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Borrowing and Loans; Article 111 governs the borrowing pcwer of both the Central and State Governments. This article prohibits the Central

Government frcm borrowing except under the authority of Federal law. A State Government shall not borrow except under the authority of State law, and State law shall not authorise a State Government to borrcw except frcm the Federation or, for a period of not exceeding twelve months, frcm a bank approved for that purpose by the Central

Government.^ The Central Government, thus, has ccmplete pcwer under the Constitution to determine the pattern and conditions of borrcwing or contracting of loans by the State Governments of Peninsula Malaysia.

The States are dependant on the Central Government for much of their finances. The Central Government could take advantage of the States' dependance and consequently assume de facto or indirect

responsibility over those subjects or areas of States' competence. The States' very restricted power to borrcw further emphasized States'

57. ibid., 58. ibid.

59. See Grewal, B.S., op.cit., pp. 20-22; Watson, M.M., cp.cit., pp. 121-122; Watts, R.L., op.cit., pp. 211-213; and May, R. J.,

op.cit., pp. 114-123 and 134-145.

60. For Sabah and Sarawak Article 112B provides that borrcwing within the State must have the approval of the Central Bank of the

of irritation, particularly for States like Kelantan (controlled by the Parti Se-Islam Malaysia -PAS- or the Pan Malayan Islamic Party -PMIP- fran 1959 to 1969), controlled by a party different frcm that

controlling the Central Government. Such States, starved of finance, could be forced to seek seme other means of finance. Kelantan was one such case.^

For 1963 the Auditor General noted that because the Kelantan Government's total cash and bank balances were less than the Central Government's credit balance with the State in the Consolidated Revenue Account, the Kelantan Government was able to rely largely on Central Government's cash to pay its bills. He reported that

"This situation continues at the date of this Report. It appears therefore that the State Government has borrowed Federal funds without the authority of State law contrary to the Federal Constitution.

61. Kelantan's increasing need for finance frcm 1962 onwards was

partly attributable to its very costly Sungai Kelantan Bridge. The State Government had requested a Central loan but it refused to agree to the central loan terms, part of which was the submission of the bridge plans to the Federal Public Works Department. Denied a Central loan it proceeded to construct the bridge, now costing $5.5 million, attempting to finance it out of State funds. See The Straits Times, 1.3.1962 and 1.6.1962. The Auditor-General reported that "Although it was appreciated that a loan would be needed, the project was put in hand without a loan having first been negotiated with the Federal Government." See Auditor-General, Report on the Accounts of the State of Kelantan, 1962, Kuala Lumpur, Government Printer, 1963, p. 3. Writing on the State's accounts for 1963, the Auditor-General reported that "the manner in which this project has been undertaken is not such as is likely to safeguard public funds to best advantage or ensure value for money.. .Like the 1962 Estimates, the 1963 Estimates gave the

Assembly no indication of the total cost of the project, and in my opinion, the Assembly's control over this expenditure was thereby correspondingly weakened." See Auditor-General, Report on the Accounts of the State of Kelantan, 1963, Kuala Lumpur, Government

Printer, 1964, p. 4. The State partly paid for the bridge by raising a loan of $3 million frcm the Banks. According to the Auditor-General this loan was raised with due authority during Nov.-Dec. 1964 but had not been repaid within the twelve months as

required by the Federal Constitution. The State in 1966 passed a law to raise a new loan of $2 million frcm the Banks to repay the existing one and, accordingly to the Auditor-General, the Central Government agreed to this arrangement. See Auditor-General, Report- on the Accounts of the State of Kelantan, 1964, Kuala Lumpur, Government Printer, 1966, p. 7. By September 1969 the balance of $4,185 million still to be repaid by the State Government was fully settled by a loan of $4.2 million frcm the Central

Government. See Auditor-General, Report on the Accounts of the State of Kelantan, 1968, Kuala Lumpur, Government Printer, 1970, p. 41. It seemed that Kelantan got away with disobedience.

62. Auditor-General, Report on the Account of The State of Kelantan, Kuala Lumpur, Government Press, 1967, p. 5.

He reported that the Attorney General implemented two measures to overcome the above de facto State borrcwing.^ First, Central

Government's cash with Kelantan's was segregated and placed in a Special Bank Account. Second, Central Government's credit balance with Kelantan was reduced frcm about $6 million to just over $1 million when the 1964 accounts were closed. Despite these measures, the Auditor-General

reported that

"The situation has not been wholly satisfactory in 1965 and is now under review. It appears that the State has again in effect used Federal money for its own purposes."

On February 20, 1964, the Kelantan State Government made a financial arrangement with a private conpany to raise additional revenue. The State Government granted a mining and forest concession to the

Tirribermine Industrial Corporation Limited in return for advance payments of royalty amounting to $2.5 million. When the Corporation extracted the timber and minerals on which the royalty was due, it had to pay fifty percent of the royalty due and retain the other fifty percent until the whole prepaid amount was refunded. In certain circumstances the

agreement stipulated that the amount advanced could be forfeited.

The appropriateness of the above financial transaction depended on what constituted borrcwing. On this, the Auditor-General commented that

"There is no law requiring the company to make a prepayment in respect of royalties. As the prepayment is to be set off against forest royalties paid after the third year, this appears to constitute borrcwing by the State contrary to Article 111(2) of the Federal Constitution. This is the view of the Attorney-General with which the State disagrees.

