re\ iew officers in Treasury, they are then integrated according to sectoral requirements and sent to the Cabinet for re e--% and deliberation Oni then it is sent to both Houses of lcgps.ature for fund appro.a through the Supply Bill .4ccounts structure and public accounts. Public cpenditure is coemed b the federal constirurion and rele%ant statutes All public funds are accounted for under the federal consolidated fund or the memorandum account. or specified under an\ specitie statute, except for raIcs and ducs under Islamic law isuch as :akat. !ftrah, and battu!niai All public resenues and e,periditurcs must be coxcred under the federal consolidated fund or memorandum accounL as appropriate. and must be appro% ed by Parliament, thus pros ding the opportunity for elected representit.ie to ;crutinc and debate all aspects related to the management o public funds The public accounts of the federal go emment are prepared by the %ccuuntant General and audited b% the .Auditor General These statements are 2enerall submitted for audit two to three months after the end of the tiscal .car. certified bx the Auditor General si months after the end of the fiscal year., and tabled in Parliament at the ;ame time as the new% budge is submitted 23 B. EXTENDING FISCAL PLANNING AND PERFORMANCE MANAGEMENT TO OFF-BUDGET EXPENDITURES 2.10 Like many other developing countries, Malaysia has made strategic use of different types of nondepartmental public entities in development and capacity-building initiatives. These entities include off-budget agencies for specific development purposes, public enterprises, and, for the past 15 years, corporatized and privatized agencies. To support these government, semi-government, and private activities, the government extends public funds in the form of direct grants, recoverable loans, and loan guarantees. Unlike in many other developing countries, in Malaysia these funds are generally budgeted and their use reported. But despite the often considerable resources going to nondepartmental organizations, these entities are not part of the government's fiscal planning and are not subject to the same level of scrutiny through the regular budgetary process or to the same level of performance regulation as departmental entities are. Extending the Coverage of Fiscal Planning 2.11 At the beginning of the budget process the Treasury and the Economic Planning Unit prepare an economic and fiscal report reviewing national and global economic developments and projecting fiscal revenues and expenditures under various macroeconomic scenarios. This report has an annual outlook, focuses on the cash flows of the federal government, and omits contingent liabilities. On the basis of this report the Cabinet determines the government's fiscal strategy and the overall spending ceiling for the next fiscal year. The Treasury then allocates indicative ceilings to ministries for ongoing programs. The Treasury submits a final version of the economic report to Parliament with the budget. 2.12 The Malaysian government has the basic process right; but it can be refined by: (i) extending the.focus of fiscal planning and projections (in the economic and fiscal report) from cash flow requirements to the financial position of the whole of government, including statutory bodies and public corporations; and (ii) incorporating the contingent liabilities of the government in fiscal planning. Incorporating the government's financial assets as well as its contingent liabilities in the analysis of the economic and fiscal report would enable the Cabinet to consider these issues in its fiscal strategy. To separate bureaucratic accountability for fiscal analysis from political accountability for fiscal strategy, the Cabinet could make the economic report publicly available and publish its fiscal strategies separately in a fiscal strategy statement. Moreover, publishing the Cabinet's fiscal strategy before its discussions on the budget policy statement would bind the Cabinet to a fiscal constraint before it discusses new policies. Moreover, publishing the three reports-showing the government's fiscal situation, its medium-term fiscal strategy, and its policy priorities-would lessen the uncertainties faced by investors and the public at large. 2.13 Extending fiscal planning and projections to the financial position of the whole ofgovernment. This is not a difficult task. Almost all the financial information needed is available in public accounts. Two steps are required: finding out the financial position of the central government (ministries and departments), and consolidating it with that of the other public sector entities (statutory bodies and public corporations). Although the 24 government operates on a cash basis, information on its financial assets (equity investments, recoverable loans) and liabilities (including the guarantees) is reported in memorandum accounts (see Annex 2). The statutory bodies and companies already operate on an accrual basis and publish their balance sheets, so their financial position is known. The government's pension liabilities and funds are managed by statutory bodies, so their financial position is also known. All this information is in databases of the Accountant General's Department, which can produce these reports on request from fiscal policymakers. The Budget and Finance Divisions could request financial statements for the whole of government from the Accountant General's Department. These divisions carry out the projections for the central government's cash flows and have the capability to extend their analysis. The key issues are to calculate the impact of macroeconomic variables on government assets and liabilities and to extend the planning horizon to two or three years. 2.14 Incorporating fiscal risks. Governments issue many types of guarantee-deposit insurance to the banking sector, guarantees on pension funds, guarantees on the borrowings of statutory bodies and public corporations, contractual guarantees on corporatized and privatized operations. The consequences of such guarantees are rarely taken into account in fiscal planning. Nor are guarantees subject to the same rigorous rules as on-budget items. As a result fiscal policymakers seldom comprehend the full fiscal risks from guarantees, and often see them as an inexpensive and politically attractive form of government support-fiscal risks in Malaysia arise primarily from explicit and implicit guarantees to financial institutions. 2.15 As the role of the state in Malaysia shifts from providing services directly to guaranteeing against residual risks, it faces a growing need for expanded capacity to analyze and manage the contingent liabilities associated with guarantees. And a well- developed regulatory and public disclosure system becomes particularly important when the government embarks on privatization while holding explicit or implicit obligations to cover residual risks and ensure particular outcomes for the private sector. In a growing economy the government's risk of contingent liabilities becoming actual liabilities is smaller because guaranteed entities are more likely to fulfill their debt obligations, and corporatized and privatized operations are more likely to become profitable. But this risk is higher in a shrinking economy and uncertain macroeconomic environment. Thus current conditions call for immediate attention to improving the management of the government's contingent liabilities. 2.16 There are several means for doing this. Accrual-based budgeting and accounting standards would make the potential fiscal cost and hidden subsidies of contingent liabilities more transparent before a guarantee is issued. Quantitative risk analysis would reveal the difference between the full risk premium and the fees charged by the government to assume an obligation. Bringing off-budget commitments into the budget and recognizing the hidden subsidies associated with contingent support would reveal the long-term costs and benefits of the government's commitments and increase public scrutiny of the potential use of public funds. But while accrual-based budgeting and accounting and sophisticated risk measurement methods constitute best practice in managing contingent liabilities, building such systems requires much time and administrative capacity. As the government builds its capacity to manage contingent 25 liabilities, it is more sensible to have a system requiring it to assess current risks, make a rough provision for contingent risks in the budget, and publish a statement of contingent liabilities and overall risk exposure (Table 2.1). Table 2.1. Steps to Control the Risk of Government Programs and Promises Fiscal policy Public finance institutions Before the * Assess how the obligation fits with the Evaluate the program's risks on government state's role and strategic priorities their own and as part of a accepts an * In considering options for policies and portfolio with existing risks, obligation forms of support, take into account the estimate the potential fiscal cost (program, associated financial risks and the of the obligation, and set commitment) government's capacity for managing additional reserve requirements risk Design the program well to * Define and communicate the standards protect the government against for and limits of government risks involvement to minimize moral hazard While the * Stick to the preset limits for government * Budget and account for the government responsibilities obligation and disclose it holds the * Monitor the program's risk obligation factors After the 9 Execute the obligation within its preset Report the actual fiscal cost obligation falls limits and observe lessons for future relative to the estimates, evaluate due policy choices performance, and penalize I I failures Note: Annex 3 explains these steps in greater detail. 2.17 The government can take immediate steps to deal with existing contingent liabilities. First, it should review programs associated with existing guarantees, identify contingent liabilities and risk factors, and quantify them to the extent possible. And when possible, it should restructure programs to minimize its risk. Next, to link contingent liabilities to fiscal planning, the Treasury could combine them in a portfolio with state debt and other public liabilities when evaluating correlations, sensitivity to macroeconomic and policy scenarios, and overall risk exposure. 2.18 Meanwhile, the Budget Division should improve controls over the issue of new guarantees by streamlining the review process for program risks with the budget process. It should develop measures to consider any noncash program involving a contingent fiscal liability like any other budgetary or debt item-from the viewpoint of aggregate fiscal stability, allocative and technical efficiency, and accountability. The government should choose contingent and implicit forms of financial support only to the extent of its ability to manage risks and absorb contingent losses. In addition, the Accountant General's Department could develop reporting standards for contingent liabilities. Even though government accounting is cash-based, memorandum statements in the public accounts could be used to report contingent liabilities. The statement of contingent liabilities should include all quantifiable contingent liabilities-not just direct 26 government loan guarantees, which are already reported. The Budget Division could also prepare a statement of fiscal risks, for submission to Parliament with other budget documents. The statement should show existing fiscal risks separate from new ones. 2.19 The expanded fiscal reporting would enable the public and the market to monitor the government's full fiscal performance. As investors, credit rating agencies, and other market agents consider both direct and contingent fiscal risks in their analysis and investment decisions, they would encourage not only budgetary but overall fiscal discipline. Greater fiscal transparency would also facilitate parliamentary scrutiny. In the medium term the government could develop a comprehensive risk strategy with a picture of overall risk exposure, a clear statement of risk preference, a reserves policy, and guidelines for evaluating, regulating, controlling, and preventing risks. While specific risks could be monitored by particular regulatory and supervisory agencies, the Treasury-particularly the Finance Division-bears responsibility for managing the government's overall fiscal risk. The Finance Division is probably best equipped to analyze the contingent fiscal risks and to decide on hedging and other risk control instruments. And risk evaluation and program design are probably best placed with the Budget Division, which would have the authority to approve potential financial commitments of the government. The Treasury is currently reorganizing the Finance Division and intends to create a unit dealing specifically with issues related to privatization and contingent liabilities. The new unit would provide better coordination between budgetary requirements and allocations and will undertake risk management on government investments. Moreover, a trust fund has been created to make early provision for contingent liabilities expected to be realized. Extending Performance Management to Nondepartmental Public Entities 2.20 The support to nondepartmental entities can be substantial relative to the total budget. Under the memorandum asset account, recoverable loans amounted to RM48 billion in December 1996 (over 80 percent of the total budget) and RM52 billion at the end of 1997. Of the total of RM48 billion outstanding at the end of 1996, statutory bodies accounted for 19 percent and companies for 20 percent. Investment expenditure for nondepartmental entities and operations amounted to RM10 billion in 1996 and RM12 billion in 1997. Most went to companies, almost all of which also received direct grants and loans. In 1996 the government extended guarantees worth RM13 billion, and in 1997 RM23 billion-almost twice as much. At the end of 1996 the government had extended guarantees for at least 10 statutory bodies and 16 companies (see Annex 5). 2.21 Many of these transfers to nondepartmental entities may not be fully transparent. Direct assistance through grants, investments, and loans is treated as expenditure in the budget-included in the annual estimates and listed under specific expenditure categories. But the information is inadequate to allow much detailed or meaningful parliamentary examination and debate through the annual Supply Bill. Moreover, indirect assistance through guarantees and tax expenditures-an array of tax benefits, breaks, and exemptions-is not budgeted. And the tax benefits are not reported. 27 2.22 Most nondepartmental entities face few requirements in performance reporting and measurement. While statutory bodies are required by law to prepare an annual report, the emphasis is usually on detailed reporting of financial performance, with only limited reporting on program performance despite being required to prepare Program Agreements for budgetary purposes. Corporatized and privatized entities-in all respects private concerns, often taking the form of a public or private limited company-are subject to corporate laws governing financial and other performance reporting, but face no reporting obligations for budgetary purposes. Although a special unit in the Ministry of Finance monitors their activities and progress, the results do not enter into budget deliberations. 2.23 To improve fiscal discipline and accountability for the use of public resources, all those nondepartmental entities, including statutory bodies which impose budgetary costs, should be required to undertake more structured annual reporting. These reports should be used as inputs in the annual budget estimates and Supply Bill deliberations. The entities should report not only their financial performance, but also their goals, objectives, and strategies and how these fit in with broader national goals. The resources allocated to the entities should be closely tied to their performance. For these purposes, three actions are suggested: (i) relate the objectives of nondepartmental entities to the strategic plan of their controlling ministry; (ii) group transfers to nondepartmental entities as administered items in the budgets of their parent agency and include the expected benefits from these transfers in the agency's program agreement; and (iii) improve the transparency of nondepartmental entities. 2.24 Bringing nondepartmental entities into parent agencies' planning and budgeting. The first two suggestions require understanding the difference between departmental and administered items and the implications of this difference for managerial accountability. Departmental items are those controlled by a department, such as salaries, allowances, and outsourced activities. Administered items are not controlled by the department but administered by it on behalf of the federal government or parent ministry. These include benefit payments, grants to other levels of government, and other types of transfer payments, though the focus here is on subsidies to nondepartmental entities. Decisions on these transfers are generally made at the Cabinet or ministry level, with little participation by program or department managers. 