THE battle against Covid-19 pandemic-inflicted global economic crisis has witnessed unprecedented fiscal stimulus package by governments around the world leading, leading to substantial rise in government debt.
Since 2008-2009 global financial crisis, governments had accumulated more debt than ever, which stood at US$70 tril or 27.5% of total global debt (US$255 tril at over 322% of world’s GDP) at the end of 2019.
With the Covid-19 fiscal response in full swing, the global debt burden is set to rise dramatically this year.
A prolonged period of record-low interest rates had made it extremely easy for sovereigns to borrow more money.
However, investors are concerned that rapidly rising government debt may find it harder to turn to fiscal stimulus amid diminishing scope for further monetary easing.
Can the Malaysian government afford the debts it is piling up to stabilise economy?
The blow-out in fiscal deficit triggered by the Covid-19 pandemic is leading us to ask: how are we going to pay for all of this?
Aren’t we imposing a huge debt burden on future generations? Surely a day of fiscal reckoning will come.
How did we get here?
Since 1997-1998 Asian financial crisis, federal government had incurred unbroken 22 years of budget deficit though the deficit has been narrowing progressively for eighth successive years, from 6.7% of GDP in 2009 to 2.9% of GDP in 2017 before resetting to 3.7% of GDP in 2018 and was reduced to 3.4% of GDP in 2019.
As the government ramped up the Covid-19 fiscal response in full swing, the fiscal deficit will widen to an estimated 6.0% of GDP, nearly double the original target of 3.2% of GDP presented during 2020 Budget.
This marks the second highest deficit ratio since blowing up a deficit of 6.7% during 2008-2009 global financial crisis.
Of the RM295 bil or 21.1% of GDP Prihatin economic stimulus package and Penjana short-term economic recovery plan, RM45 bil or 3.2% of GDP is direct fiscal spending.
The government has always been borrowing to finance its budget deficit or finance any fiscal stimulus after netting off the revenue collection and reprioritising of expenditure, including trimming down non-critical expenses as well as subsidies rationalisation.
It is inevitable that government debt will rise above pre-pandemic levels as the government extends life support to the economy with increased cash handout, financial relief, targeted spending and borrowings while collecting less tax revenue due to lower oil revenue, higher unemployment and many businesses are struggling on demand retrenchment.
Higher amount of borrowings will push current government debt (RM823.8 bil or an estimated 58.9% GDP at end March) higher this year and beyond.
Between 2012 and 2019, government debt had increased by 7.5% annually, from RM501.6 bil or 51.6% of GDP at the end of 2012 to RM793.0 bil or 52.5% of GDP at the end of 2019.
Contingent liabilities, the amount of debt guaranteed by federal government increased by 6.8% annually to RM275.1 bil (18.2% of GDP) at the end of 2019 from RM143.1 bil or 14.9% of GDP at the end of 2012.
The outstanding liabilities increased further by RM53 bil to RM280.4 bil or 20% of GDP.
Between 2012 and 1Q 2020, contingent liabilities have increased by a cumulative of RM137.3 bil or an average of RM17.2 bil per year.
The combined amount government debt and contingent liabilities had expanded by a faster rate of 9.8% annually to RM1.068 tril or 70.7% of GDP at the end of 2019 (RM644.7 bil or 66.4% of GDP at the end of 2012).
It stood at RM1.104 tril or an estimated 78.9% of GDP at the end March.
With the exception of the crisis period, the government has to find the right path between budget deficit (or fiscal stimulus) and restraint to keep its debt level within sustainable level during the good times and stable years.
How much more can we borrow?
The choices of budget deficit financing whether via direct fiscal balance sheet funding or a combination of off-budget balance sheet financing would depend on the overall sustainable debt level (both direct debt and contingent liabilities).
Malaysia’s fiscal rules state that borrowings are only used to finance development expenditure as governed by the Loan (Local) Act 1959, the Treasury (Local) Act 1946 and the Government Funding Act 1983.
The government’s operating expenditure must be financed by its yearly revenue. The statutory limit of the federal government’s outstanding debt instruments must not exceed 55% of GDP.
As at end March, federal government debt stood at RM823.8 bil (estimated 58.8% of GDP) has exceeded self-imposed administrative limit of 55% of GDP.
Hence, there is a need to seek Parliament’s approval to relax these binding fiscal limits during the crisis period to allow funding for the fiscal stimulus and also for the forthcoming 2021 Budget on November 6.
The statutory limit was last revised higher to 45% (from 40%) effective June 2008 and to 55% effective June 2009.
The debt to GDP ratio should not be a cause for alarm in the current moment from a historical perspective as we had far higher debt to GDP ratio between 60.1% of GDP and 93.1% of GDP during 1982-1991.
But, the government has to carefully balance the need to have higher binding fiscal limits against the potential erosion of fiscal institution’s credibility in maintaining sound fiscal management.
A debt-to-GDP ratio of 60% is quite often noted as a prudential limit, suggesting that crossing this limit will threaten fiscal sustainability.
Nevertheless, the limit cannot be interpreted as being the optimal level of public debt, taking into consideration the future growth and revenue path as well as the capacity to repay during the possibility of adverse shocks.
Backed by still respectable sovereign debt rating, investors’ demand for Malaysian bonds are still high as they consider it to be a safe asset in these uncertain times.
Tapping on domestic sources (ringgit liquidity) to fund the budget deficit means no currency risk compared to sourcing from external borrowings.
Isn’t this a problem?
The growing mountain of debt means that, even with low interest rates, the amount government pays for repayments is its third-largest budget line of total operating expenditure.
The fiscal stability framework has set an administrative rule that DSC must be kept below 15% of revenue or operating expenditure.
Debt service charges (DSC) have been growing rapidly by 8.6% per annum from RM15.6 bil in 2010 to RM32.9 bil in 2019. In terms of operating expenditure (OE), DSC made up 12.5% of total OE and had been increasing progressively over the years from 9.7% in 2010.
In the 2020 Budget, the ratio is estimated to increase to 14.5% of total OE.
DSC share of total revenue also increased to 12.5% in 2019 from 9.8% in 2010.
In 2020 Budget, the DSR to revenue ratio is projected to reach 14.3% and it will rise higher given the expected lower revenue growth amid lower interest payment, thanks to the declining interest rate environment.
When the economy has recovered, the only way to avoid adding to the debt pile is to consolidate and reduce budget deficits by boosting taxes or cutting public spending, including to rationalise the exponential growth in operating expenditure (emoluments, pension payment, supplies and services). – June 22, 2020
Lee Heng Guie is the executive director of Socio-Economic Research Centre, an independent research organisation.