CHAPTER 11: MINISTRY OF FINANCE

INTRODUCTION

The Ministry of finance is headed by a Minister and under him are two Deputy Ministers. The Ministry has a multiplicity of functions to perform and objectives to achieve. For this purpose, a large number of Divisions and Departments have been set up. The chart on next page shows the administrative and organisational structure of the Ministry and also the functions of the numerous Divisions and Departments under it. The Chart also shows the role of the Central Bank (Bank Negara Malaysia) in this framework.

As the functions of the various Divisions and Departments are already indicated in the Chart, it is not necessary to look at them in greater detail for our purpose. However, as the Government expenditure has shown a rising trend because of greater Government participation and involvement in the economy, we will, in this Chapter, examine the way Government exercises control over its expenditure and how it raises revenue to meet this expenditure. Having done this, then we will briefly look at the role of the Central Bank in the economy of Malaysia.

CONTROL OF EXPENDITURE TREASURY CONTROL

The Treasury is responsible for enforcement of the financial provisions of the Constitution and Financial Procedure Ordinance, and also is directly involved in the administration of other laws having financial implications.

The Treasury has general responsibility to see that the money spent by the Govern­ment is spent wisely for the purpose intended by Parliament, and the financial commitments incurred are covered by specific legislative authority. Treasury control of expenditure is a continuous day-to-day process but is particularly marked at the time when the Annual estimates are being prepared. The subsmission to, and the detailed item by item scrutiny by Treasury officers of the Estimates prepared by Ministries and Departments is the annual occasion for a comprehensive review of the Ministries' and Departments' activities and general trend of expenditure in the context of current government policies. In the process, any wasteful, uneconomic or un­necessary expenditure proposals are eliminated.

DEPARTMENTAL CONTROL

While the Treasury clearly plays a crucial role in the control of expenditure, the importance of Departmental control must be emphasised. The fact that over and above departmental control there is control by the Treasury does not remove the respons­ibility of the Department itself to ensure that money is spent in the best way possible, and where expert knowledge is required on a subject to see knowledge is obtained and applied.

AUDIT

An integral part of control over government expenditure is the supervision and chock over actual spending that is made by the Auditor-General. He is appointed by tho Y*ny Di Pertuan Agong on the advice of the Prime Minister. He shall not be removed from office except on the like ground and in the like manner as a Judge of the Federal Court. The Auditor-General is required to audit the accounts of the Federal and State Governments and other Statutory Authorities. He submits his report to the Yang Di Pertuan Agong who shall cause them to be laid before the House of Representatives. Reports effecting the accounts of States are also sent to the Rulers or Governors of the States who shall cause them to be laid before the State Legislative Assembly.

The Auditor-General occupies an entrenched position independent of the Executive been taken to safeguard the collection and custody of public money; whether payments were made in accordance with proper authority, and were properly charge­able and supported by sufficient vouchers or proof of payment; and whether the provisions of all laws relating to the moneys or stores subject to his audit have been in all respect been complied with. In the performance of his functions, the Auditor- General may call upon any person for any explanation and information, has access to all records (including all secret matters unless expressly excluded by law) and examine upon oath or affirmation any person he may wish. His department in fact makes a running 'spot' audit throughout the year. He may also make recommendations and generally conmment upon all matters relating to public accounts, public moneys and stores.

The Auditor-General occupies an entrenched position independent of the Executive and is expected to impartially scrutinise and report on the accounts of the government.

INLAND REVENUE ORGANISATION

The Head of the Inland Revenue Department is the Comptroller-General of Inland Revenue who has the care and management of all inland revenue duties comprising income tax, development tax, estate duty, etc.

He is also the Registrar of Business and the Collector of Estate Duty for the purpose of the Registration of Business Ordinance and the Estate Duty Ordinance of Peninsular Malaysia respectively and is responsible to the Collector of Stamp Duties in the eleven branches in Peninsular Malaysia.

An important branch of the Department is the Investigation Branch, primarily responsible for the detection of tax evasion.

CUSTOMS AND EXCISE ORGANISATION

The Royal Customs and Excise Department, Malaysia, is headed by the Comptroller- General who is responsible to the Minister of Finance, through the Permanent Secretary of the Treasury, for the general administration of the department and for all policy matters relating to customs and excise.

FUNCTION

The principal function of the department is the collection of customs and excise revenue for the Federal Government and the prevention of evasion of such revenue. It is the biggest revenue earning department and is responsible for the collection of more than 50% of the total Federal revenue.

FINANCING OF GOVERNMENT EXPENDITURE

In order to carry out their multifarious activities, Governments must obtain the services of labour and other factor units and acquire goods produced by private business firms. Governments may simply take these services and goods by force, compelling persons to provide their resources without payment or for less than the current market prices. In earlier centuries such practices were common; in later years conquering armies followed the same procedure, and even present democracies draft men into the armed forces.