2.25 While using departmental resources, department managers can decide whether or not to make a transaction, or to direct resources to one use rather than another-and thus can be held fully accountable. But what about administered items, where managers have little or no ability to influence the use of the resources? Here the main focus of accountability relates to the department's contribution to achieving the desired outcomes from the transfers. The expectations for the nondepartmental entity receiving the transfer can also be set in terms of its contribution to achieving the planned outcomes. 2.26 Where appropriate, information on the planned uses of administered items and their planned contribution to outcomes should be required in the program agreement and other external planning and reporting documents. This is one channel through which 28 nondepartmental entities could be brought under the performance management framework. 2.27 Improving the transparency of nondepartmental entities. Not only are many of the subsidies to nondepartmental entities less than fully transparent in the budget, these entities seldom identify their performance plans, strategies, and performance milestones in the annual estimates, making it difficult to evaluate the performance of the controlling ministry. Thus it would be desirable for all nondepartmental entities to provide a strategic plan showing in detail how their performance would contribute to achieving the controlling ministry's overall goals and objectives. The strategic plan should be reflected in the annual budget estimates and subject to scrutiny and debate by the controlling ministry, central agencies, and elected representatives. If in addition performance information on the use of the subsidies were included in the parent department's program agreement, all operations of the nondepartmental entities would come under the full scrutiny of the annual budget process. 2.28 All financial assistance packages for privatized or corporatized operations should be pegged to detailed information on financial and nonfinancial performance as part of the normal budget process. Even where such entities do not seek financial assistance, they should be required to report on their performance to the appropriate regulatory agency, which should use the information in justifying its own annual budgetary allocations. And implicit subsidies-guarantees and tax breaks-that are not shown as expenditures should be calculated and included as memorandum items in the vote budgets of ministries and, when possible, in program agreements. 2.29 Transparency also needs to extend to the financial reporting for nondepartmental entities. Although the government's annual statement of accounts contains details on public expenditures, it does not show any details on the use of budgeted transfers and subsidies in nondepartmental entities. These details can be found in the books of the nondepartmental entities, and some aspects of financial performance are picked up by the Auditor General. However, in order to make the nondepartmental entities more fully accountable, all their expenditure details could be disclosed in public accounts. 2.30 To ensure accountability for tax expenditures, which are not presented in the public accounts, these expenditures should be accounted as transfers to nondepartmental entities and treated like any other subsidy. Memorandum items could include a statement showing the cost of tax incentives provided to nondepartmental public organizations, particularly to corporatized and privatized entities. Direct guarantees on the borrowings of nondepartmental public organizations are shown in the public accounts as memorandum items, but indirect guarantees arising from privatization and corporatization contracts are not. The statement of guarantees could be extended to include all types. 2.31 Although statutory bodies submit an annual report and audited accounts to Parliament, as required under their enabling statute, these reports are often two to three years late. Just as annual reports are an essential part of performance management and accountability for departmental entities-complementing the strategic plan by showing what has actually been achieved-they are also essential for nondepartmental entities. 29 Timely and relevant annual reports should be mandatory for all types of nondepartmental public entities. C. STRENGTHENING LINKS BETWEEN CABINET POLICYMAKING AND THE BUDGET PROCESS 2.32 Supplementary budgets seem to be the norm in Malaysia. They occur every year, ranging in size from 10 to 30 percent of the original budget. Although the Modified Budgeting System has lessened the pressure from line ministries for supplementary budgets, it has not lessened the pressure from the Cabinet. The budget restrains the administration-but not the politicians. New policies introduced by the Cabinet during the fiscal year have been the main cause of supplementary budgets in the past five years. 2.33 Supplementary budgets undermine fiscal discipline and distort the strategic allocation of resources agreed to during budget formulation. They show that the Cabinet may not have full ownership over the resource allocation agreement and faces weak incentives to adhere to it. A close look at the budget process reveals the missing link between the Cabinet's policymaking process and budget formulation: there is no procedure early in the budget process in which the Cabinet determines its priorities and announces new policies. Instead, it introduces new policies during the year. Once these policies can no longer be financed by budget transfers, the government requests a supplementary budget. When that falls short, it overspends appropriations. 2.34 During budget formulation the Cabinet is consulted twice-at the beginning, to set the expenditure ceiling, and at the end, to approve the allocation of resources. At the second stage the Cabinet generally cuts the overall budget, identifies a few programs as priorities, and sends the budget back to the Treasury to reflect these cuts in program budgets. These last-minute, generally across-the-board cuts undermine the credibility of earlier budget negotiations between the Treasury and the line agencies. Although central agencies such as the Treasury and the Economic Planning Unit are consulted during policy formulation by the Cabinet, their consultation does not necessarily link policymaking with the budget process. Since the new policies are dealt with piecemeal throughout the year, they are not considered under a single fiscal constraint nor do they compete for resources. Some of the policies have nonbudgetary financial implications but involve contingent liabilities. State guarantees issued on the debt of public corporations or during privatization and corporatization have almost no immediate budgetary implications, but they have future financial implications and increase the government's risk exposure. These contingent liabilities are not fully considered during fiscal planning. 2.35 Two measures would help in forming a transparent link between the Cabinet's policymaking and the budget process: (i) extend the coverage of fiscal planning and projections to the consolidated fiscal position of government and publish a fiscal strategy statement (see above); and (ii) announce the Cabinet's policy intentions through a budget policy statement early in the budget process. 30 Reflecting Cabinet Priorities Early Through a Budget Policy Statement 2.36 An announcement of the Cabinet's collective policy decisions early in the budget process-in a budget policy statement-could help improve fiscal discipline. It would create an initial position for the Cabinet to adhere to, and pressure to justify any later deviations from this position. In addition, by linking the government's medium-term strategy (the development plan) to annual budget formulation, the budget policy statement could provide line ministries with policy direction on which to base new policies, and the Treasury with guidance for negotiating these policies with the line ministries during budget formulation. The Cabinet's decisions on policy priorities should be made under a jointly recognized fiscal constraint, and thus should follow the announcement of fiscal policy in the fiscal strategy statement. At this point the Cabinet would know how much room there is in the budget for new policies. 2.37 Ideally, the Cabinet would decide on its priorities after reviewing the annual reports and evaluations of line ministries, and its policy directives would guide the ministries' strategic plans. But line ministries are not required to prepare strategic plans or annual reports. Although a few do publish annual reports, they appear too late in the year to provide inputs to the Cabinet's discussions of new policies. In the medium term the government could consider requiring line ministries to publish timely annual reports, which could be used in discussing the budget policy statement. It could also require line ministries to prepare medium-term strategic plans reflecting the Cabinet's priorities on sector policies and tying them to the ministries' budget requests. This arrangement would not necessarily eliminate the introduction of top-down policies during the year, but it would discipline it. Ministers who submit new policies to the Cabinet during the fiscal year would have to explain why they did not do so during budget formulation and why their policies deserve to be treated as exceptions. And Cabinet members would have to explain to each other why they are deviating from their collective decisions. D. IMPROVING PERFORMANCE MANAGEMENT 2.38 The Malaysian government embarked on a concerted effort to improve the quality and performance of public services in the early 1980s. It introduced Total Quality Management in the late 1980s and early 1990s, transforming the work and performance management culture in the public sector. At the same time, it introduced the Modified Budgeting System as part of reforms of budgeting and performance management. This brought about a major change in public sector performance, both financial and nonfinancial. The government complemented the two reforms with a set of management improvement initiatives-the Civil Service Improvement Circulars, or PKPAs- introduced in phases from the late 1980s through the mid-1990s. The PKPAs provide basic guidelines for improving service delivery and management processes. 2.39 All these initiatives were part of a range of public sector reforms under the government's New Public Management drive. The New Public Management philosophy aimed at building a culture of excellence in the Malaysian public sector. It emphasized accountability, improved performance, service quality, and service delivery. But several issues went unaddressed or received too little attention, including the need for a strategic implementation plan to integrate the public sector reforms. As a result, public managers 31 have difficulties relating to the goals of these innovative reforms. And few ministries or agencies have a comprehensive strategic plan integrating the policy goals, the program objectives, and the rationale for resource allocation. 2.40 Moreover, implementation of the performance management system has been less than successful. Public sector managers show a perceptible lack of enthusiasm for performance management and most avoid performance measurement, perhaps for fear of being labeled inefficient or ineffective. Managers tend to focus on inputs, perhaps assuming that a larger budget allocation or a larger staff equates with good performance. They are reluctant to undertake strategic planning, perhaps out of a belief that it is arduous. And the public sector lacks a sense of accountability that can create pressure to produce results. Financial accountability-compliance with financial rules and regulations-is often the focus of legislators, program managers, and auditors, and little attention is given to management and program accountability-managing for results. Compounding this neglect is an apparent lack of leadership by the central agencies-vital if results-based management is to be institutionalized. 2.41 These are typical problems in most countries that reform their public sectors. To address these issues, the central agencies need to: provide strategic direction and guidance to operating agencies on how to incorporate the PKPA guidelines into an integrated performance management framework; and strengthen the links between program performance management and the budget process by requiring the line agencies to prepare strategic plans and annual reports, and improve performance monitoring and evaluation across the government. Building an Integrated Performance Management Framework 2.42 Each of the PKPAs on its own is an excellent tool for improving performance, and all have helped to varying degrees to enhance government products and services. Together, they have the potential to ensure the effectiveness of all government programs and activities. What is lacking is their integration into a coherent framework of performance management. The Modified Budgeting System calls for an integrated approach toward program performance management, and it is complemented well by the ISO, total quality management, and related initiatives. But neither the central agencies nor the operating agencies seem to have looked at the PKPA initiatives with a view to developing a comprehensive, integrated performance management system that is closely linked with policymaking and budgetary allocation. 2.43 Moreover, there is a lack of strategic direction and guidance from central agencies on how to incorporate the PKPAs into integrated performance management. All government agencies are required to fully implement every circular, and their progress is closely monitored by the Panel on Administrative Reforms, to which the agencies must submit regular progress reports. But the panel is concerned only with ensuring that the agencies implement the circulars fully and on time. And under the panel's close monitoring and supervision, the agencies do whatever it takes to be able to report progress in implementing the circulars-all while performing a host of functions and tasks with increasingly limited resources and no coherent strategic performance plan. 32 Not surprisingly, the result of all this is often only superficial implementation of the circulars. Faced with growing constraints and pressures and the demand to implement the many circulars, many agencies have resorted to meeting requirements merely on paper. And agencies tend to look at each initiative in isolation rather than as part of a whole. For example, an agency may claim to comply fully with the requirements under a circular, but it may not be able to link those requirements with the achievement of certain outcomes or with the policymaking process in resource allocation. Thus while the PKPAs are a commendable effort and certainly in line with the goals and objectives of the New Public Management movement, their implementation has weaknesses that need to be addressed. 2.44 Moving from compliance to accountability for results. To be effective, performance management must link inputs, processes, outputs, and outcomes. Measures of performance management that look at each of these factors in isolation will provide only a narrow picture of performance. For example, we can assess the effectiveness of a process by looking at cost, timeliness, and similar measures. But even if we find that the process is effective by these measures, it does not necessarily mean that the program itself is effective or that it achieves the desired outcomes. Nor does assessing outputs by such performance criteria as quantity ensure either effectiveness or desired outcomes. 2.45 Under the Modified Budgeting System there is a strategic performance management framework in place. All program managers are required to work out a program performance agreement that identifies most of the key factors in ensuring a program's effectiveness and thus essentially forms an integrated performance framework. The performance agreement addresses the four key focuses of a performance management system-inputs, processes, outputs, and outcomes-and links them with others-including goals and objectives, needs assessment, and evaluation. But this basic framework could be strengthened by integrating the PKPA guidelines. Each circular can be fitted into one or more of the four key focuses of performance. And each can contribute to the achievement of program goals and objectives (see Annex 4). 