This article first appeared in Corporate, The Edge Malaysia Weekly, on June 13 - 19, 2016.

MANY governments run deficits funded by borrowings. But, a recent comment by Oxford Economics that “higher public debt and the prospect of fiscal slippage could be just the catalyst for one or more credit agencies to respond by downgrading Malaysia’s credit rating” is bringing the spotlight back to the state of the country’s public finances.

Government debt has soared significantly since the 2008/2009 global financial crisis when it borrowed heavily to fund two stimulus packages to cushion the economy against external headwinds. The first was a RM7 billion package of additional direct spending introduced in November 2008. This was followed by a RM60 billion allocation that included national savings bonds, private finance initiatives and direct support guarantees.

At the end of 2015, the Ministry of Finance (MoF) said public debt stood at RM630.5 billion, or 54.5% of gross domestic product (GDP), just shy of the self-imposed ceiling for public debt of 55% of GDP. Between keeping its borrowings under the official cap and maintaining the budget deficit at 3.1% of GDP this year, the government is walking a tightrope.

To release some of the pressure, it has shaved a portion of its liabilities off the books. In particular, the government said last week — in response to Oxford Economics — that it is transferring liabilities from loans offered to civil servants to a newly established statutory body called the Public Sector Home Financing Board (PSHFB).

The PSHFB was set up to manage the public sector home financing facility. It has the power to use its properties to raise funds, borrow any amount of money to meet its obligations, with the approval of the MoF, and can invest its monies by depositing in banks, investing in government-issued securities and securities issued by and fully guaranteed by Bank Negara Malaysia. Some RM21.9 billion in liabilities have been transferred to PSHFB.

Moving these liabilities off the balance sheet reduces government debt to RM626.9 billion, or 51% of GDP as at end-March. By the end of 2016, MoF hopes to see public borrowings reach a steady 53% of GDP.

The figure excludes the state’s towering contingent liabilities. As at end-2015, contingent liabilities had grown to over RM170 billion, or 15% of GDP. The lack of transparency in items taken off the government’s balance sheet makes it difficult to monitor their risk. Further growth in contingent liabilities can also be expected as the government considers handing over operational responsibilities related to civil service pensions to the Retirement Fund Inc.

At over 50% of GDP, Yeah Kim Leng, professor of economics at Sunway University Business School, says Malaysia is only “moderately indebted”.

“Malaysia is in a position to cap its public debt. If the government continues to consolidate its fiscal position, the debt level is not an issue. The risk of a debt crisis is not elevated at this juncture if Malaysia can ensure sustainable growth, keep inflation manageable and has sound fiscal policies,” Yeah says.  

Within Asean, Malaysia’s government debt as a percentage of GDP is relatively high among developing economies, but is far behind Singapore, where government debt runs up to 105.6% of GDP despite its budget surplus position. However, it is worth noting that Malaysia’s public debt growth has outpaced many of its neighbours over the last decade. Countries like Indonesia and Philippines, in particular, stand out for having reduced government debt significantly during the same period.

Christian de Guzman, vice-president and senior credit officer at Moody’s Investors Service, notes that Malaysia’s debt levels are high compared with similarly-rated countries. However, the rating agency said the country’s debt structure, with nearly all its debt denominated in ringgit and deep domestic liquidity (as manifested by large institutional investors such as the Employees Provident Fund), suggests a commensurately higher capacity to carry debt.

“We do not currently envision government debt levels crossing the 55% of GDP threshold as a downward rating trigger. In fact, our affirmation of Malaysia’s A3 rating in January already incorporated an increase in the debt levels to above the threshold,” he says.

Many Keynesian followers would argue that pulling public debt lower to give the government extra room to increase borrowing is not, in itself, a bad thing. On the cusp of executing the 11th Malaysia Plan and major infrastructure projects, heavy government spending is required. Borrowing to support expenditure plans through the issue of new Treasury bills and government bonds, particularly when old ones have matured, is only to be expected.

Fiscal policy should be anti-cyclical. The government should follow an expansionary policy during an economic slowdown and contractionary policy when the economy is in a high growth rate, says a MIDF economist. It is, in other words, timely to borrow more now.

The philosophy is sound if executed by a government that values fiscal discipline.

Prime Minister Datuk Seri Najib Razak has taken steps to consolidate the government’s fiscal position and rationalise its spending. He started last year with removing broad-based subsidies and the implementation of the Goods and Services Tax. This was quickly followed by the recalibration of Budget 2016 after the Brent crude oil price dipped to touch US$29 per barrel in January. He slashed RM9 billion from the original operating and development expenditure.

The commitment to fiscal consolidation was reiterated again last week, when the MoF issued a statement detailing practical steps to rationalise state spending. Among them are careful recruitment of civil servants — with no new unit or institution to be established and prohibiting the appointment of third-party consultants, except for highly technological projects that require specialised knowledge. Official visits and the number of officials allowed to go overseas will be limited and the use of government premises for events will be prioritised, while administrative costs like printing and supplies will be trimmed.

Imposing budgetary guidelines is important, considering the growing pressures on government revenue and the moderating pace of the reduction in fiscal balance. Federal government revenue declined by 5.3% to RM48.8 billion in the first three months of the year. This was due to the sharp 38.2% drop in non-tax revenue to RM9 billion — receipts from investment income (mainly from Petroliam Nasional Bhd dividends and petroleum royalty) fell 58.1% in the first quarter of 2016.

But, adhering to spending limitations is tricky. Emoluments take up most of the government’s operating expenditure, but the Congress of Unions of Employees in the Public and Civil Services is adjusting poorly to budget cuts. In the last month, it has asked for a one-month Hari Raya bonus for civil servants and demanded the retraction of a circular that prevents the hiring of new staff. Najib partly obliged by announcing RM500 in special “financial aid” for civil servants in conjunction with the festive season.

Populist decisions like that are at odds with the government’s sermon of prudent spending. To stay on course with its fiscal consolidation plan and keep debt manageable, the government will have to carefully consider such acts of generosity at the expense of pubic finances.

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