As a usual practice today, the taking of factor units by force is regarded as highly inequitable, and is resorted to only in extreme cases. The normal procedure is to obtain factor units and produce goods by paying for them current market prices. Accordingly, by some manner the Government must obtain the funds necessary to make these payments. The sources of Government revenue are:

1.Sale of Goods and Services: To a very small extent. Government sells the services produced to the user and thus finances the production of the services in the same manner as does a private enterprise. The costs of various licensing activities and a portion of the costs of operation of the courts are financed by the charging of fees and fines. The Post Office is financed out of the revenue it receives. Similarly, other publicly owned organisations like electricity, water supply, toll-bridges and the like are financed by charges made against the users. Governments also obtain revenue from the sale of land and royalties from the lease of mineral rights on public land. In most case, however, either government services are of a character that they cannot be sold to the users (defence) or the sale basis is considered contrary to accepted standards of equity (education and medical services).

2.Borrowing: This method, in a sense provisional or temporary source, is the borrowing of money. Just as individuals or business firms may borrow in anticipation of other revenues, so may Governments. It is ordinarily presumed that the money borrowed will eventually be repaid from other sources, although in practice this may not always be the case. Sovereign governments may repudiate their debts or they may continue indefinitely to refund maturing debt by the sale of new issue. Borrowing is the residual form of financing. It is resorted to only when all receipts have been taken into account.

The Methods and Sources of this Borrowing are:

The internal sources available to the authorities: At all times the Treasury seeks as a matter of routine to make the fullest use of surplus balances on internal accounts of government departments and of extra-budgetary funds (e.g. Employees Provident Fund, National Insurance Funds, and the Issue Department of the Central Bank).

Governments may resort to the printing of paper money «•> n mmm. <>t I'uylMU their bills. Governments, unlike individuals have the power to create monoy and uivti it legal tender qualities. So an increase in the fiduciary note issue generates an inflow of funds into the Treasury. The printing of paper money is normally'avoided as a source of government revenue because its use is too easily abused. Once this method of financing is started, it is difficult to stop, and runaway inflation can start.

3.Funds borrowed by the issue to the public of debt which is not negotiable, and is not therefore bought and sold on a market. This is called "non-market" borrowing. The Treasury borrows direct from the public by the issue of National Savings Certificates, Defence Bonds, Premium Savings Bonds, and by taking deposits from the public in the Post Office Savings Bank. All these liabilities are repayable on demand.

4.The funds borrowed by sale to the public of negotiable Government securities and bills. These are bought and sold on a market and for which market prices are quoted.

The Government borrows in the Stock Market by the issue of securities. New issues of Government securities are made from time to time by the issue of Treasury Bills. Government expenditure is incurred fairly evenly throughout the year but revenue comes in irregularly, most of it is received at the end of the financial year. The government makes up the difference by borrowing, largely through the issue of Treasury Bills. This is short term government debt and is called "floating debt".

1.Intergovernmental Grants/Loans: Some governments may receive revenue in form of grants from other governments, in the form of grants in aid, block grants, and other types. They may also receive loans from the World Bank, the Asian Develop­ment Bank and other sources.

2.Taxation: It is the most common, and the most important method of financing government activities. The Government provides numerous services to the community without any charge. The provision of these services costs the Government large sums of money. The revenue collected by the above methods does not sufficiently defray the whole cost of the service. So the Government has no alternative but to collect the difference by various forms of taxes. The payment of the tax does not in itself enable the taxpayer to receive any governmental service to which he would not otherwise be eligible. The basic distinction between taxes and other sources of government revenue is the compulsory element involved. The individual has no choice in the matter, if he is eligible for payment on the basis of some standard established.

Since the tax is compulsory payment, the Government must not abuse this power to raise taxes. Because of the compulsory aspects of taxation, the collection of taxes may have very significant effects upon the behaviour of individuals and the functioning of the economy. This must be taken into consideration in the selection of taxes if the tax structure is not to interfere with the attainment of the economic goals of society. Furthermore, if the goals of society are to be realised, the burden of the taxes must be distributed among various persons in a manner consistent with those goals.

OBJECTS OF TAXATION

The purpose of taxation is not merely to raise revenue to meet government expend­iture. There are many kinds of taxes and each type of tax is designed to achieve a specific purpose. Let us now look at some of the objects of levying taxes.

In the earlier days, taxes were mainly levied to meet the Government expenditure Expenditure was estimated and, following proposals submitted by the Minium ol Finance, taxes were imposed to meet the cost. Taxes which are used for tlm purpnti) ol collecting revenue are called revenue taxes. They are to pay for the goods imil torvlcoi produced by the Government, either to meet the whole cost or hIsh to mako up tho deficit where receipts do not cover expenditure.