2.46 Program managers should be required to review the PKPAs to see how they could fit into the MBS framework and could help in enhancing program performance in different areas. To encourage managers to see the PKPA requirements as essential performance management tools rather than mere regulations with which they must comply, implementation of the requirements could be made optional. Agencies and program managers could instead be held accountable for program performance, linked to resource use through the budgetary process. Incentives should be built in to reward them not only for achieving specified results but also for innovative and strategic use of the PKPA management tools. 2.47 Creating a sense of ownership. Implementation of the PKPAs is overseen by MAMPU and two other agencies. MAMPU's tasks are carried out by its Inspectorate Division, which reports to the Panel on Administrative Reforms. This panel is charged not only with monitoring progress in implementing the PKPA requirements, but also with encouraging ownership of the PKPAs by the agencies. The Financial Management 33 Services Division of the Ministry of Finance is tasked with overseeing all financial reforms, and the Establishment Division of the Public Services Department is responsible for all personnel issues related to the PKPAs. 2.48 The agencies' efforts to create a culture of excellence in the Malaysian public sector through the PKPAs emphasize training and retraining, documentation, dissemination, and appreciation and recognition activities. While both laudable and necessary, these activities focus more on bureaucratic compliance than on ownership and effective use of the initiatives. For example, senior officers due for a promotion are asked to prove that they have assiduously implemented the PKPAs in their agency, not that they have used these management tools strategically to improve its performance. Further compounding the problem, the PKPA-based reform agenda is seen more as generated by MAMPU than as inspired by the government. This perception has undermined support for the agenda even among central agencies such as the Economic Planning Unit, the Public Services Department, and the Treasury. The large number of circulars and their lack of focus have also contributed to the skepticism and cynicism among public officials about their purpose and utility. 2.49 To overcome these weaknesses, the government needs to undertake reform efforts focused on a "developmental" philosophy emphasizing greater ownership of the reform agenda and the role of the PKPAs as useful management tools for improving performance. A marketing approach to create awareness and participation will have better chance of success than the present administrative "reward and punishment" approach. In addition, the central agencies need to allocate to line agencies the resources to implement the reform agenda. Otherwise, the PKPA reforms will continue to be seen by agency heads as an add-on agenda, to be undertaken only when time permits or sanctions are imminent-or worse still, as purely a reporting requirement. Strengthening the links between program performance management and the budget 2.50 Like many developing countries, Malaysia uses a macro-level indicative planning approach to development-and has done so since the 1960s. But the lack of strategic planning at all levels of the public sector in Malaysia means that there is only a tenuous link between development plans and the annual budget and the tendency to see the development plan exercise as distinct and different from the annual budget exercise is a common problem. The lack of strategic planning also leads to weak linkages between program performance management and budget formulation. A range of problems could be attributed to lack of strategic planning: the gap between objectives and outcomes, weak links between outputs and outcomes, neglect of evaluation, high level of budgetary transfers, and frequent supplementary budgets. 2.51 Improving the links between program performance management, budget formulation and development plan through strategic planning will require concerted effort by all key institutional players-Parliament, the Cabinet, central agencies, and operating agencies. But the initiative, drive, and leadership must come from the Treasury, which as guardian and principal manager of the limited public resources is best positioned to strengthen these links. A first step is to ensure that each agency clearly 34 understands its role in national development. The national planning documents-Vision 2020, the National Development Policy, the Second Outline Perspective Plan (1990- 2000) and its components, the Sixth and Seventh Malaysia Plans-provide the big picture. If adopted, a budget policy statement would provide a means for the Cabinet to explain its medium-term policy priorities, clarifying the links between the national plans and annual budget formulation. 2.52 Based on this national direction, each agency needs to: develop its own three-year strategic performance plan containing its long-term goals and objectives, and break down the strategic plan to annual performance plans of programs, activities, and projects with clear performance objectives; and strategize the use of the budget as a tool for realizing the annual plan. Also essential in strengthening the links between performance management and the budget are monitoring, evaluating, and reporting on performance. Much of this is provided for in the Modified Budgeting System, in itself a well-planned performance management system. It looks strategically at all important aspects of performance management. It recommends the use of program logic and strategic planning and of a performance management tool in the form of the annual performance agreement between agency managers and the Treasury. It also has in place a suitable requirement for program evaluation. 2.53 Developing a strategic plan. Planning for performance sets the parameters for an agency's success. The agency decides what needs to be done and how to do it. Through strategic planning, the agency: (i) establishes its mission, formulating a brief, clear statement of the fundamental reason for its existence; (ii) establishes the long- and short- term goals it must meet to achieve its mission, focusing on key areas where results are needed; and (iii) determines the strategies, programs, and activities for achieving the goals. 2.54 Once the agency has identified the package of programs and activities, it could: (i) identify the needs of its clients and stakeholders; (ii) review the priorities of the Cabinet; (iii) prioritize programs and activities on the basis of current stakeholder and customer needs and Cabinet priorities; (iv) define specific, measurable, and attainable objectives for each program and activity-what results are to be achieved and when; (v) identify implementation strategies and alternatives; (vi) establish relevant, suitable, and verifiable performance indicators for each program and activity; (vii) set milestones for checking progress and ensuring deliverables; and (viii) set up an effective program evaluation system to ensure the effectiveness and appropriateness of each program. 2.55 Another part of strategic planning is to look at organizational design, the budget, and personnel to ensure that the structure and resources to implement the programs and activities effectively are in place. Form must follow function. Once the strategic planning is completed, the outcome must be communicated to all agency personnel-to galvanize an orientation to results-based performance. 2.56 Formulating the budget. The budget process follows on the strategic plan. The agency could: (i) review the implementation of the previous year's plan and the degree to which objectives have been achieved, to identify programs needing to be strengthened, modified, or terminated; (ii) analyze the current year's plan to identify major issues that 35 need to be addressed, including key external factors and internal strengths and weaknesses; (iii) review the rationale for programs and activities in terms of their contribution to the strategic plan and their targeted results; (iv) set realistic performance objectives in terms of quantity, quality, cost, and time; (v) identify the resources needed to implement the programs and activities-and an alternative course of action in case the optimal resources are not available; and (vi) identify and establish a clear framework for evaluating program performance. 2.57 Monitoring performance. Monitoring against the milestones set is essential to ensure that programs and activities are on the right track. The task is to determine whether the results that have been achieved are in line with the standards set for quantity, quality, cost, and time. If there turn out to be problems in implementation, the management can reprioritize goals and objectives, refine strategies, and reallocate resources. 2.58 Today's monitoring efforts, by both operating and central agencies, tend to focus on the fiscal resources expended and the physical progress made by projects. The Implementation and Coordination Unit of the Prime Minister's Department, which monitors development projects, captures this information in detail but scarcely touches on outcome or impact. The Treasury's monitoring of operating expenditures also leaves much to be desired. Its performance tracking system relies heavily on financial performance. Where output measures receive attention, they tend to be easily quantifiable ones, and even then there is no clear link with the budgetary and program performance management process. 2.59 The Treasury needs to make serious and immediate efforts to devise a clear and practical system for tracking, monitoring, and reporting program performance. It could begin by reviewing the integrated management information systems that several agencies and statutory bodies have successfully put in place on their own initiative. 2.60 Evaluating performance. Essentially, evaluating performance means asking simple questions: Are we doing the right things in the right way to achieve the results we want? Is our current performance good or bad? Is it reaching our targets or meeting last year's performance levels--or is it falling short? If so, by how much? And what is causing the shortfall-manpower, material, money, method? 2.61 Evaluating performance enables management to take action to improve future performance. But the evaluation results are also essential inputs in resource allocation. Program managers should use them in strategic and annual planning, for decisions on the effectiveness of programs and activities in addressing a problem or meeting a societal need. The central agencies need to ensure that the information is used strategically in resource allocation to reflect the government's long-term policy goals-allocating resources based on priorities rather than relying on across-the-board cuts or increases. 2.62 Evaluation at the macro level is subsumed under the Economic Planning Unit, though mostly for development expenditures. The Treasury is supposed to take the lead for operating expenditures, but does not seem to have played an effective role. Although mandated by the Modified Budgeting System, program evaluation has been given serious 36 attention by only a handful of agencies, such as the Ministry of Health. Other operating agencies are equally keen to fully implement the Modified Budgeting System and the necessary program evaluation, but the Treasury, despite preaching the agenda for the past nine years, has not given adequate encouragement or support. 2.63 Nor has the Office of Auditor General played much of a role in reviewing agencies' performance and their use of scarce resources. Although it has undertaken performance audits in the past, the efforts have failed to produce results. And the office is unclear about the need for and importance of evaluating program performance. Its functions thus far have been limited to ensuring financial accountability, despite the leadership's strong and repeated emphasis on ensuring management and program accountability. 2.64 Reporting performance. Communicating the results of performance monitoring and evaluation is vital to the continued credibility of an agency and its programs and activities in the eyes of its stakeholders and clients. The information needs to be communicated to policymakers, central agencies, and other authorities with the power and responsibility to allocate resources and to support programs and activities. It also needs to be communicated to agency managers and staff to ensure their support, commitment, and ownership. 2.65 Today, performance results are reported to Parliament annually through the budget performance report of the Ministry of Finance, but little or no debate takes place among legislators and key policymakers on program outcomes and results. Again, financial accountability tends to be the focus, not performance management and program accountability. 2.66 Annual reports showing how agencies implemented the previous year's plan, their progress toward objectives, and the reasons for any deviations from the plan are an essential part of performance management and accountability. Yet line agencies face no requirement to prepare them. Some agencies, such as the Ministry of Health, do prepare annual reports, but the reports appear too late to provide input to budget allocations for the next year or to the Cabinet's discussion of policy priorities. The Treasury could strengthen performance management and accountability by requiring line ministries and agencies to publish timely annual reports and disseminate them to stakeholders, clients, and the public. E. AN ENHANCED PUBLIC REPORTING FRAMEWORK 2.67 The suggestions above imply an enhanced public reporting framework-one that would bring Malaysia into the league of best practice along with only a handful of industrial countries. This may seem as an overambitious goal but Malaysia already has a transparent public reporting framework and excellent management capability-and the will to improve its systems even more. So while the goal could be considered overambitious for other developing countries, for Malaysia it requires simple modifications to its public reporting system. 37 2.68 The modifications are in two distinct but complementary areas: fiscal reporting and performance reporting. The suggestions for fiscal reporting can be summarized as follows: (i) expand the coverage of the economic and fiscal report to incorporate the balance sheet items and fiscal risks of the whole of government; (ii) publish a statement of fiscal strategy in which the Cabinet announces its overall fiscal targets; (iii) publish the economic and fiscal report twice a year-once before the statement of fiscal strategy to provide an update and again with the budget document to provide an outlook; and (iv) extend the coverage of the public accounts to include the fiscal risks arising from all types of government guarantees. 2.69 The suggestions for modifying performance reporting are aimed at a common performance management regime across the government, with each ministry, departmental entity, and nondepartmental entity preparing: (i) a three-year strategic plan showing its mission, objectives, goals, and strategies; (ii) an annual business plan showing how it will achieve its goals through implementation of programs and activities; and (iii) an annual report presenting its achievements at the end of the fiscal year. Also suggested is that the Cabinet publish a budget policy statement early in the budget process announcing its policy priorities and guiding the strategic planning of line agencies. 38 3. FUTURE CHALLENGES IN A MODERN ECONOMY: GOVERNMENT'S EVOLVING ROLE 3.1 Malaysia's economic growth over an extended period has been phenomenal, similar to other East Asian miracle countries. Sound macroeconomic management, prudent fiscal policies, an open economic environment supportive of competition, a strong and well functioning civil service, political stability, and a vibrant private sector have been key to Malaysia's success in achieving high rates of economic growth and dramatically reducing the level of poverty. The economy has been transformed from one that produced primary commodities to one with a diversified export base and significant high-tech manufactured export. Over the past two decades, the standard of living enjoyed by the Malaysians has increased tremendously. Growth and modernization have improved people's welfare; life expectancy has increased, educational attainment has risen, infant mortality rates have dropped, and there is improved access to health and educational facilities. 