This article first appeared in The Edge Malaysia Weekly on March 21, 2022 - March 27, 2022

THERE was a lot of money talk in and outside parliament in the fortnight leading up to the March 17 tabling of Malaysia’s first supplementary budget this year — seeking RM8.4 billion for spending done under Budget 2021.

There was no mention of whether that RM8.4 billion meant that last year’s (revised) fiscal deficit of RM98.78 billion, or 6.5% of GDP, would have to be revised closer to 7% of GDP when the actual figures for 2021 are released later this year with the tabling of Budget 2023.

But that’s small money relative to the RM13 billion that Finance Minister Tengku Datuk Seri Zafrul Aziz said Malaysia needs to repay 1Malaysia Development Bhd (1MDB) loans in 2023 or the RM28 billion that the government’s fuel subsidy bill could be this year if oil prices stay at US$100 levels (see accompanying story).

In fact, The Edge’s calculations show that Malaysia needs RM16.2 billion this year and RM13.31 billion next year to cover 1MDB-related principal and interest. The RM15.76 billion left in the 1MDB Asset Recovery Fund (versus the RM38.8 billion outstanding obligation as at Feb 28, 2022, even after paying RM13.31 billion) means that there is a shortfall of RM23.04 billion that the government needs to cover with new debt.

Those headline amounts are also small relative to the RM50 billion in financing that Mass Rapid Transit Corp Sdn Bhd (MRT Corp) said the Ministry of Finance (MoF) has committed to for the Mass Rapid Transit 3 (MRT3) Circle Line project, which is expected to need RM31 billion for construction, RM8 billion for land acquisition and RM11 billion set aside for other related expenses. The utilisation of the RM50 billion depends on how the project is managed over the next eight years, MRT Corp CEO Datuk Mohd Zarif Hashim told reporters.

To be sure, these multibillion-ringgit expenses that the government needs to find money for are not entirely comparable in terms of their benefits to the people and the economy.

While some experts, including economist Dr Nungsari Ahmad Radhi, question whether now is the right time to implement MRT3, those supportive of the project say, if well implemented, MRT3 will benefit those using public transport, help reduce our carbon footprint and help reinvigorate the sluggish construction sector.

As the RM50 billion needed for MRT3 is likely to be financed by government-guaranteed debt under Danainfra, this amount is not counted as part of Malaysia’s statutory debt and therefore does not affect the 65% statutory debt ceiling.

At end-2021, the federal government’s statutory debt — which comprises outstanding Malaysian Government Securities (MGS), Malaysian Government Investment Issues (MGII) and Malaysia Islamic Treasury Bills (MITB) — stood at RM922 billion, or 59.7% of GDP, and is expected to rise to 63% following Budget 2022 expenditure, which is still below the statutory debt ceiling of 65%, Zafrul told parliament on March 14.

Direct federal government debt, however, is slightly higher at RM979.81 billion at end-2021, or just over 63% of GDP, as the statutory debt figures that Zafrul quotes exclude some short-term borrowings and conventional treasury notes. Budget 2022 spending looks set to push direct federal government debt well over 65% towards 70%, especially if additional fuel subsidies have to be fully funded by debt, our back-of-the-envelope calculations show.

If one were to include debt directly guaranteed by the federal government of RM310.39 billion as at end-2021, some of which are in no immediate danger of default, the country’s direct and directly guaranteed debt burden would be close to RM1.3 trillion at end-2021, or about 83.5% of GDP. This figure has exceeded RM1 trillion since 2018 while the country’s direct federal government debt alone is set to cross that mark this year.

This is where Danainfra’s debt for MRT3 will fall under, but most experts contacted are less concerned about the impact of MRT3 than they are of the country’s longer-term fiscal sustainability if fiscal and revenue reforms do not happen.

“MRT3 is big-ticket spending, but it is also a long-term project. Therefore, the pace of debt financing can be spread out over a number of years,” says Winson Phoon, head of fixed income research at Maybank Investment Banking Group in Singapore.

“While Malaysia has limited fiscal space, the building of MRT3 is necessary from the perspective of national infrastructure development with long-term benefits to the public. The government can ‘make space’ by rationalising other expenditures, such as replacing the blanket fuel subsidy with a targeted and progressive approach,” Phoon tells The Edge.

The ability for the government to “make [fiscal] space” with nine more months before 2022 ends is perhaps why the government is still maintaining its fiscal deficit forecast of 6% of GDP for this year, despite additional expenses incurred due to floods. Zafrul also reiterated the government’s commitment to a fiscal deficit target of 3% to 3.5% by 2025.

With the first phase of MRT3 only slated to open in 2028, with the entire project to be completed by 2030, there is still time for policymakers to make sure that more people will utilise the infrastructure that the country is expected to pay for in the years to come.

“As it is a long gestation project, the [borrowing] cost will be spread out among generations, who will benefit from the project, to bear part of it,” says Lee Heng Guie, executive director of the Socio-Economic Research Centre (SERC), a non-profit think tank of the Associated Chinese Chambers of Commerce and Industry of Malaysia (ACCCIM).

As jobs for MRT3 are only expected to be tendered in May and awarded towards the fourth quarter of this year, Lee expects the impact of the project on the construction sector and multiplier effects on the overall economy to be negligible this year, but to be spread throughout the construction phases with knock-on effects on the building materials and real estate sectors.