Today the problem of raising revenue has becomo mom complex I ho Government has acquired over the years far more responsibility',, anil tho motliods it uses to collect revenue have to be consistent with its objoctlvos. Griutoi degrees of literacy and political consciousness impose on tho Government certain constraints. A tax structure which soaks the poor will result In political upheaval and the downfall of the political party in power. Tho Governmont weighs all the methods carefully before selecting the most apt method in given circumstances. To bring about a more equitable distribution of wealth and income the Government imposes death duties which remove inequalities in the ownership of wealth, progressive income tax and surtax to remove inequalities in income.

There are certain vital industries which the state may want to develop, in case there is war. A country wanting to industrialise may have to protect certain infant industries at the early stages of development. For these reasons, customs duties may be levied, not only to raise revenue, but to protect industries such as agriculture and chemicals from foreign competition.

The Government can regulate certain taxes to secure ends which it considers desirable and which cannot be achieved by the mere operation of the price system. If the society consumes excessive liquor or is smoking heavily, it can levy high purchase taxes. The resulting high price reduces the consumption of these products. Normally, the tax on luxuries is higher than on necessities.

The relationship between expenditure and revenue can be used as one of the weapons to fight against cyclical unemployment. During periods of depression, it can lower taxes to stimulate demand and during periods of inflation it can raise taxes to dampen demand. By manipulating its taxes it can influence the level of economic activity and employment. It can also mobilise its resources by favouring certain regions and discriminating against others — it could grant tax concessions to industries established in depressed areas where labour and resources are idle.

So we find that different forms of taxes have different impacts, on the working of the economy. In some cases they are used to raise funds for public purposes, in some cases to prohibit or regulate certain activities, and in others to equalise the distribution of wealth. Whatever the objective, in the process of implementing them, revenue is raised.

CLASSIFICATION OF TAXES

There are numerous ways of classifying taxes. We may first of all distinguish between taxes on output, income or expenditure on the one hand, and capital taxes on the other. The former are taxes on flows and the latter on stocks. Estate duties (capital gains tax) are an example of capital taxes, the size of the tax depending on an individual's stock of wealth.

A further distinction can be made between direct and indirect taxes. A direct tax is one which gets at income directly, that is, a tax which is levied as a straight deduction from income irrespective of the way in which it has been earned or the way in which it is used. A direct tax cannot be avoided in the sense passed on to others. We can classify direct taxes as:

(i) taxes on income – income tax, surtax, profits tax, company tax.

(ii) taxes on capital – estate duty, capital gains tax.

(iii) other taxes – vehicles road tax, local rates, stamp duties,.

An indirect tax, in contrast, is one for which the taxpayer’s  liability varies in proportion to the volume or value of particular good, sold or purchased. Individual taxes are levied on certain commodities and it is anticipated that the person taxed will compensate himself partly or fully at the expense of another, the ultimate consumer. It has the advantage that it is difficult of evasion and the burden is not loll directly. Moreover, payment may be made at convenient times, and a means of taxing small incomes is avoided.

A customs dut is an indirect tax on expenditure, the amount paid depending on the value or volume of the commodity imported. A customs duty falls on consumers. It is difficult, if not impossible to shift it on to the exporters. An excise duty is an indirect tax, levied this time on goods manufactured and .consumed in the country imposing the tax. Cigarettes, beer and liquor are favourite targets for excise duties. It is obvious that the consumer can avoid paying them by not consuming cigarettes or beer or not buying imported goods.

Indirect taxes tend to cause a dislocation and diversion of trade from the course it would otherwise pursue. In practice the disturbance is minimised by applying taxes only to commodities for which the demand is largely inelastic. Indirect taxes used to consist mainly of excise duties, but since 1930's due to the change in the role of fiscal policy customs duties have contributed largely to revenue. If duties are really protective they cannot produce revenue but may be justified in assisting infant industries or keeping out dumped goods.

Indirect taxation is the main form of taxation on low incomes and is levied mainly on articles of wide consumption to ensure wide contribution. At the same time this form of taxation is the least equitable since it falls most heavily on the lowest incomes and has no relation to the capacity of the taxpayer to bear the burden.

STRUCTURE OF TAXATION IN MALAYSIA

Let us examine the tax structure in terms of direct and indirect taxes.