3.2 These enviable outcomes were a direct consequence of government strategy- initially public sector led through the New Economic Policy of the 1970s, with a vision of equity and poverty reduction, export orientation, and heavy government involvement in economic activities; and then private sector led through the concept of Malaysia Incorporated of the 1980s and the National Development Policy of the 1990s with a vision of facilitating private sector growth through greater deregulation, better incentives, and closer collaboration between the public and private sectors. The government's privatization policy of the past decade enabled the private sector to participate in economic activities which were once the domain of the public sector, particularly in developing infrastructure. Reducing the role of the state activities which were once the domain of the public sector, activities which were once the domain of the public sector, particularly in developing infrastructure. Reducing the role of the state in the economy alleviated the pressure on public expenditures. The budget has recorded a surplus from 1993 until the East Asian crisis. 3.3 The role of government is evolving. The government is preparing to meet the second-generation challenges ahead, arising largely from Malaysia's advanced level of development and its ambitious goals of Vision 2020. These entail a rethinking of the government's role in tertiary education, tertiary health care, social protection against income risk, and infrastructure. In all these areas, there is a potential role for the private sector in provision and financing, and the government's role is shifting more and more from being a provider of these services to a financial supporter. In this evolving public- private partnership, the goal of the government is to reduce the fiscal burden while ensuring equity in delivering public services and efficiency in allocating and using public resources. The most advanced sector in this process is infrastructure, where "privatization" backed up by government support began a decade ago; but Malaysia 39 could learn from international experience in infrastructure strategies that will improve the viability of projects. In tertiary education, there is a need to expand supply and corporatization of universities is underway; but this needs to be accompanied by a better financing system for students to ensure greater accessibility and equity. In health, the government has been contemplating for over a decade the corporatization of hospitals and the introduction of a national insurance scheme; this is a complex issue still debated among OECD countries and there is no perfect solution. In social protection, the role of the government as a guarantor of income risk is debatable; many countries like Malaysia do not support a Western type of social protection, such as unemployment insurance, and are looking for alternative mechanisms. 3.4 This chapter reviews Malaysia's achievements in major sectors that affect the budget-health, education, safety net, and infrastructure-and raises some challenges that Malaysia faces in dealing with second-generation issues-tertiary health care, tertiary education, income risk management, and infrastructure financing. The chapter does not attempt to provide solutions to these complex issues but provides some observations and suggestions. A. FISCAL PATTERNS AND THE ROLE OF GOVERNMENT 3.5 Malaysia is a federation with three tiers-a federal government, 13 states, and an extended local government network. Financial arrangements in the federation concentrate to a large degree the powers of taxation and spending responsibilities at the federal level. The federal government undertakes sizable transfers to lower levels of government to finance both their recurrent and development budgets. 3.6 The patterns of public expenditures over the past two decades reflect the changing role of government. In pursuit of the objectives of the New Economic Policy of the 1970s, which aimed at restoring ethnic balance of the Bumiputera population and investing in people, the government was directly and heavily involved in economic activity. This extensive intervention in the economy led to a huge increase in the size of the public sector relative to the economy-from about 20 percent of GDP in the 1970s to a peak of about 58 percent in 1981. The large government presence meant a growing public sector deficit, leading to a sharp increase in domestic and external borrowing. External debt more than quadrupled between 1980 and 1985. It became apparent that government revenues could not keep pace with the growing expenditures. A looming recession prompted the government's policy changes. 3.7 The shift in strategy from public sector led growth to private sector financed development began in 1983, when a national policy announced the concept of "Malaysia Incorporated." This concept treats the country as a corporate entity in which the government provides the enabling environment-infrastructure, deregulation, liberalization, and macroeconomic management-and the private sector serves as the main engine of growth. This new approach reduced the need for the public sector to borrow both domestically and in foreign financial markets. Thus, the overall public debt burden, unlike in many middle income countries, has remained modest at 30 percent of GDP. 40 Table 3.1: Fiscal Summary of the Federal Government in percent GDP 1980 1990 1995 1996 1997 1998 1999 1998 Total Revenue 26.9 25.5 23.3 23.0 23.3 19.9 19.6 19.7 Tax Revenue 24.7 18.3 19.1 18.6 19.0 15.9 15.1 15.4 Corporate 4.9 3.9 5.4 5.6 5.9 6.1 5.3 5.7 Individual 1.9 2.2 2.8 2.5 2.3 2.4 2.1 2.2 International Trade 8.9 4.7 3.0 2.8 2.7 1.6 1.8 1.7 Sales Tax 1.3 2.1 2.2 2.2 2.2 1.4 1.5 1.4 Excise Tax 1.9 2.0 2.4 2.3 1.3 1.6 1.1 Nontax Revenue 2.2 7.1 4.2 4.4 4.3 4.0 4.4 4.2 Total Expenditure 40.7 30.8 23.2 23.1 21.4 22.0 23.9 23.6 Current Expenditure 26.3 21.6 16.7 17.3 15.8 15.7 16.3 16.6 Wages and Salaries -- 7.9 6.0 5.6 4.7 4.9 4.8 5.1 Pensions -- 1.0 1.3 1.4 1.3 1.3 1.4 1.3 Interest Payments 3.0 5.9 3.0 2.7 2.3 2.4 3.0 2.3 Transfers to Local gvts. -- 1.3 0.6 0.4 0.3 0.4 0.4 0.6 Supplies and Services -- 2.5 2.7 2.2 2.3 1.8 2.1 1.7 Subsidies -- 0.4 0.3 0.3 0.3 0.4 0.3 0.4 Capital Expenditure 14.4 9.2 6.4 5.8 5.6 6.4 7.5 6.9 Current Surplus/Deficit 0.6 3.9 6.6 5.7 7.5 4.3 3.3 3.0 Overall Surplus/Deficit -13.8 -5.3 0.2 -0.1 1.9 -2.1 -4.3 -3.9 Primary Surplus/Deficit -10.8 0.5 3.1 2.6 4.2 0.3 -1.3 -1.6 a. Latest estimates. Source: Ministry of Finance, Economic Report; various years. 3.8 Prudent fiscal policy has led to budget surplus over the past five years, rare in most countries. As a result of the private sector-led growth strategy, total federal government spending declined from about 30 percent of GDP in 1990 to only 20 percent in 1998 and 19.6 percent in 1999 (Table 3.1). Most of the decline came from a reduction in development spending, debt service payments, and wage bill. First, capital expenditure declined from about 9.2 percent of GDP in 1990 to 5.6 percent of GDP in 1997 as a result of the shift in investment responsibility to the private sector, especially in infrastructure. Second, interest payments dropped from 6 percent of GDP in 1990 to about 2 percent of GDP in 1997, reflecting reduced levels of net borrowing by the government, pre-payment of outstanding debt, and lower interest rates resulting from strong economic and fiscal fundamentals. Third, the wage bill decreased from 8 percent of GDP in 1990 to 5 percent of GDP in 1997, due to the introduction of the Modified Budget System which allowed further staff rationalization. At the same time, buoyant revenues were fueled by rapid economic growth without raising tax rates. These favorable trends resulted in an overall fiscal surplus since 1993, reaching 2 percent of GDP in 1997 (RM5.3 billion). As a result of the government's balanced current budget objective, the current budget was in surplus for most of the past two decades. The consolidated budget has also been in surplus since 1994 until the crisis (Table 3.2). 3.9 The impact of the regional economic crisis is clearly evident in Malaysia's fiscal account. In 1998, Malaysia recorded its first fiscal deficit in five years. Revenue collections in 1998 reflected the slowdown in domestic economic performance and lower tax rates to boost the private sector (see chapter 1), declining 13.7 percent over the 1997 41 level. As a share of GDP, revenue declined to 20 percent in 1998 and 19.6 percent in 1999 after holding steady at about 23 percent of GDP between 1994 and 1997. Operating expenditures were only slightly lower than 1997 levels. Development expenditure increased to 6.4 percent of GDP in 1998, after holding for several years over 5 percent, as part of the fiscal stimulus. However, although allocations were sharply increased to RM19.4 billion and RM17.6 billion for 1998 and 1999 respectively, the actual outturn for 1998 was RM18.1 billion because of delays in implementation (at the beginning of 1998, development expenditures were curtailed to reduce the deficit). The decline in revenues in combination with the counter-cyclical increase in development expenditure resulted in an overall deficit of 2.1 percent of GDP for 1998. Table 3.2: Consolidated Public Sector Finance (percent of GDP) 1993 1994 1995 1996 1997 1998 1999 General Government Revenue 31.8 32.1 28.5 27.9 28.3 24.4 22.9 Operating Expenditure 22.8 21.3 18.9 19.9 17.8 17.7 18.7 Current Surplus/Deficit 9.1 10.8 9.5 8.1 10.5 6.7 4.2 Non-Financial Public Enterprises' Surplus 8.3 7.8 7.3 8.0 9.8 7.9 6.5 Total Public Sector Current Surplus/Deficit 17.3 18.6 16.9 16.1 20.3 14.6 10.7 Development Expenditure 19.6 15.1 13.6 12.1 14.2 15.6 16.2 General Government 7.8 6.6 7.4 6.0 6.6 6.0 8.4 Non-Financial Public Enterprises' Surplus 11.8 8.5 6.2 6.1 7.6 9.6 7.8 Overall Surplus/Deficit -2.2 3.5 3.2 4.0 6.1 -0.9 -5.5 Note: General government comprises Federal government, state governments, statutory authorities and local governments. Source: Economic Report, Ministry of Finance. 3.10 Malaysia has a diverse revenue base. Direct taxes, composed primarily of income tax on individuals and corporations, and natural resources tax, accounted for 40-45 percent of total revenue collection over the period 1994-1997. Tax reforms in the mid-80s followed the world-wide trend towards flatter, more streamlined rate schedules. Malaysia has an integrated system of personal and corporate income taxes with moderate statutory rates. Although personal and corporate income tax receipts have grown to 8 percent of GDP in 1997, up from 6 percent in the early 1990s, there is concern that tax receipts did not expand as rapidly as the economic base. Statutory rates have fallen across all income groups; however, progressivity was compromised as rates for higher income groups have been reduced by more than those in lower income groups. Moreover, under-reporting of income and differential treatment for fringe benefits have also reduced collection potential. The importance of taxes on natural resources declined as the Malaysian economy moved away from natural resource extraction toward more developed manufacturing and service sectors. 3.11 The crisis presents an opportunity to broaden the tax base by switching to VAT. Indirect taxes consist of export, import and excise duties, sales and service taxes. With a more open trade regime, export duties, levied on primary commodities, have become minimal and import duties have dropped. The sales tax was introduced in 1972 and imposed on manufactured goods only. The effectiveness of the sales tax has been eroded over time by exempting many industries and gradually raising the size threshold of firms liable to pay the tax. Although the design of the sales tax involves a tax credit system to compensate for tax 'cascading,' similar in some respects to a value-added tax (VAT), 42 movement to a full fledged VAT, at both manufacturing and consumption stages, presents greater advantages than the current tax credit system, both in terms of increased revenue collection and reduced administrative burden. Most countries that have switched to a VAT have achieved at least significant one time gains in revenue collection. Moreover, information gathered through the intermediate process of crediting firms for taxes already paid, would provide tax authorities with an integrated view of both direct and indirect taxation. The rate of VAT can also be varied to achieve equity and public welfare goals under a unified tax, rather than relying on the three separate sales, excise and service taxes which are administratively more demanding. To broaden the tax base by including value addition at the wholesale and retail stages and minimize the incidence of taxation on business inputs, VAT has been found the most efficient form of sales tax that can achieve these objectives throughout the world. 3.12 Sectoral allocations of spending have changed to reflect the new economic strategy of the government. The share of agriculture and rural development in total expenditure halved between 1980 and 1997 as a result of the policy shift that led to rapid industrialization and increased employment opportunities in manufacturing industry coupled with reduced availability of prime agricultural land. Expenditures on commerce and industry in the 1980s reflect the investments made in hi-tech industries, and start up contributions to programs designed to meet the goals of the New Economic Policy in terms of restructuring, but they have declined in the 1990s.' The allocations for the transport sector reflect greater reliance on the private sector for infrastructure development, most of which was in transport. Malaysia spends slightly more on education than comparable countries-21 percent of total spending, compared with an average of 16 percent for similar countries in 1997 (Table 3.3). Conversely, Malaysia spends a comparable share of its budget on health than similar countries. It spends much less on social security than Latin American countries. Like other East Asian countries, Malaysia spends a large share of its budget on transport compared to Latin America, despite the government's effort to privatize. The share of general administration is also much higher. As the economy modernizes and globalizes, the government's role would need to evolve. To a large extent, Malaysia does not have a fiscal problem and is unlikely to have one even after the crisis (see chapter 1). The government's efforts are therefore concentrated on providing the enabling environment for the private sector to thrive and the high growth rates of the past to be maintained. For that, policies in various sectors- health, education, social protection, and infrastructure-would need to progress. 43 Table 3.3: Fiscal Expenditures of the Federal Government by Sector 1980 1990 1995 1996 1997 1998 a 1999 b Total Expenditure/GDP (%) 40.7 30.8 23.2 23.1 21.4 22.0 24.7 As a percent of Total Expenditure Defense and Internal Security 16.1 13.6 17.6 15.5 14.8 11.6 13.0 Education 13.2 18.5 20.9 21.4 21.3 21.4 20.6 Health 3.7 5.0 5.5 5.9 6.2 6.5 6.1 Housing 1.4 0.3 1.0 1.2 1.4 1.8 1.7 Infrastructure /c 11.4 9.2 9.7 11.3 10.9 10.4 12.8 Agriculture and Rural Development 6.1 6.6 4.9 4.5 4.0 3.3 3.4 Trade and Industry 8.3 9.3 3.6 4.6 4.2 7.2 7.6 General Administration 6.6 7.3 12.7 10.8 11.5 11.7 9.7 Others 33.2 30.2 24.1 24.9 25.7 26.2 25.2 Current Expenditure 64.6 70.1 72.2 75.0 73.9 71.1 66.2 Development Expenditure 35.4 29.9 27.8 25.0 26.1 28.9 33.8 As a percent of GDP Defense and Internal Security 6.5 4.2 4.1 3.6 3.2 2.6 3.2 Education 5.4 5.7 4.8 4.9 4.6 4.7 5.1 Health 1.5 1.5 1.3 1.4 1.3 1.4 1.5 Housing 0.6 0.1 0.2 0.3 0.3 0.4 0.4 Infrastructure C 4.7 2.8 2.2 2.6 2.3 2.3 3.2 Agriculture and Rural Development 2.5 2.0 1.1 1.0 0.9 0.7 0.8 Trade and Industry 3.4 2.9 0.8 1.1 0.9 1.6 1.9 General Administration 2.7 2.3 2.9 2.5 2.5 2.6 2.4 Others 13.5 9.3 5.6 5.7 5.5 5.8 6.2 Current Expenditure 26.3 21.6 16.7 17.3 15.8 15.7 16.3 Development Expenditure 14.4 9.2 6.4 5.8 5.6 6.4 8.3 Memo Items: GDP (RM million) 51,838 115,828 218,671 253,732 281,888 284,473 299,683 Total Expenditure (RM million) 21,080 35,715 50,624 58,493 60,415 62,688 73,936 Notes: a. Latest estimates. b. Budget allocation. c. Includes transport, communications and utilities. Source: Ministry of Finance, Economic Report 1998/99 and various previous issues. 44 B. HEALTH SYSTEM FOR THE FUTURE: A DIFFICULT CHOICE Impressive Achievements in the Health Sector 3.13 Malaysia has been extremely successful in building a public healthcare system that is comprehensive, efficient, and inexpensive. Improvements in health indicators have leaped since independence, outperforming the vast majority of developing countries. With an increasing private healthcare supplying the rich, public expenditures on health were captured to a large extent by the poor. Today, Malaysia has, in common with the rest of East Asia, new problems such as aging populations and increased chronic illnesses. To tackle these general difficulties, the government is rethinking its healthcare system: maintaining its existing public system or privatizing it while introducing a national health insurance scheme. The choice is difficult but the goal is to preserve an efficient and equitable healthcare system. Figure 3.1 Health Outcomes Have Leapt Since 1957 Life expectancy has risen... ... and mortality rates have fallen. 