ETH withdrawals – what, why and how
THE debate over special withdrawals from the Employees Provident Fund (EPF), amid the Covid-19 pandemic and monsoon surge, continues after so long that themes like the sudden loss of income and the adequacy of pensions seem to dominate the discussion. More often than not, the arguments are usually inductive, but nonetheless valid.
This article consists of three parts; First, it will set the scene by explaining, albeit very briefly, why (we believe) the special idea of ETH withdrawal came about.
Second, it will explain why we should distinguish between reductions in poverty or income loss and the need for consumption smoothing. And finally, this article will conclude that the state, and nothing else, should complement efforts to address poverty or loss of income.
Let’s start with some numbers. In 2021, the total gross issuance of government bonds was RM163.9 billion, which is below MARC Ratings’ projection of between RM170 billion and RM180 billion. Our figure is based on the government’s budget deficit estimate of 6.5% of nominal gross domestic product (GDP). Essentially, one could infer that from a deficit spending perspective, the government has not increased debt as much as it normally should, despite the extended shutdowns and flooding.
As it stands, Malaysia’s tax revenue to GDP (10.9%: 2020) is the lowest compared to similar sized economies like Chile, Hong Kong and Singapore. According to official statistics, Malaysia’s annual household income per capita (USD 4,820 or RM 20,195: 2016) is the lowest but the highest in terms of household debt to GDP (93.2% : 2020) among these economies.
As such, raising income through taxes can be cumbersome, inconvenient and erode immediate disposable income. We can safely rule this out as it is politically very sensitive.
Therefore, we can conclude that the idea behind the special FPE withdrawal is to supplement people’s loss of income outside the framework of debt and taxes within the framework of controlling deficit spending.
To weigh in on the particular idea of withdrawing from the EPF, one must first distinguish the difference between relief from loss of income and the need for consumption smoothing.
On the one hand, poverty and income loss alleviations should be funded by the state, either through taxation, debt, zakat, or assisted by state-owned enterprises. The main reason for this is that it is an element of redistribution of wealth in an economy.
We find that the government still has enough leeway to resort to debt to solve this problem, but perhaps the government’s reluctance to take on more debt outweighs everything else. We should not worry about a downgrade by international rating agencies, as the economic damage caused by the Covid-19 pandemic is not exclusive to Malaysia.
Either way, the market would have integrated the change into the global economy anyway. Bond yields have risen in anticipation of a rate hike in 2022. Under the current circumstances, the right policy decision is to borrow more to cushion the economic damage and set the stage for a stronger recovery. Fiscal consolidation cannot come at the expense of future growth.
Non-ringgit government exposure is limited and we have enough liquidity to support an increase in short-term bond issuance. The current low rate environment also leaves us plenty of room for that, although it wouldn’t stay that low for too long.
Let’s not forget that Malaysia had much higher levels of debt to GDP in the 1990s. Our ‘fiscal consolidation’ then was to stimulate infrastructure development and it worked wonders. Malaysia can afford to go down this path again as long as the government continues to expand our economic pie.
On the other hand, the main objective of the EPF contribution is to encourage consumption smoothing, i.e. to stabilize the spending pattern of its contributors throughout the age. productive work. In economic terms, contributors’ marginal propensity to consume should be closer to zero.
We cannot stress enough the need for consumption smoothing. Consumers have imperfect information about whether to spend today or tomorrow, so they are generally more rational about the future but less about the present. The high level of household debt relative to GDP is a function of low income while prioritizing the maintenance of a “socially accepted” standard of living over affordability.
Simply put, it’s natural to prioritize instant gratification over the long term, which is why consumers tend to make unprofitable purchases today instead of preparing for retirement. EPF withdrawals should only be allowed to increase income or wealth and nothing else. This is what EPF’s contribution is for.
A sudden loss of income, especially at the aggregate level, cannot be interpreted as a decline in the consumption pattern, as it could likely be policy-induced or simply under-investment in public infrastructure. Therefore, we should separate the two issues of poverty reduction or income loss and consumption smoothing.
The objective of the defined contribution (DC) via the EPF is to allow a smoother consumption pattern over the working age of contributors. So, to “replenish” the loss in retirement savings, the government would either have to push for higher wages, raise the retirement age, or raise the CD rate in the future.
It should also be noted that the government last increased the CD rate in 1996, but with intermittent reductions over the years. Raising the current DC rate can be politically difficult, even when the economy improves, because wage increases take time.
Furthermore, failure to separate the two issues will further exacerbate the problem of pension insufficiency – the (in)ability to financially maintain a basic standard of living in a specific locality.
Official statistics show that 15% of Malaysia’s population will be over 60 between 2030 and 2035, less than 13 years from now. If the retirement age remains constant until 2035 ─ although this is highly unlikely due to longer life expectancies ─ EPF members aged 45 and over today would have to work much harder to replenish lost retirement savings.
To conclude, this article has attempted to find out as objectively as possible the rationale for the special idea of withdrawing from the ETH. He then explained the main differences between poverty reduction or income loss and the need for consumption smoothing, as they both require different policy tools. Based on these premises, this article concludes that withdrawal from EPF should only be permitted for activities that maximize the earning capacity or future wealth of its contributors in their working lives. Funding for loss of income should come from the state.
If not, the government should pave the way for some combination of overall wage increases, raising the retirement age or increasing the CD rate in the near future.
Firdaos Rosli is Chief Economist at Malaysian Rating Corp Bhd (MARC). The opinions expressed here are those of the author.