Direct Taxes. In 1978 direct taxes contributed about 45% of the total tax revonue of the Government. There has been an increase in the share of the direct taxes over the years. It will be more useful to look at the components of direct taxes, one by one:

1. Company tax. Companies pay a flat of 40% of taxable profit. However, according to the 1980 Budget companies with a paid up capital of not less than $1 million or with a net asset of not less than $1 million which conform to the equity restructuring requirements of the Government pay income tax at a lower rate of 35%. Company taxes are designed to stimulate economic growth, particularly industrial expansion. To accelerate the process of industrialisation the Government offers a comprehensive range of investment incentives, specially designed to grant relief from taxation in various forms. Investors who are establishing companies or expanding existing ones can apply for any of the following four major forms of tax relief under the Investment Incentives (Amendment) Act which replaced the Investment Incentive Act of 1968: pioneer status tax relief, investment tax credit, accelerated depreciation allowances, export allowances. As the share of the manufacturing sector in tho economy increases, the contribution of company taxes to total taxes is likely to increase.

For the years of assessment up to and including the year of assessment 1967 any cooperative society registered under any written law relating to the registration of cooperative societies was totally exempt from income tax. However, as from the year of assessment 1968 a cooperative society was exempt from tax only if the principal activities of the society consisted of:

1.transactions with its members or other registered cooperative societies;

2.marketing the produce or products of its members; or

3.selling to its members goods purchased for the purpose of being so sold.

As a result of administrative difficulties and the possibility of abuse under the system led to a revision. It was also felt that cooperatives should also contribute their share to meet the revenue needs of the nation. So with effect from the year of assess­ment 1977 all cooperatives subject to certain exemption are subjects to tax on a progressive basis. (Table II).

Table II

TAX ON COOPERATIVES
Chargeable Income	Rate of Tax
For every dollar of the first $10,000	5%
Fpr every dollar of the next $10,000	7%
For every dollar of the next $10,000	10%
For every dollar of the next $10,000	14%
For every dollar of the next $10,000	20%
For every dollar of the next $25,000	23%
For every dollar of the next $25,000	27%
For every dollar of the next $50,000	30%
For every dollar of the next $100,000	34%
For every dollar of the next $250,000	37%
For every dollar of the next $500,000	40%

Realising the various circumstances and problems surrounding existing and new cooperatives, the tax allows certain exemptions. The exemptions are intended to allow new cooperatives an inception period before they are subject to tax in order to solve the problem of small cooperatives, and to meet the need to allow for untaxed working fund which is compulsory under cooperative law, and which will eventually be returned for public purpose in the event of liquidation. As a result of the exemption of the new tax and therefore the agricultural and fishermen's cooperatives are not liable to this new tax. Given the 25% deduction! from income prior to tax and the scale rates applicable, the tax burden on most cooperatives would, in effect, be much loss than that falling on companies.

Table III

INCOME TAX STRUCTURE OF MALAYSIA
	Chargeable	Rate	Tax
	Income ($)	(%)	($)
On the first	2,500	6	150
On the next	2,500	9	225
On the first	5,000		375
On the next	2,500	12	300
On the first	7,500		675
On the next	2,500	15	375
On the first	10,000		1050
On the next	5,000	20	1000
On the first	15,000		2050
On the next	5,000	25	1250
On the first	20,000		3,300
On tho next	5,000	30	1,500
On tho first	25,000		4,800
On tho noxt	10,000	35	3,500
On tho lirit	35,000		8,300
On tho noxt	15,000	40	6,000
On tho first	50,000		14,300
On tho noxt	25,000	45	11,250
On tho lirit	75,000		25,550
On tho noxt	25,000	50	12,500
On the first	100,000		38,050
Over	100,000	55

2. Individual Income Tax. Table III) shows tho individual income tax structure of Malaysia. There are numerous deductions from gross income before the income tax is computed. The main categories of pormissable allowances include personal and family allowances, and allowances for contributions to specific activities like insurance, EPF contributions, and charitable contributions. An allowance of $1,000 is also provided for other dependents, other than wife and children. In addition to the allowances shown in Table W each resident individual, beginning with the year of assessment 1977, is granted a rebate of $600 which is deducted from tax payable. The granting of the $60 tax rebate does not apply to working wives who elect to be assessed separately on their employment. The income tax department also grants rebate of $30 for wife. The 1980 Budget quadrupled the allowances for children educated abroad from double the amount of children's relief.

Table III shows that the marginal tax rate begins at 6% and rises to a ceiling of 55% on all chargeable income over $100,000. An individual (other than a company) is liable to excess profits tax on chargeable income which exceeds $100,000.

Table IV

STRUCTURE OF PERSONAL AND FAMILY ALLOWANCES, MALAYSIA
Allowance in respect of	Actual allowance $	Cumulative allowance $
Taxpayer	4,000	4,000
Dependents	1,000	5,000
Wife	2,000	7,000
1st child	800	7,800
2nd child	700	8,500
3rd child	600	9,100
4th child	500	9,600
5th child	400	10,000

¹ The allowance for children educated abroad is four times the amount of children's relief.