80 25 70 Index 1957 100 60 ~20 120- 50 15 m 100 Infant mortality rate (per 1,000 live births) 40 40 80- 30 ? 108 - Maternal morality rate (per 1,000 live births) 20 60 10 40 0 0 1957 1970 1980 1990 1996 20 III Male life expectancy (left axis) im,7 Female life expectancy (left axis) - population(rightaxis) 1957 1970 1980 1990 1996 Male life expectancy Infant Mortality rate Female life (per 1,000 live births) - expectancy - Malaysia - East Asia & Pacific GNP per capita Upper-middle income countries 3.14 Remarkable health outcomes at low cost. Health indicators have improved considerably since independence. They have outperformed many developing countries and compare well with upper middle income ones (Figure 3.1). In particular, Malaysian men now live thirteen years longer than their counterparts in 1957, and women live sixteen years longer. In addition, births are no longer a serious threat to mothers and children-infant mortality rate has dropped to 9 per 1,000 live births (from 75 in 1957) 45 and the maternal mortality rate is down to 0.2 per 1,000 live births (from 3.2 in 1957). These impressive outcomes have been achieved at a low cost-national health expenditure is estimated at around 1.5 percent of GDP in 1996, compared with 5 percent for the average of middle-income countries. 3.15 Efficient and well targeted public spending. The government's continuous and strong commitment to health since independence has resulted in a comprehensive and remarkable public network of health services which encompasses all aspects of care and includes a very good referral system. The government remains the main provider of health care in Malaysia. As for tertiary care facilities government hospitals provide 80 percent of inpatients beds. The government is also the main provider of primary care facilities. Public spending is well targeted to the poor partly due to self-selection by the rich to use private health care (Hammer, et. al. 1996) and partly due to good access to health services and low fees. Some 95 percent of the population is located no more than five kilometers from a public health facility; 90 percent of the population has access to safe drinking water (compared to 62 percent in Indonesia). Fees for out-patient treatment are only RM1 for a generalist and RM5 for a specialist (double for foreigners) and quite low for inpatient care (they differ according to class of service). Between 1970 and 1997, the MOH budget has remained constant and low at around 1.3 percent of GDP and 6 percent of total government spending (Figure 3.2). Figure 3.2: Public Health Expenditures Have Held Steady 7 140 6 120 5 100 { 60 2 40 0 0 1970 1980 1990 1995 1996 1997 tl expenditure as percent of GDP (left) g expenditure as percent of total government expenditure (left) --AReal spending per capita (right) Source: Ministry of Health budget and Malaysia Central Bank. 3.16 An increasing role for the private sector. The government has encouraged the private sector to expand2 since the late 1980s to "develop the hospital system without increasing public expenditure to steer Malaysian society away from a welfare state for health care" (Figure 3.3). The private hospital sector is predominantly urban-based, concentrated on high-return curative care, and is largely for-profit. The government has also embarked on a strategy of corporatization for public hospitals and privatization of some healthcare services. Accordingly, the National Heart Institute was corporatized in 1992, while the General Medical Store was privatized in 1993. These changes were followed in 1997 by outsourcing major non-medical hospital support services (a clinical waste management facility, biomedical engineering maintenance services, facility engineering maintenance services, cleaning services, and linen and laundry services). Private care accounts for half of total health spending and is predominantly financed by user payments. 46 Figure 3.3: Participation by the Private Sector Has Increased Dramatically 1957 E private hospitals I public hospitals 1980N MS 1990 1995 1997 0 50 100 150 200 250 number of hospitals 1980 private inpatient beds 19W* puic inpatient beds 1995 1997 0 05 10 15 20 25 30 35 40 number of inpatient beds (n thousands) 1980 * private physicans 1 public physicans 1995 0 1,000 2,000 3,000 4,000 5.000 6,000 number of physicians Source: Ministry of Health, Malaysian Medical Association, World Bank staff estimates. Improving Budgetary Allocation in the Health Sector 3.17 Despite the great achievements in the Malaysian health sector, important challenges remain. There is regional disparity in health outcomes which has probably contributed to increased inequality; a declining spending on preventive care; and a shortage of public doctors.' 3.18 Regional disparity prevails. Despite good access to public health care, a major concern remains the unequal distribution of hospitals and primary care facilities, especially in poor states. In hospital care, Kuala Lumpur has over four times more beds per 1,000 inhabitants than Kedah. In primary care, Kuala Lumpur or Melaka have more than twice the number of health facilities per 10,000 people than Sabah. Although the 47 uneven distribution is partly due to differences in population density across states-the lower the density the higher the cost of sustaining the facilities-a more balanced allocation could be achieved. There are regional differentials in health status as well, Figure 3.4: Do State Health Expenditures go Where Incomes are Lowest? Not Quite. 250 * Kuala Lumpur 200- f 150 Terengganu 0 100 - / Sabah fitted line excluding Kuala Lumpur c) Kelantan Pahang\ Kedah 50 0 0 20,000 40,000 60,000 80,000 Average household income in RM Source: Ministry of Health, World Bank staff estimates. particularly detrimental to poor states such as Sabah and Sarawak. Maternal mortality rate in 1993 ranged from 16 per 1,000 live births in Penang to 77 in Sabah (MOH 1996 annual report). Immunization coverage for measles in 1996 ranged from 76 percent in Selangor to 95 percent in N. Sembilan. The incidence of typhoid (per 100,000 people) in 1996 varied from less than one in Pahang to 22 in Kelantan, while the incidence rate for TB (per 100,000) ranged between 5 in Perlis and 164 in Sabah. Despite the clear need to spend more in certain regions, the relationship between state income and health budgets is weak (Figure 3.4). 3.19 Spending on preventive care is declining. Malaysia has done so well in public health that its disease pattern has shifted towards those that are curative in nature. Curative care costs more than preventive care, and thus accounts for a larger share of expenditure-in 1997, about two-thirds of current expenditure went to secondary and tertiary care. But preventive care should have the first claim on public resources because it creates large externalities and is subject to under-spending by households. Control of communicable diseases also alleviates poverty.4 Recent trends in spending have not favored preventive care (public health)-it has been declining as a share of total health spending since 1990 (Figure 3.5) and in absolute terms since 1996. Although the government has so far been able to finance all necessary public health programs, new communicable diseases have emerged following world trends, such as TB and HIV/AIDS epidemics, and would require higher budgetary allocations. In Malaysia, the HIV prevalence rate, at 0.62 percent, is above the average for the region. Moreover, prevention of chronic diseases is crucial in reducing the future burden of disease and is usually not adequately reflected in public policy. Three particularly important areas for action include: tobacco use, unhealthy food (such as fat intake which increases the risk of coronary heart disease); and secondary prevention of major cardiovascular diseases (e.g., 48 monitoring blood pressure and cholesterol or cancer screening). There is also room for improving immunization coverage. Singapore and Thailand have achieved almost universal inoculation while 4 percent of one-year-olds in Malaysia remain non- immunized against DPT and polio and 14 percent are not immunized against measles. Spending on preventive care could therefore be increased in light of these developments. Figure 3.5: Distribution of Health Expenditures 1990-1997 In percent of health expenditures 00 80 o Other 60 g Medical Care 40 * Public health 20 0 1990 1995 1996 1997 In percent of public health expenditures 100 - - Other 80 * Medical Care M Dental services 60 N Health education and Food Quality Control 40 Epidemiology 20 m Family health a Public health management 0 1990 1995 1996 1997 Source: Ministry of Health budget. 3.20 There is a shortage of medical personnel. Wages account for only 50 percent of operating expenditure in health, well below levels in most upper-middle income countries. The low payroll level is due to relatively low wages in the public sector and a larger public-private gap in health than in other sectors. The wage differential could reach 3-4 times for experienced doctors and double for nurses. Also, fewer staff than deemed necessary operate the public health service because of the difficulty of maintaining staff in public facilities. MOH operates all health facilities, including 80 percent of the country's inpatient services, with only 45 percent of the country's doctors. In 1996, the vacancy rate in government posts was 35 percent for highly-skilled "managerial and professional" staff 13 percent rate for "support and administration" staff. In 1997, 7 percent of doctors left the public service. 49 Malaysia is Adjusting to the Challenges Ahead 3.21 The Malaysian health care system has worked very well but new challenges are emerging: the population is aging, incomes are rising, and the pattern of disease is evolving. These changes are expected to alter both the overall level and the composition of health care expenditures. To meet new demands and continue to provide its population with better living standards, the government's goal throughout the Seventh Plan is to expand and improve health services. An important aspect of this goal is the corporatization and privatization of health facilities and services. Because this increased role of the private sector in provision of health care would mean higher cost to consumers, the government would complement its privatization strategy with the introduction of a health financing scheme. 3.22 Malaysia confronts significant challenges in implementing these major policy reforms, which could dramatically transform its health care system. The pro-poor accomplishments of the existing system need to be preserved under any future transformation. Policymakers appear unsure of the appropriate scope and pace of new reform initiatives. There is a perception that substantial capacity building in health policy and management still needs to take place to successfully design, implement, monitor and evaluate the reform process. 3.23 Aging population, increasing chronic sickness, and rising incomes will increase Malaysia's medical expenditures. First, Malaysia's population is aging-in 1990 less than 6 percent of the population was over 60 years old; by 2020 that proportion will double. As the population ages, the cost of care increases. For example, in Singapore in 1997 in public sector hospitals, the average admission rate was 74 patients per 1,000 over the whole population, but this rate doubles for patients over 60 and triples at 70. Second, the country's disease profile is changing as the level of development increases. In 1990, less than 40 percent of the global burden of disease came from non-communicable diseases; by 2020, this share is expected to rise to 60 percent. As the pattern and incidence of diseases alter, so too do the demand for and the costs of health services. Third, rising incomes will generate proportionately larger increases in health spending. On average, studies have shown that healthcare rises by 11.4 for every 10 unit rise in income. Considering all these factors, a growing share of income is likely to be devoted to healthcare in Malaysia. 3.24 Malaysia's fiscal costs are bound to rise. The government's current investment strategy, which focuses on expanding and improving health services, will result in higher level of operating expenditure in the next five to ten years. First, the government is expanding its coverage of rural and under-developed areas and merging hospital outpatient departments with existing health facilities to form new (and expensive) community clinics. Second, the government is committed to a long term, ambitious investment program to upgrade existing public hospitals and build expensive new high- tech hospitals. This leads automatically to increased operating expenditure in the budget. Third, cost recovery is very low because it is not an objective of the Ministry of Health- in 1997, hospitals recovered less than 3 percent of their current spending. Health facilities in the public sector are funded from general taxation revenues. This is consistent with the principle of a national health service like that in the United Kingdom, for instance. Thus, 50 rising health expenditures combined with a policy of low cost recovery will raise fiscal costs. 3.25 The government is formulating a new strategy to reform the health sector. The government's two-pronged structural reform agenda aims for major changes in both the provision and financing of health care. On the provision side, Malaysia has initiated significant measures to privatize some components of its health services. One set of measures has outsourced a variety of support services used by public hospitals, including laundry, cleaning, diagnostic services and drug procurement. Another set of measures aims at "corporatization" of the public hospitals themselves, initiated with corporatization of the National Heart Institute (NHI) in 1992. Malaysia's corporatization model appears analogous to Singapore's restructuring program, which retains a reduced but significant role for public subsidy of certain classes of patient, while charging at least full cost recovery to other classes. Thus, 52 percent of NHI's patients during 1992-1997 were subsidized (including civil servants, pensioners, students and the lower income group). 3.26 On the financing side, since the mid- 1980s the government has been considering diversifying from its heavy reliance on budget subsidies by introducing an extrabudgetary health financing scheme. While no policy decisions have been announced, this could take the form of intertemporal risk pooling through medical savings accounts analogous to the Singapore model, instead of the conventional social insurance approach taken by Korea and Taiwan. However, specifying basic design parameters such as payroll contribution rates remains uncertain. Once established, the new national health fund is expected to complement corporatization by mobilizing additional resources necessary to absorb the higher cost recovery imposed by privatized hospitals. 3.27 Privatization has not yet led to fiscal savings. Furthering the role of the private sector in health care to reduce the fiscal burden and improve quality of service is a general strategy of the government. In practice, however, the fiscal outcomes of outsourcing are mixed so far. Fiscal costs of five engineering support services that were contracted out have doubled (from less than RM200 million per year to RM520 million in 1998). The cost increase was not matched by enhanced quality. Despite some improvements, the quality of services remains imperfect, partly due to the shortage of adequately trained personnel. Moreover, the legal and financial framework of outsourcing has significant weaknesses, including limited competition and transparency.s However, the concession companies are to implement quality assurance programs for all the five engineering support services so as to achieve ISO 9002 registration within 5 years of takeover. 3.28 The financial impact of NHI corporatization has not been very encouraging. Costs per unit (and budget subsidies) have risen since the corporatization. This is related to a significant rise in the payroll--civil servants agreed to leave the public sector and be "privatized or corporatized"; they lost the job security they have enjoyed so far but got higher wages. This policy was adopted to ensure employment opportunities to the affected employees and to retain medical expertise within NHI after corporatization. 51 Options for the future 3.29 One of the difficult questions facing Malaysia is how to pay for the expected rapid escalation of medical bills in an efficient and equitable way. Malaysia is well positioned since it has both a significant public and private sector which allow various options to be considered. The choices confronting Malaysia in reforming its health care system include (i) keeping its current dualistic system of heavily subsidized public health care combined with a rapidly emerging private sector for those who can afford it; and (ii) introducing a national health financing scheme and privatizing public health services (there is no convincing evidence that relying solely on private insurance schemes works well). 