The appropriateness of the transaction was challenged by the Central Government (under Article 130) in the Federal Court in the Government of Malaysia v the Government of the State of Kelantan. ^ The Central

Government argued that such a transaction amounted to borrcwing and because this borrowing arrangement was not authorised by State law it was, therefore, unconstitutional. The Federal Court held that such a transaction did not amount to borrcwing since there was no legal

relationship of lender and borrower between the State Government and the

63. Auditor-General, Report on the Account of the State of Kelantan, 1964, Kuala Lumpur, Government Press, 1966, p. 7.

64. ibid

65. Auditor-General, Report on the Account of the State of Kelantan, 1964, p. 2.

66. Malaya Law Journal, 1968, p. 129. See also Jayakumar, S.,

Constitutional Law Cases from Malaysia and Singapore, Singapore Malaya Law Journal Pte Ltd., 1971, pp. 206-225.

if the advance payments were forfeited for breach of condition.

In 1971 the Constitution was amended so as to negate the above 6 7

Court's decision. By amending Article 160, through adding Clause (2), the meaning of borrcwing was extended. "Borrow" now includes the raising of money

"by entering into an agreement requiring payment before the due date of any taxes, rates, royalties, fees or any other payments or by entering into any agreement whereby the Government has to repay or refund any benefits that it has enjoyed under that

agreement.

An opposition MP in the Dewan Raayat, V. Veerapan, during the amendment debate, argued that it was indeed the intention of the framers of the Consttitution that the States should borrcw from the Federation, except in cases of short-term loans which they can borrcw from the banks. He believed, however, that this amendment was intended to defeat the case which was heard and settled in the country and that

"if the States are prevented frcm entering into any such agreement, the States would be deprived of putting up some projects which will be for the benefit of the people of those particular States. For example, if a State Development Corporation or scmething like that would like to put up a building - the State does not have the money and then allows him a period of time to collect the rents and after that that building becomes the State's own property - you cannot do it.. .it also prevents the Federal Government frcm approving such a thing because the provision in the word "borrcw" does not allcw the Federal Government to even sanction such an arrangement.

In reply, the Attorney-General, Tan Sri Abdul Kadir Yusuf, assured the Dewan Raayat that the amendment was intended solely to tighten the word

"borrcw". He stated that, as a result of the Kelantan case,

". .we have to amend the definition of "borrcwing" so as to make it clear that in future such a method of borrcwing is clearly not in accordance with what is really defined by the Article in the Constitution. There is no other implication involved in that case.

Aware of the States' funding problems, the Central Government in February 1975 announced it was considering relaxing its restrictions on borrcwing or contracting of loans so as to enable these States to raise

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funds for development. Tan Sri Chong Hon Nyang, the Minister without Portfolio, subsequently informed the Dewan Raayat that the Central

67T. The Constitution (Amendment) (No. 2) Act, 1971 (Act A31/1971). 68. MPD, Vol. 1, No. 7, 33.3.71, col. 554.

69. ibid, col. 558. 70. ibid, cols. 558-559. 71. NST. 9.2.75.

Government had agreed in principle to allow State Governments to obtain loans frcm within or outside the country provided the sources were

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approved by it and the repayment period did not exceed five years. The relevant Constitution (Amendment) Bill was introduced in Parliament in July 1976. The Constitution (Amendment) Bill, 1976,

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sought to amend, among others, Article 111(2). The PM, Datuk Hussein Onn, / in introducing the Bill stated that

" The intention of the amendment is to relax the restrictive

provision which is at the moment existent in the Constitution with regard to borrowing by State Governments.

This amendment was necessary, he continued, in view of the States' increasing developmental and financial requirements frcm time to time. Accordingly it was thought desirable that States should be able to borrcw or contract loans frcm any source with the prior approval of the Central Government, and provided also that the repayment period did not

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exceed five years. However, the principle of the centralization of borrcwing powers had been left unchanged. In response, the Chief Minister of Penang, Dr. Lim Chong Eu, who was also an MP, approvingly remarked that

"this will enable the Federal Government to work more closely with the State Governments and vice-versa ... particularly with regard to the securing of funds for financing projects in the States. I hope that the Federal Government, once this Constitutional

(Amendment) Bill is passed, will set up a Comnittee or a body which will enable the Federal Government to work closely with the

State Governments which seek to apply for the provisions of this particular amendment to be made applicable to their States." His suggestion for the establishment of a ccmmitte seemed curious since the NFC had already been established essentially to handle Centre-State financial relations in general and loan requirements, among others, in particular. He also, again rather curiously, expressed his gratitude to the Central Government

"for having given the State Government of Penang every opportunity to make use of the development funds through these particular provisions of the Constitution. I am sure that the amendment will make it easier for all the other States in the Federation in

future to do so.

72. ibid, 8.7.76.

73. For details of the approved Bill, see Federation of Malaya, Acts of Parliament (Act A334), Kuala Lumpur, Government Press, 26.8.76, p.23.

74. MPD, Vol. 11, No. 19, 12.7.76, col. 2035. 75. ibid.

76. ibid, Vol. 11, No. 20, 13.7.76, col. 2168. 77. ibid.

of Penang had received favourable loan treatment from the Central Government ccnpared to the other States.

In amending Article 111(2) the Central Government became the final guarantor of loans. It was therefore anxious to ensure that the States

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obtained the most favourable financial terms. Abdullah Ayub, the

Secretary General of the Ministry of Finance, indicated What the Central Government would insist upon in considering loan applications frcm the States:

"It is essential for the Federal Government to ensure that the State Government do not borrcw more than what they can afford as this would effect their own viability and the credit standing of the Federation.

In addition, State loan applications would be approved by the Central Government on the basis of the economic viability of the State projects that the loans would help finance and the interest rates for such loans

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would be the economic rates. However, most States, especially the richer ones like Selangor, are usually reluctant to use the facility provided by the Amendment to Article 111(2) because to do so would oblige them to defend the economic viability of their projects and thus

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