3. Petroleum Tax. Before 1973 there was no tax revenue from petroleum. Since the discovery of petroleum in 1973 off the east coast of Peninsular Malaysia, and also off the coasts of Sabah and Sarawak, Malaysia's exports of petroleum has been increasing and this has contributed to the increasing share of direct tax revenue to the total tax revenue.

Indirect Taxes. The indirect taxes comprise of duties on exports (rubber, tin and palm oil) import duties and surtax (on liquors, tobacco, textiles, etc), and other taxes (excise duties, sales tax, road tax, and gambling tax). In 1978 indirect taxes contributed about 55% of the total tax revenue.

Export duties in respect of rubber, tin and palm oil are structured to assist producers of these commodities maintain, their position in the economy. The taxes are on a sliding scale i.e. the higher the export price, the higher is the tax rate. No export duty is imposed on rubber, palm oil and tin when their prices fall below 60 cents per pound, $500 per ton and $1,200 per pikul respectively. The 1980 Budget brought about a major reform in the export commodity tax structure to enable producers of primary commodities, particularly rubber, palm oil, and pepper smallholders, and operators of marginal tin mines to benefit from lower taxes. The new concept of commodity taxation is based on a cost plus approach. Under this concept the cost of production of the commodity is taken into account and the appropriate duties are only imposed at prices above the prevailing cost of production. Also to ensure that the duty structure does not create disincentives to producers, the maximum marginal rate has been*fixed at 50% for all the commodities. Hence, the taxes are not only equitable, but also have a stablising effect on the incomes of the producers.

Import duty revenue is mainly derived from tobacco, liquor, petrol, motor vehicles, textiles, etc. Tobacco and textiles am the two largest revenue earning items in terms of import duty since 1972. As the Malaysian economy is becoming more and more export orientated and less dependent on imports the share of import duty in total tax revenue is likely to fall.

The "other taxes" comprise of excise duty, sales tax, road assembled motor vehicles, locally refined petroleum, locally brewed malt liquors, cigarettes and various other locally manufactured goods. In view of the rising share of the manufacturing sector in the economy, the share of excise duties in total tax revenue has been rising.

THE CENTRAL BANK INTRODUCTION

Each type of bank usually specialises in a particular line of activity. We can generally classify all banks according to the functions they perform as:

1.The Central Bank. Most countries now have a central hank, the functions of which vary according to the level of economic development of the particular country. In Malaysia the central bank is the Bank Negara Malaysia. It is mainly responsible for maintaining economic stability and toes government policy.

2.Commercial Banks. The main form of banking institution In Malaysia end Singapore is the commercial bank, or joint stock bank. Commercial hanks play the most important role in modern economic organisation, are most numerous and perform various important economic functions.

3.Other Banks. These include:

(i)Industrial Banks: Industries require long term capital for buying new machinery and expanding their scale of operation. The industrial bank\ provide the much needed capital.

(ii)Agricultural or Cooperative Banks: Farmers also small industrialists need both short and long term finance. Long term loans are needed for permanent improvements of land while short term loans help them in purchasing seeds, fertilisers and imple­ments.

(iii)Savings Banks: These banks perform a useful function in collecting small savings and chanelling them to more productive uses. The idea is to encourage thrift and discourage hoarding. Savings are encouraged by both commercial and Post Office Savings Banks, but it is the latter that play a more important part.

ESTABLISHMENT

The Central Bank of Malaysia (Bank Negara Malaysia), formerly known as the Central Bank of Malaya, was established on January 26, 1959, under the provisions of the Central Bank of Malaya Ordinance, 1958. It served as the Central Bank of the States of Malaya but subsequent to the formation of Malaysia in September 16, 1963, it was renamed as the Central Bank of Malaysia. Malaysia originally comprised of the Status of Malaya (now known as Peninsular Malaysia) and the Borneo States of Sabah and Sarawak (now known as East Malaysia) and the Island State of Singapore. However, the State of Singapore seceded from Malaysia on August 9, 1965, to become an Independent Republic.

CENTRAL BANKING PRINCIPLES

The principles on which a central bank is run are quite different from the commercial banking principles. The main objective of the commercial bank is to make profit. The Central Bank, on the other hand, is mainly concerned with safeguarding the financial and economic welfare of the nation. The guiding principle of a Central Bank is that it should act only in the public interest and for the welfare of the country as a whole and without regard to profit as primary consideration. But it does not mean that a Central Bank does not or must not make a profit. Making of profit is only a secondary consideration.

The Central Bank is defined by Sayers as "the organ of government that under­takes the major financial operations of the government and by its conduct of these operations and by other means, influences the behaviour of financial institutions so as to support the economic policy of the government".

The fact that the objectives of the Central Bank are different from the commercial banks, it operates on different principles. It is able to carry out its objectives because it (i) has the support of the government, (ii) has a monopoly for issuing currency (coins and cash) and (iii) is not only a banker for the government but also a banker for commercial banks.