3.30 Health care financing is a complex issue outside the scope of this review; thus some options are spelled out with no specific recommendation (further work will be done in this area). The first option-maintaining the current system-is certainly viable but it is likely to lead to increased fiscal costs if quality is to improve. However, there is considerable room for growth in healthcare spending before cost containment becomes a major concern since Malaysia has a low ratio of public health expenditure to GDP (around 3 percent, compared with 8 percent in OECD countries), and rapid and sustained economic growth would help pay for rising healthcare costs. The second option- privatizing major health care services and introducing a health financing scheme-is consistent with the privatization strategy of the government and is likely to achieve better results in enhancing quality, but it implies a complete overhaul of a successful public system. It also presents risks in terms of its impact on healthcare cost and equity. If Malaysia decides to pursue the second option, a government-run insurance would probably be cheaper than that provided by the private sector because the government has greater potential for controlling prices due to economies of scale and standardization. Whatever decision the government makes, its challenge is to maintain a clear definition of its responsibility for promoting efficient and equitable resource allocation in the health sector, and effectively regulating the private sector. 3.31 Maintaining the existing system. The Malaysian public health care system is working well. It is efficient, equitable, and cheap. Maintaining this system is certainly a viable option. If the government decides to do so, it will need to spend additional resources to increase the system's sustainability and efficiency. Some measures include: (i) change the composition and level of spending to achieve greater intra-sectoral and regional balance and meet the new health challenges; (ii) raise resources to better maintain the system by improving cost recovery and pricing in public facilities; (iii) promote and regulate the private sector; and (iv) reduce the cost of privatization. 3.32 Change the composition of expenditures: More investment in specialized facilities and equipment and more spending on specialized doctors will be required to provide adequate treatment for the increasing incidence of chronic disease. Moreover, the scope for preventive care needs to be broadened. Finally, distribution of health expenditures across states could better reflect needs. 3.33 Raise resources: Cost recovery has been very low so far as it was not a government objective. However, with rising costs ahead, pricing policy may need to change to sustain higher expenditures on health and contain demand. Moreover, outpatient care is over- 52 subsidized when in fact many people can afford it without subsidy. Since most people incur minor health risks, any subsidy per unit will absorb a large proportion of the total subsidy-outpatient care accounts for two-thirds of expenditures. 3.34 First, too many people have virtually free access to public facilities, especially for inpatient treatments involving costly operations. These include (i) civil servants, their children, and their parents, who are charged 1 percent of their monthly salary, up to RM8 (about US$2) per day, for inpatient treatment; (ii) government pensioners who get free medical services at all government hospitals and are reimbursed for private care if public medical service cannot be obtained; (iii) students below "0" level, who have free access to second class wards; and (iv) blood donors, people on welfare, members of certain NGOs, and aborigines, who also have free access to inpatient care in public hospitals. Second, fees are low and have not been revised since 1982 (the government is currently reviewing the Fees Act). In addition, the fee structure of public facilities is not linked to costs. The result is over-utilization of health services, especially those where quality is good and price differential with private sector is large (such as tests). 3.35 Fees need to be adjusted to better reflect costs; the list of people entitled to free care needs to be reassessed; and significant co-payments could be introduced. This can be done through more differentiated fee structure among classes in hospitals to improve self- selection. The means-testing procedure for those who cannot pay at all would remain, while the eligibility threshold could be adjusted if necessary. Cutting the outpatient subsidy will allow channeling resources to improve inpatient care without necessitating much budgetary resources. 3.36 Promote and regulate the private sector: One reason why the public health care system in Malaysia has benefited the poor is because the rich opted out. This happened because the private sector was allowed to develop. On the one hand, a rapidly growing private sector needs to be encouraged, as more of the publicly provided services can be concentrated on the poor. On the other hand, this growth has taken place with little or no regulation of fees, modes of payment, or financing arrangements by the Ministry of Health. Left unregulated, the impact on health status of the private sector is ambiguous; and exodus on higher-income people to seek care in the private sector may exacerbate problems in the private markets for health care and lead to serious efficiency problems in the market. The government has passed a new Health Facilities and Services Act in 1998 that will regulate the private sector. 3.37 Reduce the cost of privatization: For outsourcing, the government could take the opportunity provided by the crisis to revise the legal and financial framework of existing contracts, looking for more competition and flexibility, more transparency, better quality of service, and lower costs. Moreover, the financial crisis provides an excellent opportunity to further develop outsourcing and contracting-out. With private providers under-utilizing past investments (such as MRI and other heavy medical equipment, as well as acute care beds), it will help both the government and the private sector to get into a contract. This might provide urban areas, and in particular Kuala Lumpur, with a low- cost alternative to expensive public investment financed through the MOH budget. For corporatization, the government could reassess ways of curbing the rising costs at NHI, a rise that is not sustainable in the future. This could include a lower number of staff and a 53 decrease in wages, at least in real terms, in a way that does not jeopardize the quality of service. The government might also review the pricing of health care for civil servants, in particular in expensive corporatized facilities (a change in the payment method by government staff to the NHI is currently being considered). 3.38 Introducing a national health insurance scheme: lessons from East Asia. If the government decides to introduce a national health financing scheme, it may consider experimenting it first in one state, such as Kuala Lumpur, given the difficulty in predicting the outcome. Nevertheless, some issues need to be addressed relating to resource mobilization, coverage, co-payment, and pricing. The experience of East Asian countries may be relevant to Malaysia (Box 3.1). Box 3.1: Health Insurance Schemes-Concepts and Lessons from Other Countries R.:-..*uLnrjmoh:,u*.n Ii L are-bcak hcalih in3ncing reform that -IaIy , ,.nrenplanir i .kel to be similar to rie mandator% medicl iatingi accoun: introduced in SineapLre ir. jrk4 In s,'wpar the o%.irment financLa med.cal care irom ta:.?ion and contriburons to ihe stl e nunda'cr. ;acire cher..e th: Cco-ral Pro%ident Fand ICPF I \i prcrnt. emploN .ec pa: '1.1 pLrcLrt of il x.r ar, me rher CPF account, Their fmr.loer conribxci- the -n amount nAIL A rlnAt l NI.A* L! 41i pcrL n LW sUa: r nterin ihL 1 PF Of :hi., mmni!-.% ir,uni. ,- . Cerccnt -intu . Lnin ud i daj - \1di'a%i ac.uur.t, dcpendin%4 - i e -ublect Lu an uppA LuI:.ric \n inJli idual can -. ichdraw% fund' fro: hledirh . accun: i mccr h&-pirali.a:icn eharces incurred h, iin.J: or h:- -mmcdice family China is e..p.rirncrt.n, .. iri the nlMical ia in-.s account model in .1 mi.jl cri On shi ad% 1ntauL .idA. unlike iocial insirarcc acd :±-b.scd finarcin.-. [hk . invh i;-roach .%ill no! place an undul. heai y burden on iHe decreAsing shar of ykuniz and orcducti, .orl erc. arid '.. i1 Ire: public k. pcnditure from the acarles of cconomic C.ci4 The curren oenerarion of %A a c-carners is ob.igcd c so e "or the future instead of rcl\ine on the uncertain taes .f the nexi cencralion tor future suppor, Thii. ;rrnotoll ra- base. t3elfespandin s eoriInl shll Tu'ards urban mdsnil emplu-,ment. Ir "SS,South Korea Iunened it; naionl healrh s%sicm. ,hich is lareely iinanced cut f ab social inna nirdace. i naiir.al heaihh mnurance schme, i vill be imrrportant i% cuntrol denarud pa¶ on heathe.re ; stema throagh mandatorN pauent cent,butions G.venmmmcni .hich manage hcalih msurance programs .t aUT imposing a limit on pa[,ent demand håte eperenced an abrupt escaltion in mcdical cos In Thailand, spendng On The cmivi sersanLs medicil scheme. which *icetisrly pass for all civil ser.ant' medical care. rose 13 percent per year in real ierms berteen 19 and i992 E. \edisase CeoSrs -45 pereri of paiueni.si txptnses and ot-.f-pocket pay ments coa,er 55 percent Patieri are :Kus held acciuntable on IVwa front; MLtdishield jlso regu:rcs paTiens to rake responsibilr fonr o-ifth ath,. custs uf iher catastroph;c care aume countres ha.e impltmer.id cosi-shann angsude iheir c.amnprehcnsisc% healh insaurance proarnms L nder the South Korean social insurance program paiicntS are cspected ro bttr 55 p.rcen ,1 the rmsurance cests or cut-parier care nd 2. pr.rcenr tioards in-pa!eni eare coseraxe In prantuce. bcaue f ;horiage et funds. in-paiints end up pa,.ing much more toward, iheir mn care In 1992, the propornon paid b. paitn[s to-ards th-eir en,irL me-dic!z care Lnaxunted to SI percei if the toia: cost Tavw%an's new Nanornal Heålth Insuraric Program hau set xen lov. cst-sharmg raiis-patients hnc to pa 9 percent of [he cost of all out-paiicnr . s and f percen tcossards the cost of insunng nospiralr:arinn expcnses Praiu: Priåsng poli- is an :inpoarnt desc co imprxse medicl ser' ces distinburion ihrouchou the cconom Somermes patienis cannot affird thc our-of-pocke csts charged bs gosem-rmrnt, especiall in the casc of espensis e hospital treatments The poor max be discouraged from seekmg important medical senrces if fees are prlhibilisehN high This situalian cal:s for i seleerise pricing far enan .egments of the populanorin Such a pric ing poll-, con?ciousl% differentiites pnes accordin to ineome brackei so ihai public subidie, can be tar:cd insead *fdsrib-ated mdiermnal, One nechism b- wxh:ch thi can be aehie. ed is self selecun charumn lower pres for sen ces more ikely To be used b- the poor (e g bY locaiioni Aemrm%elt, subsidie, can be directed to rd:xdual usrs b means-te;run S:n£apore's recent health reforms demonrsTrate iha[ the combintinn of these approiches preomu3es . fairer publie nealthcare s\stem Explieit pnee dizrimtinmaion is budt around four d,ïerent classes ot huspital strd in publc-sector ho5pitals. from clasý C. thriugh cla; B2 ind BI to .x r aseending lesel of comfor, The subsidt prouded b% gsermment to eich clias3 ares from 84 perceny of hospi al costs in t lowesi class C, ro l percent in B2. 36 perecni Bl. and 13 percent in A Publie hospi[als pros ide financial counscing to help in-patienis selet an affordable cias; of ward Patuenta unable to pay iheir subsidi zed hospital bills can appl. for a means-tested grint from their Hospital Medifund Commirtee Thi; sftrcr net is atilable to hnu-,holds in the lotesi one- Ihird of The income distribuunn Source Ncholas Preseot. i 1- i/.n I.'lua,e R:u,e Hrslth. (u bArn.1 The Economr;c Intellience Linit Hemlthcare A-ua, I'@v 55 C. LEADING THE WAY IN HIGHER EDUCATION 3.39 Malaysia has achieved universal primary education and doubled secondary enrollment. However, spending on higher education has not been progressive. After independence, the NEP aimed to redistribute income and human capital to the Malay population who were disproportionately located in the poorer areas. As a result, primary and secondary enrollment rates have soared. The ethnically-based targeting policy raised education outcomes by reaching lower income groups and increasing Malays' participation. The government has fulfilled and exceeded its commitment to provide services with substantial external effects (primary education); and even services that are essentially private goods (higher education) to aim for ethnic balance. Although providing primary and secondary schooling is pro-poor, higher education is regressively subsidized. Moreover, tertiary enrollment rates in Malaysia are lower than other countries with similar income levels and growth prospects--only about 11 percent of those aged 19 to 24 are enrolled in tertiary education (including students overseas may add another 5 percent), compared with 60 percent in Korea and 35 percent in the Philippines. The government intends to increase tertiary enrollment to 40 percent by the year 2020. 3.40 The lags in tertiary education are partly due to insufficient qualified secondary education students and partly to insufficient supply of institutions. To resolve the first constraint, the quality of education, mainly at the secondary level, is being revisited to increase the pool of qualified students that would go to tertiary education. To resolve the second constraint, supply of tertiary education needs to be expanded in an efficient and equitable manner. Some of the expansion of tertiary education would come from private universities, but public universities will also need considerable expansion. To accomplish this, financing tertiary education becomes an important issue. The potential exists to adopt progressive, fair and efficient reform by expanding and improving the grant and loan schemes to students. Income-contingent loans that are repaid according to income, and are thus less burdensome, are one option. If Malaysia succeeds in implementing similar or even better reforms of this type, it could become a world leader in education policy. Achievements and Challenges 3.41 Educational outcomes have risen but remain low at the tertiary leveL Over the last several decades the Malaysian government has stressed the value of education as an economic and social instrument. This commitment has manifested in considerable expansion of public outlays from the early 1970s to the mid-1990s by a factor of around nine (Figure 3.6). A major consequence of this policy has been the extraordinary growth in enrollments (Figure 3.7)-enrollment rates increased by nearly two-thirds in lower secondary education and more than doubled in upper secondary. Adult literacy rates are about 95 percent, among the world's highest. Arguably this has contributed to the rapid economic and productivity growth in the last quarter of a century. Despite very fast growth, enrollment in tertiary education remains low-it increased from 4 percent in 1980 to 11 percent in 1996 (excluding students overseas). 56 Figure 3.6: Education Expenditure on the Rise, 1970 to 1999 Total Education expenditure (left) 16 Total Education expencture as a percent of GOP (right) 7 14 6 12 5 10 5 4- 8 6- 4 -2 0 , 0 1970 1980 1990 1995 1996 1997a 1998b 1999C a. estimated actual. b. latest estimate. c. budget allocation Source Ministry of Finance, Ministry of Education. Figure 3.7A: Enrollment Rates in Public Institutions Have Risen 1970 to 1995 1970 Primary (ages 1970 6-1 1) E Lower Secondary 1980 (ages 12-14) 0Upper Secondary (ages 15-16) 1990 j Post Secondary (ages 17-18) 1996 * Tertiary (ages 19-24) 0 10 20 30 40 50 60 70 80 90 100 Note: 1970 data refer to Peninsular Malaysia only. Source: Ministry of Education. Figure 3.7B: Malaysia Lags in Tertiary Education Compared to the Region 140 gPrimary 120 g Secondary 100 1 0 0 Tertiary V 80 680 40] 20 4: 0 . Note: Gross enrollment ratio as percent of relevant age group in 1996. Source: UNESCO Statistical Yearbook, 1998. 3.42 Subsidies have been progressive for primary and secondary but regressive for tertiary education. Government expenditures have become better targeted to the poor over the period of the NEP. For primary education, 28 percent of expenditure went to the 57 poorest 20 percent of the population in 1973; by 1989, this share had increased to 36 percent (Hammer et. al.). Subsidies to higher education are improving but still regressive, being a transfer to relatively wealthy groups. In 1973, only 3 percent of higher education expenditure went to the poorest 20 percent of the population, while more than 50 percent went to the richest 20 percent (Figure 3.8). The richest 40 percent of the population received 70 percent of expenditures. By 1989, 10 percent of expenditures went to the poorest quintile, 24 percent to the richest quintile, and still over 55 percent to the richest 40 percent. Figure 3.8: Higher Education Subsidies are Usually Regressive (Distribution of education benefits, 1989) 40 35 . 