Describing MRT3 as “a critical public infrastructure project for the expansion of the country’s productive capacity through better connectivity and efficiency”, Lee also noted that Singapore last borrowed to fund infrastructure in the 1970s and 1980s to pay for the large upfront cost of building Changi Airport as well as the republic’s first MRT lines.

“By the 1990s, with the economy growing rapidly, the Singapore government paid for infrastructure in full from its revenue,” says Lee, who is concerned about the Malaysian government’s fiscal sustainability and the country’s debt burden.

“It is worrying that public debt had increased by 7.7% per annum in 2015-2021 to RM979.8 billon, or 63.5% of GDP, at end-December 2021; total debt and liabilities stood at RM1.3 trillion, or 83.6% of GDP, at end-December 2021. Debt service charges had increased by 9% per annum in 2018-2022 to reach RM43.1 billion in 2022, making up 18.4% of total revenue. This means that for every RM1 in revenue collected, 18.4 sen go to servicing the payment of both domestic and external loans.

“The Debt Sustainability Analysis framework simulation demonstrates increased government debt vulnerabilities in the event of any shocks, thus limiting the fiscal space and the ability to raise additional borrowings for countercyclical responses.”

The government, Lee says, “needs to rebuild fiscal space and restore fiscal and debt stability” by expanding its revenue base — reforming the tax system and strengthening tax collection efforts — rationalising and prioritising expenditure; and making sure that Malaysia increases its economic output at a faster pace than the increase in public debt levels.

“The unsustainable deficits and public debt will have a negative effect on households’ savings as they have to pay high taxes to help fund the budget deficit and service the debt service charges. This means persistent budget deficits constrain the lowering of future tax rates as it reduces tax revenue collection,” Lee says, adding that the government should start saving during good times and ensure that it gets good value for every public ringgit spent.

“It would be better for the government to get leaner and rebuild savings for rainy days. We need the government to spend prudently and run budget surpluses and add to national savings, and ramp up investments in productive assets that will boost economic growth and raise our living standards. A large fiscal space would allow it to adopt countercyclical short-term fiscal stimulus programmes,” he adds.

Maybank’s Phoon reckons that the long-term sustainability of a country’s debt burden “also relies on how quickly we can grow the size of the economy”. Citing the upcoming tabling of the Fiscal Responsibility Act and the country’s medium-term fiscal framework, he says the government “clearly recognises the need to ensure fiscal sustainability”.

“The problem is that Malaysia’s debt burden has outpaced GDP growth over the past 10 years and unfortunately, [it is coupled with an] even lower growth in government revenue. As a result, the interest-to-revenue ratio has risen noticeably and we will be heading to a very challenging scenario if such a trajectory continues for another five years,” he adds.

“To strengthen fiscal sustainability, [Malaysia] needs both revenue and expenditure measures,” he points out, noting that two-thirds of the government’s expenditure are fixed costs such as emoluments, retirement charges and debt service charges.

Noting that Malaysia’s headline public debt ratio has risen roughly 10 percentage points after each of the past two crises — the 2008 global financial crisis (GFC) and the Covid-19 pandemic — a seasoned observer says Malaysia “needs very strong political will and discipline to see meaningful results in fiscal consolidation”.

“Malaysia probably knows it did not repair its public balance sheet fast enough after the GFC when it enjoyed steady growth … There are structural weaknesses in public spending that need to be addressed. If Malaysia doesn’t go fast and far enough, when the next global economic crisis hits, the public debt ratio could well rise by another five to 10 percentage points.”

Meanwhile, Nungsari says Malaysia needs to weed out wastage in the system and ensure that the debt the country takes on yields the desired economic benefits.

“Not all debts [are alike],” he says, objecting to “inefficient” debt and how private investment has declined as a percentage of GDP despite a growing debt pile. “In that sense, [debt] has been wasteful,” he adds, noting the country’s 25 years of budget deficits in both good and bad times.

Nungsari reckons that now is the right time to implement targeted subsidies. “Anything that improves the efficiency and effectiveness of fiscal spending should be done as soon as possible,” he says.

Additional fiscal space created from subsidy rationalisation can go towards aiding those more deserving as well as fund economic activities that spur GDP growth.

UOB Bank Malaysia senior economist Julia Goh reckons that the country “will have wider capacity to issue debt to finance sustainable development” so long as its economy and nominal GDP grow faster than debt.

While the ongoing Russia-Ukraine conflict poses downside risks to the global growth outlook and an upside risk to inflation, Goh is keeping UOB’s 5.5% GDP growth forecast for Malaysia for now. “There is a wide range of positive and negative factors at play for Malaysia. We concluded that in the near term, despite the potential negative external effects, Malaysia still has several levers of growth, including being a commodity exporter, beneficiary of diversification, the reopening play and ongoing policy support that includes the resumption of mega projects and subsidies to cushion the impact of higher commodity costs,” she says.

Officially, Malaysia’s economy is forecast to expand between 5.5% and 6.5% this year, a rebound from 3.1% last year and a contraction of 5.6% in 2020. The forecast is within the 5.7% and 5.8% currently expected by the International Monetary Fund and the World Bank respectively.

With the country’s borders reopening and the economy moving into the endemic phase from April 1, there is a good chance of Malaysia hitting those growth forecasts this year after falling short in 2021. Beyond meeting headline numbers, however, the country needs to make sure real fiscal and revenue reforms happen to demonstrate to the world that it is serious about fiscal sustainability.

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