FUNCTIONS OF A CENTRAL BANK

1.To Issue Currency. Although the Central Bank of Malaysia was established in January 1959. It did not issue currency for the country until June 1967. Prior to this, currency used in the country was issued by the Board of Commissioners of Currency, Malaya and British Borneo (commonly known as the Currency Board) whose currency commonly called the Malayan dollars was, until January 16, 1969, legal tender in the countries now comprising Malaysia, Singapore and Brunei. For various political, economic and financial reasons, the Currency Board existed side by side with the Central Bank in Malaysia. It was only since June 1967 that the Currency Baord ceased to be the currency issuing authority in Malaysia, following the assumption of such powers by the Central Bank.

2.It Acts as a Banker to the Government. The banking business of the govern­ment is transacted by the Central Bank. In the same way, as a commercial bank performs ancillary services for its customers, so does the Central Bank for the Government. Such services inlcude:

2(a)Management of the National Debt: The Bank manages the local funded debt of the Central government as well as the issue of Treasury bills. It arranges new issues and conversions, records transfers and pays the interest on the stock to the holders as it falls due.

2(b)Administration of the Exchange Equalisation Account: Not all countries have such accounts. For example, in U.K. the Exchange Equilisation Fund was set up in 1932 in order to even out temporary fluctuations in the value of sterling in terms of other currencies, which resulted from the inflow or outflow of short term speculative foreign capital. In short, the function of the Exchange Equalisation Fund is to buy the surplus or supply the deficit of the amount of currency as need arises. This maintains stability in exchange rates which is essential for international trade.

(c)Controlling and Managing Foreign Exchange Operations: Foreign exchange is the currency of other countries It is required by individuals and businessmen to buy goods and services from and to make gilts or loam to people in other countries. At the same time, they will be buying our currency to pay for their purchase here. The two-way nature of these transactions means that as long as relative price are right, most of our demands for other countries currencies will be financed by their demands for our currency, leaving only small differences to be financed by movements of gold or foreign exchange reserves.

Most countries tend to hold as reserves only convertible foreign exchange because it will be readily accepted by almost all countries in payment for goods and services, inconvertible currency may be acceptable only by the country that issued it. Foreign exchange is required in trade because there is no single currency that is acceptable by all countries although many countries use sterling and USA dollars.

When a country is having balance of payments problems, then the Central Bank controls the sale of foreign exchange and the outward flow of its foreign currency The Bank tells them the type and size of transaction involving foreign exchange which will be allowed according to the policy in force.

The Central Bank administers the Exchange Control Ordinance 1953, on behalf of the Central government. The governor of the Bank is the Controller of Foreign Exchange for Malaysia.

4. Advises the Government on General Financial Matters: The Central Bank is in the best position to advise the government on monetary and financial matters. It gives advice on the likely economic effects of its financial policy. The Treasury has the last word and is responsible to Parliament for whatever decision reached. Bank maintains close liaison and cooperation with Treasury. In fact, the Bank is frequently called upon to advise on a wide range of economic and financial matters. The governor and senior staff sit on many government committees concerned with national planning and development, trade policy and commodity agreements, taxation, company legislation and other important economic and financial matters;

5.Grants Advances to the Government: The Central Bank may grant "ways and means" advances to the Government to tide it over temporary budget deficits, but the total amount of such advances is limited to 12Yi% of the estimated annual revenue and such advances must be repaid within three months after the end of the govor nment's financial year. The Bank is precluded from making further advances until all outstanding advances have been fully repaid.

6. Participates in International Financial Institutions: The Bank is tho designated depository for Malaysia in its official transactions with the International Monetary Fund, the International Bank for Reconstruction and Development, and the Asian Development Bank. It plays its role in international monetary affairs.

(c)The Bankers' Bank. Generally, we can say that the Central Bank acts as bankers' bank in three roles. They are:

-acts as the custodian of the cash reserves of commercial banks,

-acts as the lender of last resort, and

-acts as bank of central clearance, settlement and transfers.

(iii)(a)The Commercial Banks keep part of their reserves with the Central Bank just as individuals and institutions do with commercial banks: In just the same way that a commercial bank looks after a customer's deposits, the Central Bank looks after the deposits of commercial banks.

In addition banks are required to maintain statutory reserves with the Central Bank. They earn no interest and are not part of the cash ratio that the commercial banks are required to maintain. These reserves can be varied to suit changing economic conditions. By varying the reserves the Central Bank can influence credit creation.

The practice of depositing reserves has certain advantages. First it economises the use of cash. When the cash is in the hands of one bank rather than numerous commercial banks, it can be more effectively used. Second, it gives the commercial banks the opportunity to increase their reserves by just discounting bills with Central Bank in time of need instead of relying just upon their own reserves. Lastly, it gives the Central Bank the power to influence the credit policies of commercial banks.