0 x CD 6 203 C5 15 - 10 - > 5 Secondary SHigher 1 2 3 4 5 Income quintile Source: Hammer, et. al. 1992. 3.43 Education accounts for a high and increasing share of the government's total budget. Education has absorbed around 5 percent of GDP (20 percent of the total budget). Compared to other similar countries, this is high (typically it is less than 3 percent of GDP). The highest share of the education budget goes to primary and secondary education (about 35 percent each in 1998); tertiary education accounts for 20 percent (Figure 3.9). This intra-sectoral allocation is in line with the public good principle of primary and secondary education. Recently, there has been increasing emphasis on university education because there are huge gaps in enrollments-budgetary allocations grew at 11 percent per year on average since 1994, compared with 9 percent for secondary education and 4 percent for primary education. However, the increase in the tertiary budget (150 percent between 1985 and 1995) has far exceeded the increase in enrollment (70 percent) and the cost per student rose by 50 percent to about RM20,000 per year (Figure 3.10). Since current enrollment, excluding students abroad, is about 11 percent, the government's goal of raising tertiary education enrollment to 40 percent by 2020 implies the need for substantial increase in the budget, even if private universities expand. 58 Figure 3.9: Allocations to Tertiary Education are Increasing Total expenditure allocations for education gPrimary gSecondary rlTertiary 14 '4 12 10 o5 8 L5 4 0 1994 1995 1996 1997 1998 1999 Source: Ministry of Education. Figure 3.10: The Cost of Tertiary Education is Rising 25,000 1 lCost per student 20, 000 15,000 10,000 tL 5,000 : 1970 1975 1980 1985 1990 1995 Source: Ozat Mehmet and Yip Yat Hoong. Human Capital Formation in Malaysian Universities, Kuala Lumpur, Institute of Advanced Studies, 1986. Ministry of Finance. Figure 3.11: The Private Sector is Growing Rapidly in University Education 160 - EPrivate Instiutions 140 - N Public Institutions 120 - 100 - E 80 - z 60- IV 040jj j* 20 1985 1990 1995 Source: World Bank, 1998. 3.44 Private universities are assuming a bigger role. Recently, private higher education has expanded from 156 institutions in 1992 to 417 in 1997. Between 1985 and 1995, the number of students rose eightfold and private share of total higher education enrollment increased from 18 percent to 46 percent (Figure 3.11). This rapid expansion is attributed 59 to (i) restricted supply of places in public institutions; and (ii) the ethnic quota system for admission to public institutions of higher education-more than 90 percent of private college students are non-Malays who cannot be admitted to local public universities. 3.45 The government is handling governance and control of private institutions carefully to achieve acceptable standards. In 1996, the government passed three education bills that affect private higher education so that the private and public sector are better coordinated; to regulate private institutions; and to set up an accreditation board. Higher education institutions are incorporating to improve their effectiveness, and efficiency. Except for the economic downturn, the University of Malaya would have been the first to be corporatized. Twinning programs with foreign universities are now very common. 3.46 Next steps. Although investing in tertiary education is crucial to upgrade skills and increase productivity-based growth, it should not undermine the achievements in primary education by reallocating budgetary resources to higher education. Since tertiary education has a high cost per student and, arguably, has little externalities,6 it is inequitable and unsustainable to finance it from revenue, so it is essential to start raising public university fees, foster the private education sector, and establish a funding mechanism. For that, international experience is useful. Funding arrangements in Malaysia's higher education 3.47 There are two main government funding arrangements for higher education: (i) a heavy subsidy in public universities; and (ii) scholarships and loans to students in private universities. First, tuition subsidy is one of the highest in the world. Annual full-time fees are around RM1,500-2,000 while average annual costs are about RM20,000, implying a subsidy of around 90 percent. On average the public sector higher education subsidy is around 30-60 percent in the U.S., Australia, New Zealand and Canada. In 1998 the Dearing Committee on higher education financing in the U.K. recommended charging fees consistent with a subsidy of this order. 3.48 Second, a large proportion of Malaysian higher education students have been supported with scholarships and loans. However, the loans were essentially grants since repayments were considerably reduced for most students, based on results. Usually scholarship assistance was contingent on graduates working in the public sector for up to a decade. Moreover, the government has been supporting overseas studies for many of the best students-tuitLon plus generous subsidized living allowances. However, the government overseas scholarships were discontinued for new students at the onset of the cTisis. 3.49 In 1997, the government introduced a new loans scheme, designed to eventually replace grants and scholarships, which covers both (minimal) tuition charges and living costs. To be eligible candidates must prove financial need. In 1998, only 10 percent, or fewer than 15,000 students, received loan assistance. Repayment conditions stipulate that students must begin to repay six months after graduation, or upon employment, whichever comes first, and the total loan must be repaid within 15 years. These repayment arrangements are insensitive to graduates' financial circumstances because set payments are due each month regardless of circumstances. Graduates in financial 60 difficulties can request deferred payments depending on their circumstances, but this process is not formalized. Loans are collected through the Inland Revenue Service. 3.50 The high public subsidy is neither equitable nor efficient. The demand for local higher education is likely to rise substantially in the coming years. This is due to the government's 2020 enrollment goals, plus the sharp increase in overseas tuition coupled with the depreciation of the Malaysian Ringgit. Public and private institutions will have to expand. There is little ground for subsidizing higher education, first from an efficiency point of view because the benefits of higher education accrue to the individual receiving it, and second from an equity point of view because all taxpayers will have to pay for the higher education received by students. 3.51 Collecting loans through the Inland Revenue Service is sensible and efficient. Other countries that use the IRS have successful and low cost collection operations. Malaysia has the institutional framework to allow and facilitate an improved loan system. Towards higher education reform: options for the future 3.52 Higher education reform would include: * raise fees in public universities; * expand funds for means-tested grants and loans * introduce a universal student loan scheme; * continue to collect loan repayments through the Inland Revenue Service; * continue to expand and improve quality of secondary education. 3.53 Raising fees in universities is a politically sensitive issue in Malaysia, as in many other countries; however, it makes sense from an economic point of view. The following suggestions are provided within this perspective. 3.54 If high up-front fees are charged (in public and private universities) without recognition of financing problems that a significant part of the student population will face, adverse economic and social outcomes will follow. Adequate financing mechanisms thus need to be put in place to support students. For those who cannot afford to pay, there is an ineffective capital market available for borrowing. The basic concern for a bank lending for human capital is that, unlike many other investments, there is no saleable collateral in the event of default such as in the housing capital market for example. There is therefore justification for government intervention to correct for the credit market failure in tertiary education. Government typically addresses the problem by acting as a guarantor for student loans by paying the interest for the period before graduation. However, because of the expense involved, loans are usually made available only to students with poor parents. Loan schemes could be provided directly by the government, or by the private sector with a government guarantee. They can be used in public universities or in private universities. Loan collection through the Inland Revenue Service will continue, since the IRS has access to information concerning graduates' incomes. 3.55 Revenues from higher fees in public universities could be used to expand the education system and retain secondary students. In Australia, the revenue is hypothecated 61 and placed into a trust fund which can only be used for higher education expenditure; this offers the political advantage of the charge underwriting the expansion of the system, and would serve Malaysia well given the stated goal of substantial expansion of university places. However, the radical enrollment goal in Malaysia by the year 2020 also requires a large increase ii upper secondary retention rates to supply sufficient eligible students for higher education. Thus some higher education revenue could be targeted to increase enrollments in upper secondary. One possibility would be to offer means-tested financial assistance to families contingent on their children remaining in post-compulsory education. This offers equity and could become part of social protection. 3.56 Private banks can provide funds to eligible students with a government guarantee. In Australia, for example, when a private bank gives a loan to an eligible student to pay university fees, the student signs a contract with the government for repaying the loan, conditional on the student's future income and collected through the tax system. The government signs a contract with the private bank on commercial terms agreed between the two parties. To make the arrangement revenue neutral for the government-given that some students will default and others will repay with an interest subsidy-the government would collect slightly more from the student than what the government would owe the bank. This arrangement will benefit all three parties: students get a loan with low burden, banks lend money on commercial terms with a low-risk customer, and the government fulfills its goal of tertiary education provision in a revenue-neutral way. 62 Box 3.2: Au.tralia. Income-Contingent Student Loan Scheme: Can II Be Applied to Malaysia? 1 hypothetical model of reform. Fit' :h.ge in public uni.er*hi'L couli be rased subt.anuaJL If charges quadruple. students %%ould pa> RMW.u1n--5.01Yi tor each % C Of full-time stud. i Rn( I6.gjr-2.l.ni for a four Near degree) Thii %.ould brine Mal'Sua in line wkiw the subsides impl:cii in nin:. other countries Sec.id all students could choose a repaNmerii plan coninnment on their 'ncom.. and lower fees could be charged f students pay upon enrollment kustral:. used this approach %%hich haz the con;idurible aJdantage of ininiediate retenue Third, intercst could be set to 7ero in real trms. thu. Et 1u;:andine debt %%oulb bL :ncrc..cd annually bN the rate of inflition The initrent raie suns d. ould bc progict;ic rCL i: -.%ill redirrbui ircome ticw,ards Praduaies with prolknLzed repamcni periods- -l:kl> the poercs of the group Fourh oanr clzti-rr ihrouch the Inland Rc%enut Ser%ice will continue. since ih. IRS ha.acLceS to informatiorn concernir grada.j_, income, and can collect loan repayrncnis aceord:ng to financial rcuminance- ifi11r he new system affect demand for higher educain? i1 h:gher char.es reduce demand. the proposed new arrangements will be self-defearing and should not be comempla.ed Ho%%e.cr. es;mares sho,% that cmen significant fee increases are unlikel, to reduce demand lor hightr education, if repaymtnts are based on future income-the net present %aue .f charges that are four imes higher than current ones is not much higher than the current upfront fees (Figure Ii 11orecier. these estimates di, not consider the charge being collected depending on income In Australia, men though an income charge %as implementcd a- Ill times the previous upfront fee. enrollments actually increased This %kas alzo becanse the ytemrnmt increased the number of places given the substannally impromed funding base Furhcr, rJ.aime to rLpa-.ment .-f a loan in a mortgace-,t 'e bais trhat is. according to time, not income) an income-nicominget charze nigh, rLduc. conciderablh a ;luJentC percepion of the hardship enta.led n repaymcnt (Fiure 2i Figure 1: Higher Fees Combined with Income-Lunringen Loans are not Burdensome inet present %al2e of harve. under Four seeraric4 fur a four-%.r dcL!ree Upfront fee of RM5,000 per year RM20,000 HECS loan; repay (ii) Upfront fee of RMS,000 per year RM20,000 HECS loan; repay ( i) Upfront fee of RM4,000 per year RM16,000 HECS loan; repay (ii) Upfront fee of RM4,000 per year; RM16,000 HECS loan; repay (i) Upfront fee of RM2,000 per year; no loan; no repay Upfront fee of RM1,500 per year no loan; no repay 0 2,000 4,000 6,000 8,000 10,000 12,000 RM Note: The RMI6.000 or RM20.000 loan for a four-year degree is paid back via an income-contingent charge ner year. until the zoul is repaid Rtpa:.riKi i chidul-.** ar* .t.u.rdire :- *nci:ic arJ, ar. 'e, :ng._rii undr RLpX;. (1) ,cenarc than und:r Rr;pa;. ili s ceranu Figure 2: Repa ments as a Share of Income under Two S stems - 7 63 D. SOCIAL PROTECTION: PAST AND FUTURE Great Achievements in Poverty Reduction 3.57 Malaysia has an enviable record of poverty reduction. In a quarter of a century (1973-95), Malaysia's real average per capita income increased 2.5 times and the poverty rate shrank from slightly over half of the population to about 8 percent. This impressive achievement has been driven almost fully by strong economic growth rather than by redistribution, like many other countries with rapid poverty reduction (Box 3.3). 3.58 But inequality has increased. After a steady decline in inequality during 1973-89, trends reversed during the 1990s-the Gini coefficient dropped from 0.50 in 1973 to 0.46 in 1989 (8 percent), then rose to 0.48 in 1995 (4 percent). Thus, although mean incomes of all income groups were increasing, the growth in mean income diverged across groups-since 1989, the share in income of the richest 10 percent has increased sharply Bo.x 3.3: Income Distribution liorsened in Many East Asian Countries Dunne 19'3-95. onl, about 1 5 pcrccntage points out of 36 3 percent reduction in polerty is attributed io redibinbution. the rest is due to growth A rull rediitribution component has been found in most counties across the world that ha%e hicieLOd rapid reductiun in pu'ertr, Within East Asia. income distribution worsvned in man. c*un4inLfL In N1layaou. althouch the redistnbution component remained positive dunno 193-95. it turned nepiv'.v siarln j!9. si2nain unr%cning income distibution If the distribution had remained tho .ame, p,).crt% would ha'e declined by over 5 5 percent betwecen 1989-92. the penod with the worst redistnbut.on component. instead of by just 2 5 percent After 1992. the distnbuton component remained neativc but much smalle ice figurei Decomposition of PovertN Reduction into Growth and Redistribution Components in East Asia 2-4 .12 Z,g 10 S-Iurce %%orldBfank.sritl 64 whereas the bottom seven 70 percent have lost income shares (Ahuja 1997). A similar pattern is found across states-inequality declined between 1973-89 and increased between 1989-95 in most major states. States which showed continuous decline in inequality (Kedah, Penang, Perak, Perlis and Federal Territory of Labuan) are those that lost population shares during 1984-95 due to migration of the poor. The widening income gap was mainly due to the difference between the growth rates of the rural and urban economies-almost all modern and urban-based sectors registered double-digit growth rates, while agriculture grew only by 2 percent per year. Figure 3.12: The Distribution of Poor across Malaysia, 1997 Percent of total poor Labuan Johor <1% Kuala Lumpur 4% Kedah <1% 12% Sarawak Kelantan 9% 22% Sabah 21 % Negeri Sembilan 2% Terenggane 10% 1% Selangor Pahang 3% Perak P. Pinang 6% Perlis 8% 1% 1% Note: Poverty line used is the official poverty line at RM425 per household per month for a household size of 4.6 at 1995 prices. This translates into RM 98 per person per month, close to $2.5/day using purchasing power parity exchange rate. Source: Malaysia Household Income Survey, 1997. 