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Saturday, June 5, 2010

Can a nation go bankrupt?

IT is common to hear of individuals and companies going bankrupt. But for a country to go bankrupt – is that possible?

Such is a rare phenomenon, but national bankruptcy is not impossible. In the past, it used to happen after a country had to empty its treasuries to go to war. For example, Germany went bust twice – once after losing World War I and again after losing World War II.

The risk of national bankruptcy exists in modern history too; such is the case for Argentina in 2001 and Iceland two years ago. And it is proven that such risk is not contained merely to third-world and developing nations. It can happen to developed nations too.

At present, the risk of national bankruptcy is seen by many as running high in certain parts of the world – in this case, the euro zone comes to mind.

The underlying notion of national bankruptcy is pretty much the same as most personal and corporate bankruptcies; and that is, the inability to repay debts when they are due.

Countries with huge fiscal deficits and debts – in particular, external or foreign-currency debts – are said to face higher risks of being insolvent. The concern is that the governments’ deficit spending and debts could spin out of control that they might find it hard to service their interest payments, let alone pay back their dues.

Take the case of Iceland. In late-2008, its banking system – that saw the country’s three largest banks then having combined debts, largely to foreign investors, that exceeded six times the nation’s gross domestic product (GDP) – became a casualty of the global financial crisis.

The inability of Iceland to repay the huge foreign debts resulted in the loss of confidence in the country’s system, and its currency, krona, plunged to become almost valueless to outsiders. This also implied that the country could no longer pay for its imports.

Running out of money, the country had to seek a lifeline from the International Monetary Fund (IMF) and Russia. Of course, such assistance always comes with strings attached as outlined by the IMF.

The core issue is really about the confidence of foreign investors, explains RAM Ratings Bhd group chief economist Dr Yeah Kim Leng.

“There are certain indicators that rating agencies use to gauge a country’s ability to manage its finances. When certain criteria are not met, it will result in a country’s credit rating being downgraded. This could affect investors’ confidence and result in foreign capital pulling out of the country and draining the country’s reserves,” Yeah puts in simple terms.

Greece is the most recent example of a country whose credit rating was downgraded to a “junk” level by an international rating agency. With fiscal deficits at 13.6% of GDP and rising public debt levels that reached 125% of GDP last year, there has been a loss of confidence in the country’s ability to manage its finances and repay its foreign lenders without the help of other EU member countries.

Over the week, several reports emerged to refute the projections made by the Performance Management & Delivery Unit (Pemandu) of the Prime Minister’s Department that Malaysia could go down the Greek road and become bankrupt by 2019 if no drastic efforts were done to cut spending and reduce public debts.

Malaysia’s economy had recovered

Several high-ranking government officials claimed the remark was an exaggeration, as Malaysia’s economic fundamentals were strong and the country was well positioned to ride out its fiscal challenges over the longer term. For one, they argued that Malaysia’s economy had recovered and were expected to grow at healthy levels going forward.

They also pointed to the fact that Malaysia had been enjoying more than 10 years of comfortable trade surpluses and international reserves remained at healthy levels. Last year, the country’s total trade surplus stood at RM118.4bil, even though that was a decline of 16.6% from the preceding year, while international reserves as at the end of March 2010 stood at US$95bil (RM311.2bil).

(This compared with Greece’s trade deficit of US$42.8bil (RM140.25bil) and international reserves of US$5.5bil (RM18bil).)

Another plus point for Malaysia is that, although its public debt at RM362bil represents 50% of GDP, the bulk of it are domestic borrowings. They like to compare this with Japan, whose public debt at present is more than 200% of its GDP, but they mainly comprise domestic borrowing.

Some would argue that if a country’s debts were mainly made of up of domestic borrowing, the headache could be less. This is because the country can always print money to repay the domestic funds. Nevertheless, printing money, if uncontrolled, could result in the local currency losing its value and the country could face a situation of hyperinflation – another element that could destabilise a country’s financial system – as in the case of Argentina in 2001.

Deficit financing is forgivable if the money is used to finance projects that will bear fruits in terms of future revenues for the government, says Malaysian Rating Agency Corp Bhd chief economist Nor Zahidi Alias.
“Such revenue stream can help the government to reduce deficits or build up surpluses in time to come; hence this factor should be taken into consideration when analysing a government’s ability to meet its financial obligations,” he explains.

“If a deficit is not financed through money creation or large increases in government and external debt, then incurring a budget deficit, especially during challenging times like these, is justified,” Zahidi adds.

Malaysia’s fiscal deficit last year stood at RM47bil, or 7% of GDP, as the Government implemented RM67bil worth of pump-priming measures to mitigate the effects of the global economic crisis.

Certain assumptions

To be fair, Pemandu’s bankruptcy remark was made based on certain assumptions (after all, economics is all about assumptions). These assumptions include that if the national debt level were to continue growing at 12% per year, resulting in the total debt level to exceed RM1 trillion by 2018.

Malaysia’s situation may not be likened to that of Greece per se. However, if the Government’s finances are not managed properly, we can come face to face with our own set of different problems in the near future.

Harsh remarks as that made by Pemandu may be hard to swallow for some. But it is warnings like these that jolt us into action and reform, for in this fast-paced and competitive world, no country can afford to remain complacent and maintain that business-as-usual approach and expect to progress and prosper.

 By CECILIA KOK,cecilia_kok@thestar.com.my

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