(iii)(b) The Central Bank is the lender of last resort: The commercial banks lend money to the Discount Houses. The loans are short term and can be recalled at any time. This is why such loans are called money "at call". The Discount Houses invest most of their funds in Treasury bills and government securities. When there is a sudden increase in demand for cash from the public, the commercial banks recall their loans from the Discount House. The pressure may be greater from some banks. The Discount Houses look around for cash to meet their requirements. If they are unable to get any money and the whole market is short of cash, they are forced to the Central Bank. The Central Bank does not provide loans to commercial banks directly. It comes to their assistance only indirectly through the discount houses. It is to these discount houses, and discount houses alone, that the Central Bank acts as a lender of last resort.

The Central Bank dictates the terms at which it lends as a last resort. In particular it dictates the rate of interest payable on money so borrowed and the period for which cash may be borrowed. The Central Bank lends to the discount houses by discounting for them first class bills (bills which have least risk) or lend-ing against acceptable collateral securities. The rate of interest payable on loans or rediscounts is called Bank Rate. It is the minimum rate at which the Central Bank stands ready to lend as a last resort to discount houses. It is above the discount rates ruling in the market. The level of rates in the money market depentis on the current level of the rate charged by the Bank for loans, and on the market's expectations as to the future trend of the rate and as to the extent to which they are likely to be obliged to borrow from the Bank at that rate. The Bank Rate is the "penal-rate" and is costly for the discount houses to borrow from the Central Bank. This ensures that the discount houses will only go to the Central Bank as a last resort when the whole money market is short of cash. By making borrowing dearer, it can limit the total amount of credit and money in the economy.

The functioning of the monetary system depends upon the knowledge that the Central Bank will always lend to the discount houses as a last resort. It is by virtue of this knowledge that the commercial banks are content to keep their reserves at the agreed minimum of 10 per cent of their deposit liabilities, since their first iine of reserves for the replenishment of cash is the money lent at call to the discount market, and the banks know that the discount houses will at any time be able to repay the loans, because they know that, if all else fails, the discount houses can borrow the cash from the Central Bank.

(iii)(c)Provides Facilities to settle Interbank indebtedness — The commercial banks hold part of their cash in the form of balances at the Central Bank. These bankers' balances at the Central Bank provide the commercial banks some of the advantages a private customer derives from an ordinary banking account. The commercial banks can make payments to each other by cheques drawn on their accounts at the Central Bank, and they can draw out the notes and coins they want.

The first — their payments to each other — arises from the operation of the banks' clearing'. Although the bankers' clearing provides a machinery by means of which each bank can set off the payments which it is due to make to another bank against those which it is due to receive from that bank, at the end of the clearing each bank has a net position with every other bank, and this has to be settled by a transfer of cash. This transfer takes place by adjustment of the bankers' balances at the Central Bank.

The Clearing House arrangements were instituted by the Central Bank in January 1959. Before this the smaller banks had maintained balances with each of the larger banks, a practice which continues for local clearings outside Kuala Lumpur. All commercial banks are required to use the clearing facilities, those banks without branches in Kuala Lumpur sending their cheques direct to the Central Bank or to their agent banks.

THE POWERS OF THE CENTRAL BANK

It is important to recognise the position of the Central Bank. It is at the centre of the monetary system of Malaysia. Thus, although, it perform all the varied functions dis­cussed earlier, its most important function is that of controlling the commercial banks (including other financial institutions) in such a way as to implement the monetary policy of the government. It has wide powers to regulate the banking system and ensure high standard of banking services to public. It is able to perform its vital functions because:

-it has the sole right to issue notes;

-it.can control the amount of credit created by commercial banks;

-it can dictate the terms on which it lends to the discount house.

Monetary Controls

Let us now examine the methods used by the Central Bank to control the volume of credit. We can classify all methods into two categories — (i) Quantitative and (ii) Qualitative.

Quantitative Methods

The aim of quantitative controls is to limit the volume of bank loans and advances. This is done by:

(i)Manipulation of Bank Rate — We have mentioned this point earlier when discussing the functions of a Central Bank as a lender of last resort. When the whole money market is hard pressed for cash, the commercial banks recall their money at call to the discount houses. The discount houses are forced to go to the Central Bank. The Central Bank cannot refuse to lend but it can dictate the terms at which it lends. The rate at which it lends is higher than the market rates of interest. It is costly to borrow. Hence, the discount houses are discouraged from borrowing from the Central Bank. Even if they borrow, they try to repay the loans as quickly as possible. This they do by reducing or recalling their loans. In this way, the volume of credit is reduced.