3.59 The poor are mainly rural and concentrated in a few states; but they are literate and show no gender bias. There is clear regional concentration of the poor (Figure 3.12). Kelantan, Terengganu, and Sabah accounted for about 27 percent of the poor in Malaysia in 1984; this share increased to 50 percent in 1997. Another 25 percent of the poor lived in Perak, Kedah, and Sarawak. Also, over 75 percent of the poor lived in rural areas in 1995; and poverty was three times higher among farmers. Poor households have a larger family size-the headcount index is more than double the national average in families with more than seven children. Unlike most other countries including the East Asian countries, Malaysia's poor are relatively educated. Also unlike other countries where poverty is concentrated on the female population, Malaysia's poor are both men and women. Over 65 percent of poor household heads had at least primary education, and the mean schooling years for the poor, at about 6.5 years, is very close to that of the population as a whole, at about 8 years. Moreover, women have benefited relatively equitably from rapid economic growth-they have about the same income and access to social services. Female life expectancy is about five years higher than males; infant and maternal mortality has declined steeply. 65 3.60 The high rate of employment has contributed to social protection. Malaysia had virtually reached full employment prior to the crisis. To meet the labor needs of the growing economy, the government adopted a more liberal foreign labor policy--over one million legal and about 800,000 illegal foreign workers were in Malaysia in 1997, about 2 percent of the labor force. Reflecting the sectoral growth in the economy, over 50 percent of total workers were employed in manufacturing, construction, wholesale and retail trade and hotels and restaurants; only 15 percent were employed in agriculture. The Malaysian Safety Net 3.61 The main components of the social safety net are: * free and accessible health care and education; * rural development; * welfare programs for the hardcore poor; * social assistance programs for elderly, disabled, orphans, and other vulnerable groups; * flexible labor market; * retraining and retrenchment benefits for the unemployed; * provident fund for workers in the formal sector; * pension for workers in the public sector. 3.62 The Malaysian poverty reduction strategy is well rounded and aims to increase the productivity and self-reliance of the poor. The government's philosophy of social protection is to build human capital by providing universal basic education and healthcare, selectively granting low-cost housing, improving infrastructure (especially in rural areas), providing income-generating schemes to the poor, and limiting income transfers to the hardcore poor or unemployable poor (Box 3.4). Heavy public investment in education and quality health care for all citizens of Malaysia can be singled out as the main component of the social policy to eradicate poverty and reduce inequality. This, in turn, has contributed to Malaysia's spectacular economic growth. 3.63 Social assistance programs to the poor have been adequate in scale and in scope... Social assistance encompasses a variety of programs meant to support the poor by promoting rural development, assisting in nutrition and education of their children, providing low-cost housing, and helping vulnerable groups such as the elderly, disabled, single mothers, and orphans. Overall income-tested social assistance spending in Malaysia in 1997 was around RM650 million (Table 3.4). If micro-credit programs, which are similar to social assistance programs, are included the total expenditure comes to about RM750 million. This was expected to go up to about RM800 million by 1998 and represents less than 2 percent of current spending. and regional budgetary allocations continue to be further targeted to match needs. The government's strategy for balanced regional development is directed at diversifying the economic base of the less-developed states by investing in infrastructure, including road, water, and power. The Ministry of Rural Development (MRD), which oversees most safety net programs, gives priority to the seven poorest states namely, Kelantan, Sabah, Kedah, Terengganu, Sarawak, Perak and Pahang (as reflected in Figure 3.13). 66 These states constitute up to 72 percent of the MRD budget for the Seventh Malaysia Plan Development Expenditure, and each of these states (with the exception of Perak) was allocated no less than 10 percent of the total development budget (compared with an average of 5 percent for the other states, excluding Federal Territory). There is still some discrepancy, however, between social allocations and poverty alleviation needs. For the Seventh Plan period, state-wise budget allocations of MRD show that three poorest. states-Kelantan, Sabah, and Terengganu-which account for over 60 percent of the poor and over 75 percent of the hardcore poor, were allocated 32 percent of total development budget; and six states-Pinang, Melaka, Negeri Sembilan, Johor, Perlis, and Selangor-which account for about 8 percent of the poor, were allocated 28 percent of budget, excluding multi-state projects (Figure 3.13). Figure 3.13: There is some Discrepancy Between Social Allocations and Needs across States 25 - 15Kd 501 Sore:Mnity fRua Deelpmn,o P ' N S000bil- Sevnt Masi Plan. 0 0 5 10 15 Pemoent ofDOevalopment BWget alloawed to state Source: Ministry of Rural Development, Seventh Malaysia Plan. 3.64 Social insurance schemes include pension, social security, and some retrenchment benefits; there is no unemployment insurance. Malaysia has three main pension/social insurance schemes-the Employment Provident Fund (EPF) which covers the entire labor force in the formal private sector, the Pension Trust Fund for retired civil servants, and the Armed Forces Fund for retired military personnel. The EPF is a mandatory contributory provident fund in which 23 percent of gross earnings of employees are deposited. Of the total EPF savings, 48 percent is contributed by employees and 52 percent by employers. There are three different accounts within the EPF: Account I holds 60 percent of the savings and cannot be withdrawn before the retirement age; Account 2 holds 30 percent of the savings and can be withdrawn every five years strictly for house purchase/renovation; Account 3 holds the remaining 10 percent of total savings and can be withdrawn for financing expenses of major medical catastrophies. At the end of 1997, EPF membership stood at 8.27 million, an increase of over 7 percent from the previous year. The stock of contributions in 1997 stood at RM131 billion, up by over RM16 billion from 1996. 67 B(% 3.4: The 11alaisian Philusoph% of Poverty Reduction -%-J! uJ. iravg In !QQ() the aiion.i1 Dl%eloprncnt P.I 'JOPI %ka launched a., the successor ot the \e% 1-conolmii% Polic% F P IhL unuiatet .2,oal A:o jC1h:Ce. r.3ZnCnal nLrit h directunu anti- p,\tn prograii at the hardivre polr ohIl ihcr pro,.gram- Ior th Craoi,_tiion of po\rit in -eneral continued. miini-. through rural d%elkpmerI -%her m t If the pO-r 11 I\. I he go ernmen: !trateg% .:'es pri0rit;, to ir.cimt-ceneratmng proscets inprL%emenit O fi:rastru:ure and amenntT,. and progranis fir anitudinal ch.jn.:ie: amonL, the poor W df:.r avit.ince I jko pro% ided 1%.1 hardLore poor households. [hc rapid ,.pan:in off the conrini fueilatcd these vftfr!.' %%hile In0n-1_V.rnmental r.anaon and tri prikj:e mmor complemeni d I!hen h.- Inplemni tng [heir owi p ;r:. pro'.rIn1, R..n tjh2 . ..e i ' i,, .'')L e .,,.r Kural poor beneI ted frOm thC InIL.irated .1-:ricultaral De%eloprnent Projecti. th proiisiun -.f a2rLculture infr. stru iu're. repl.uting sc.hemI s Lind conslidation and rehibilitaiinor and support ser ies T"ht prorni- led t' incrcased pruduli%ii -i' a:riCLItUral labor E:fo to r.ite hardtor. p, erti %.2 pearlit. ided t%. the PPR I intruducd in 19SI) to mneet the 13ir,.in.: nicd. or thi, group It enc,1mpj-c, inpme-gniratin prol%et- and the .1cukIInon ot po'iLe L %ilue uLh .1 'Lli-rclianct and hard %%ork. pilu dr.Zt w%ellate a.s<.:.uncc [he Vhcu'.ernomen launched the .\nanah Sahin Bumipuiera lSHi-PPRI loan 'cheim in !092 %%hich eiibled 1JLh hardcore poor hou,eliold to obiain ar intere 1-4rvc loan ii incrKe s. thjir in Cme P.*r*n..rh, .p h '. nt * In add:tior. it PPR [. ith th'. upPOrl Of pri.ate coipanic- NkU(.;s implemented arious prowram. in p.niliular Anianah Ilkhiir \ ,lasia\ Ile .ind th *iit-haed Ya'. :san Ba.miI Kemihinani i N Bk he. cmpumented the ..-ruint ffir ti. rcduce h.irdcire po%cri\ . 1IM proidcd intercNt-lfree :oanr to hadore pOr h0o'.choIJ, < the. could raise roulir:. nd li%estock and ipin anil lu.i I l inless I Nch . 1 t d 1 i1eta1lin ani J v chliik. .:r%icini- and repai- N BK proarain kcihed on kill tra in %i. ll uarranted mpn l). ment :Jucatl.1.n a JINiNt :nce and bener houSia. RL, o nriiin thi d tieL t iOC 11 L 0 .111 ihe -,,%errInm1nt i l %%J, rm ide i %.ith an int.ret-free loan to imcre c it. capital tund IL . r , un m iun Ih -oi.ernn ieni al,, '1mpleinJiicd proira i, ihat iimpro,. LJ the poor s qualiti of life r-\ .s.tedi %CJ'g erOe t uf hSILe ameniies ind Ncr'. % parcularl. to rural areas Acccn to sate w\Latr or i) hLallh L I . i th n '-I it Qkm trInmi c,.h hiyu,chold i 14 pretti much ii %er-;al Rural are.s are j, cr%,J h 0n1bliC don"al team and d.pcn ;aries i.ace health team ind thi 11 t1n doctor ;er-tice to renoite ar, ii cc' it, educaTiona! faLili ti -- t the [-ur encured - . hou I.ihold, jre it uhin i. km of a pririlar . chou. jnJ ha\. C.Old LLC, [0 -C0e,!indar. -choo!, h Addit:on .1r:LIu '. in ds ot ed ti onal a. 't* lled *Ue :1, .' I.11J il4hip. and free ItLAlook . 1..I .ind .ccnntin' ian. n and uniforni . %%cre pri0 \dCd to tudenti. In poor ILus:uI,;d- - lime :. n h I .I. in... ir 3.65 Like many developing countries that do not support the Western type of social protection, Malaysia has been reluctant to introduce an unemployment insurance,' fearing disincentive to work and increased production costs. Instead, the government maintains a flexible labor market by linking wages to productivity-this policy has worked well during the crisis by keeping unemployment low. The government also provides retraining opportunities for retrenched workers and bears the entire direct costs of retraining. Further, according to Section 69 of the Employment Act, 1955, retrenched workers must be paid layoff benefits, or compensation. According to a labor report released by the Human Resources Ministry, a total of RM 119 million in severance pay and retrenchment benefits was paid to 28,196 workers by 1,223 employers between January and May 1998 in peninsular Malaysia. Thus, on average, each retrenched worker was paid RM4200. This compares well to a basic unemployment insurance. 68 Social Risk Management for a Brighter Future 3.66 Recent trends in the evolution of trade and technology have created great opportunities for improvements in welfare around the world. The other side of the coin, however, reveals that the exact process that increases the opportunity for welfare improvement also increases the variability of the outcome for society as a whole and even more so for specific groups (Box 3.5). This was demonstrated by the recent financial crisis in East Asia. However, although growth was largely behind the reduction in Box 3.5: Social Protection as Social Risk Management As countries develop and globalize, they become more vulnerable,to systemic risks The role of the government in social protection becomes one ,0 . k :-r1r-. -r.r I -'k r.i ., .! rc.-. r. .k :or _, .rri r i . --oial protection: helping individuals,:. X i . I- .. J M111.1 ma.: *'L c.:r m I L -1 L '-. N.. -. n14 r' cr ent consistsofpubtic measures intel. ' .rd.. [u.e 'r.u. naliirijl in scopc. d1 'ark r.1[ 1 f rotarr. %. 2uur..J b%i h. ulrn ient I Ith u h i1:: aard idcd dra aitic IlprOtiment i In ir:1N L'[IMO ' l d r. . o prblel. qUliC l .iro;c -hai threJEn the concession I injn IJancia, l b l j.ni, r , pri-01 e :h1L r,jt: .a Jn th, rc ia, a h i.*-h I,:% ' o" n on - p,i.nient 7hL conlr.icid tarift %tructure 'A ) .uJ.'L1nce: %k IMhOt com1pCnNoui -n jrranc mcnt, t ind % . r%;Ntablishtd *..nl*, ln I 'h but 1,% u h inur lc% ci". r c1'1,,..n r..i:1 are i chronic pr-:bm. a,ercJed hi lack of cnforcenicrit ormpoundinj it, rc _ *ni e ... Ind.ih \\ acr inhcrit:J a. urianticipareJ nit2nirudL Or ph:. ical rch.iilianii_..r tor it.C V% -I . .. :-dce 1W TLL;r"u rc and in the mid: .- . !I ihi, I V% K 'ni ner.-hip chjn2ed h inds th1r in imc. Ju-ir n fl1r,t 1L:r %Lar, t operonini1'r . r-i tt the c rmm nut madc nr; : kik-rr,.. 2fl, . n . rn r than R%14-'i nillnn in iddition io oihcr suprtn The Malaysian approach runs counter to international trends and may have undermined, rather than promoted, the privatization process. * A competitive bidding process might have helped to avoid the consumer backlash against higher rates. IWK embarked on a i.ir C pL"c 1 r, r:,.unup..igLn io inform the public of the scaleof its investments and serv1.L inipr, 0une ri i%%h icni wu-- paiddividends in terms of positive media reporting. But ompuoi,wn n biddirn_. nichi hxic accomplished this much earlier as well as revealing sone -f thk pr.inzi prohk..m' * Splitting the concession area into distinct jurisdictions would have aided the government's capacity to regulate the private supplier. The U.K. and some developing country cities (Manila and Mexico City). have used benchmarked competition so that the regulatory authority is able to compare and assess performance of the different operators, even though the operators do not directly compete with one another. * Incentive regulation, such as "price-cap" regulation, offers a strong incentive to limit costs. Guaranteeing the minimum rate of return undermines this, and creates contingent liabilities for the government. * Linking water and sewerage makes it easier for private sector concessionaires to collect revenues. They can charge for sewerage services as an add-on to the water service, because consumers are more willing to pay for water utilities. In Malaysia, failure to reconcile water and sewerage authorities led to serious problems, Source: World Bank, 3.81 Learning from past mistakes. The failure of the Indah Water Konsortium stems largely from de-linking water and sanitation-water and sanitation have not been considered together because water is state controlled and sanitation is federally controlled. Serious consideration of a regional approach that combines water and sanitation services would permit states to offer distribution concessions for water and sanitation combined to private entrepreneurs. Considerable international experience with such concessions suggests that they need to be carefully designed and they require a regulatory authority to deal with the complex issues of water and sanitation, but they can yield high pay-offs. 77 Power 3.82 The power sector in Malaysia is not competitive enough. New power generation technology permits smaller scale economic efficiency, and regulatory innovations have introduced a major upheaval from a vertically integrated power structure to one that unbundles the sector into generation, transmission, and distribution,13 and fosters competition through free entry into power generation. A strong regulatory framework is required to maintain a competitive structure. This model has brought about lower prices and higher quality service, but there are some limitations. Free entry can be restricted, especially where supply depends upon access to limited resources (in particular, the Box 3.8: Argentina Nlas HNell Hae the 11wt Competiti%e Pritr Indusir-. in the Hkorld LE The %rd or 1 00 . n rx or-,01' c1tp . 1 11 i i m'.ll its w. L !I '.irLd - . r Ik ) . n*1L aron jildn , ncher !I plant , h %%i[i c7 . paLII i; :.I%L" i i Ii r .i .ITN ,rc .rkCl.Zd to hL i1 .r.iTi n :. h% ti end 0'F 2 \10 \10.t oi the n.w pL ni %k r plr. . : mpIl . %c .r. ned . hrialog . hILh all-% ,-reat..r operallt,n.11 a1fIiciknc. CJ 1111C. 1 1 ":11.illr -c.. hI r. :r.iJitonal them al and hid., po,cred .ner,tmon. :JA-. riuIi.,n wn. 'n wer. I* .ruLd 1.- rro.Jr.d --.i r. plus ..Leral I jrc s'llc ~U n11rs a b 1.x h pr, ti aiPV iC 17LTor- rr tr.i h.l. .ic 10 111.. o .0 ' h., ral Jdc itii[i i )t f*t L. er, i u [n I i:till, r,l ix e h T11I11 WU :r , :. .1bil 0 dir*o.ti,. cw itr-si w r , - n ra i L- l*... t . r I li r . u- fr a rL . 'en,e1 thOSL .'.ali l r_L.41:rcn11 ! ' :i nl to , I lI :1,._ i J 1 1 J. IiWilfulUilli iiltlJ c~ ~ul nI p:.0' [ .4311 flhi..".iiJ 1.,j ir II L' oitr3o d: to - 1i1 I.. 1i 'l perc.nt -ist'licir nec.d tho,Le ..th rcak rrlju .irc u 1ni oilyr'.*. ,