On the Malaysian economy, government still thinks it knows best

Author: Tony Pua, Kuala Lumpur

In 2009, when the Malaysian prime minister first launched the New Economic Model (NEM) the policy was deemed a paradigm shift from a government-dominated economy to one that will be spearheaded by the private sector. Prime Minister Najib Razak famously said, ‘the era where the government knows best is over’.

It was difficult to argue against the thrusts of the NEM. Key initiatives included plans to ‘re-energise’ the private sector, which would ‘stimulate a jump in investment in high value added products and services, generating sustained growth and high income’.

The NEM also called for the eradication of distortion-creating incentives and, more impressively, proposed ‘transparent market-friendly affirmative action’ — a revolutionary concept in a country where race-based preferences are institutionalised.

But after nearly five years much is left to be desired. Instead of empowering and trusting the private sector to lead the charge, the government appears to be floundering over a deepening vicious cycle of state-driven control and investment.

The clearest example of how ‘the government still knows best’ is the creation of a new sovereign wealth investment fund, 1Malaysia Development Berhad (1MDB), with a RM5 billion (US$1.5 billion) government-guaranteed loan as its start-up capital. While its initial objectives were laudable — ‘a strategic enabler for new ideas and sources of growth’ — the reality was far from this vision.

After a failed joint-venture with little-known Petrosaudi International Ltd to invest in oil-exploration exercises in Central Asia, 1MDB has essentially re-focussed its entire strategy inwards.

There are essentially two key-sectors which drive 1MDB today — real estate and energy. Neither are ‘strategic enablers’ to help Malaysia ‘break new ground’.

In the real estate sector, the government sold land to 1MDB at dirt-cheap prices which provided the opportunity for 1MDB to do quick revaluations to secure multi-billion ringgit bank loans to finance its projects. The land for the much-touted Tun Razak Exchange (TRX), for example, was acquired for RM194 million (US$60 million) from the government in 2010 but was revalued twice to RM1.1 billion (US$335 million) and RM1.59 billion (US$485 million) all within two years. In fact, based on its recently completed financial report for the year ending March 2013, the group’s properties that were acquired at bargain basement prices from the government made further revaluation gains of RM2.7 billion (US$825 million).

To give 1MDB a further leg up, and to ensure that 1MDB is able to repay its loans, the government legislated incentives for financial institutions to locate and relocate its offices within TRX to enjoy 100 per cent tax exemptions. On top of that, developers undertaking projects with 1MDB in TRX will enjoy 70 per cent tax exemption and other benefits. Private sector real estate developers are unsurprisingly up in arms because 1MDB not only enjoys access to cheap land and easy access to funds due to its government ownership but also 1MDB gets highly preferential treatment to ensure that its property projects will succeed at others’ expense.

More importantly, Malaysia already has one of the most efficient and matured property development private sectors in the world. The entry of 1MDB into this space adds little or no value to the industry.

The story is similar for the power-generation sector where energy production has been privatised and matured over the past 20 years. Instead of encouraging greater competition between these independent power producers (IPPs) to increase efficiency and lower tariffs, the largest IPPs were inexplicably acquired under the 1MDB umbrella.

1MDB is now the single largest power producer in the country after the national power company, Tenaga National Berhad (TNB). 1MDB spent RM12.05 billion (US$3.6 billion) acquiring three major IPPs with expiring concessions. It funded these acquisitions entirely by debt. The sovereign wealth fund was understandably heavily criticised for overpaying for these assets, which generate sufficient cash flow only to pay a little more than the interest cost.

As a result, under pressure to enable 1MDB to generate sufficient profits to repay these debts, the federal government has recently awarded a 2000MW coal-powered power plant contract to 1MDB — despite its proposed tariffs being higher than the competition in February 2014. In April, 1MDB was awarded another directly negotiated contract for a 50MW solar-power plant.

Hence instead of witnessing a welcome ‘era where the government knows best is over’, we are seeing the complete opposite where the very vehicle created by the prime minister himself, 1MDB, has entered the fray where the private sector has been vibrant and competitive.

In fact the actions of 1MDB have created a vicious cycle of government investment and intervention, which becomes increasingly difficult to reverse without causing immediate and substantial financial pain. Since its inception five years ago, 1MDB has accumulated RM42 billion (US$12.8 billion) in debt to become the single largest corporate debtor in the country.

Its 100 per cent ownership by the Malaysian government has resulted in regulatory capture. Its debt acquired at relatively high cost will only pressure the government to grant 1MDB projects with more and more incentives, or to award more lucrative projects for 1MDB to recover from its astronomical debt levels.

The outcome is not only just about the entry of a new government-owned player in the real estate and power generation sector. The real negative impact is the ‘crowding out’ of the private sector in the country.

Instead of phasing out ‘distortion-creating incentives’, more have been created. Instead of ‘re-energising’ the private sector, the government is doing the exact reverse causing a decline in private sector investments necessary to achieve ‘sustained growth and high income’.

While 1MDB will prove to be a blatant example of increased government intervention, it certainly is not the only guilty government-linked company (GLC). The recent years have been littered with many examples of the government awarding lucrative projects to government-linked entities — such as the lucrative Sungai Buloh Rubber Research Institute prime land granted to the Employees Provident Fund, or GLCs taking out the private competition, such as UEM’s acquisition of Sunrise Bhd and Permodalan Nasional Bhd’s acquisition of Malaysia’s largest publicly listed developer, SP Setia Bhd.

Asian Development Bank analysts in 2013 observed that of the ‘33 GLCs up for divestment by the Government, only 15 had been completed as of February 2013’ — for a 2014 deadline. The case of 1MDB strengthens the study which found that the ‘limited divestment has been offset by new investments, with a spate of acquisitions by GLCs in private sector finance and property development for instance, making it more of a diversification than a divestment program’.

Finally, the study concluded, ‘it is clear that a stronger GLC presence generally has a discernible negative impact on private investment’. It added, ‘when GLCs account for a dominant share of revenues in an industry, investment by private firms in that industry is significantly negatively impacted. Conversely, when GLCs do not dominate an industry, the impact on private investment is not significant’.

Therefore, it cannot be more obvious that the much-touted ‘New Economic Model’ is essentially a pretty document with no substantive implementation in place. The time for change is certainly now. Unfortunately, the government is unable to ‘break [the] logjam of vested interests through political will and leadership’.

Tony Pua is a second term member of parliament from the Democratic Action Party (DAP) and a member of the Federal Parliament’s Public Accounts Committee. He was in Canberra for a forum to discuss ‘Race, Religion and Royalty’ in Malaysian politics. 

This article first appeared here in the New Mandala.