The rate at which the discount houses borrow is the Bank Rate. If the discount houses have to pay higher interest rate, they will also charge higher rates for their loans and advances. So when the Bank Rate goes up, the market rates also go up. So the Central Bank by raising the Bank Rate (or discount rate) can discourage borrowing because borrowing is now more costly. This too brings about a reduction in the volume of bank deposits and the power of the banks to create credit.

The Central Bank controls the interest rate structure of the commercial banks through the Association of Banks in Malaysia.

(ii)Open-Market Operations — It is a name given to the purchase or sale of govern­ment securities, short term as well as long term, at the initiative of the Central Bank, as a deliberate credit policy. By means of this device, the Bank can artificially induce the required degree of stringency in the money market. The mechanism hinges on the fact that the commercial banks all maintain accounts at the Central Bank and regard these bankers' deposits as part of their minimal cash reserves. As the reserves expand, their capacity to create money increases, and as the reserves contract their capacity to create money is reduced.

The theory of open-market operations works thus: Let us suppose for example, that the Bank makes net sales of securities. They are paid for, by institutions or members of the public by cheques drawn on the commercial banks. These cheques will be cleared and result in a debit item owned by the banks to the Central Bank which will be settled by a reduction in bankers' deposits. Since such deposits are regarded by the commercial banks as part of their cash reserves, the banks will find that their cash ratios have fallen below the minimum requirement. In order to restore their reserves position, they will recall their loans and advances to the discount houses which will be forced into the Central Bank. In this way, the Bank Rate is made effective. Cash reserves are reduced, the ability of the commercial banks to grant loans and advances is reduced, loans and advances become more costly. The ultimate situation is that the total supply of credit is reduced. The reverse process comes into operation when the Central Bank instead of selling securities buys them. It simply means that if the Central Bank takes care of the legal tender money, credit will take care of itself.

(iii)Funding — It is a name given to the conversion of short-term into longer term, more permanent obligations. The receipts from the sale of longer-term securities are used to repay shorter term liabilities. Funding has been widely used in Western countries with references to National Debt management, as an instrument of monetary policy. By funding activities the short term assets like Treasury bills are reduced. Since they constitute part of the liquidity ratio of commercial banks, their reduction results in contraction of bank deposits and hence their power to create credit.

(iv)Credit Rationing — This refers to the restriction placed by the Central Bank on demands for loans and advances, from the private sector. It is necessary during periods of inflation and when the country has balance of payments difficulties. Credit is rationed by limiting the amount available to each customer.

(v)Varying Reserve Requirements — The Central Bank has the power to vary the statutory reserves, cash and liquidity ratios of the commercial banks. In times of strigency it could increase the statutory reserves, cash and liquidity ratios. These ratios can be varied to suit different economic conditions.

Qualitative Controls

Tho Central Bank also has the power should need arise to use selective controls. The aim of selective controls is to divert bank advances into certain directions or to discourage them from lending for certain purposes. In U.K. these qualitative controls are widely used because of their balance of payments problems. They can be used in a wide variety of forms:

(i)regulating the minimum down payments on specified goods particularly durable consumer goods like sewing machines, cars, refrigerators.

(ii)regulating the minimum payment period on all installment credit.

(iii)requesting (known as moral suasion) or issuing directives to commercial banks to give bank advances only for certain purposes — encouraging them to lend for productive purposes rather than speculative purposes.

So tho Central Bank by use of both quantitative and qualitative controls can restrict the volume of credit. In order to ensure that the comercial banks carry out the requirements, it is given power to investigate from time to time, under conditions of secrecy, the books, accounts and transactions of each licensed bank and any branch, agency or office outside the country established by a licensed bank incorporated In Malaysia. The banks are also required to submit regular returns to the Central Bank giving particulars of all loans and advances, both secured and unsecured, granted to certain categories of borrowers. Since 1968 the Central bank is also empowered to recommend to the commercial banks the rates of commission and other charges payable to banks including rates of interest.

COMMERCIAL BANKS

The evolution of banking in Malaysia since the early 1960's has been profound. The quest for growth and profits has led the commercial banks to reach out for new business far more aggresively than they had done in the past. Since its establishment in 1959, the Central Bank has constantly urged the domestic commercial banks to branch out into areas, especially in the rural sector, where banking has been inade­quate or non-existent. As a result, the significant growth of the banking system has brought with it a corresponding rapid expansion in the branch network of the commercial banks, especially in areas previously unbanked or inadequately served by banks. Credit and other banking facilities which had hitherto been enjoyed only in the urban centres are now rapidly available to a wide area in non-urban Malaysia. So banking facilities are fairly well spread throughout the country. There are sufficient banks to cater for the banking needs of the country for the time being and expansion of banking services is likely to be through the expansion of the branch network of existing domestic banks rather than in the establishment of new banks.