Debt to GDP ratio on uptrend without significant fiscal reforms

by DR SAILESH K JHA & WONG XIAN YONG 

WE DEFINE Malaysia’s annual debt/GDP ratio as the sum of the general government debt and our estimate of contingent liabilities of the government as a percentage of nominal GDP (TD). In the first stage of our model estimates for the debt-to-GDP ratios, we assume no implementation of significant fiscal reforms in 2023-2026. Based on our parameter inputs entered into our TD debt/GDP model, we estimate a print of 109% in 2025 and 116% in 2026 versus 81% in 2022 under our base case scenario. 

Even if we just focus on the federal government debt to GDP ratio, we expect a print of 61.6% in 2025 and 62.2% in 2026 versus 60.4% in 2022 under our base case scenario. The main conclusion is that in our base case, Malaysia’s debt/GDP ratio, regardless of which metric is used to define the debt/GDP ratio, is headed north if significant fiscal reforms aren’t implemented. 

The main drivers of the rising debt/GDP as ratio as represented by TD in the post-2008 Global Financial Crisis era have been rising contingent liabilities since 2017, falling federal government tax effort ratio since 2012, and rising federal government expenditures such as subsidies, and federal government debt/ GDP ratio have more than doubled during the 1997-2022 period. The main reason for the large rise in the TD during the 1997 to 2022 period is that the federal government primary balance needed to keep the debt/GDP ratio constant has to be in surplus but the actual primary balances have printed deficits since the year 2000. 

Hence significant tax enhancement and expenditure reduction policies need to be implemented fairly quickly in our view and 2024 should be the timing of these fiscal adjustments otherwise the TD situation from 2027-2030 will be even worse compared to our estimate of 116% for 2026 versus 80.1% in 2022 in our base case scenario. 

The challenge is that even if GST is re-introduced at 6% in 2024 by the government, the TD will rise to 108.1% in 2026 from 81.1% in 2022 in our base scenario. Hence, accompanying policy measures such as significant reduction of contingent liabilities, subsidies, emoluments, or development expenditures is necessary to ensure that the TD is on a declining trend from 2025 onwards. 

In conclusion, without significant fiscal reforms, the risk of a sovereign rating downgrade by 2025 rises significantly. Note that one of the most important triggers of sovereign rating downgrades are jumps in government debt/GDP ratios, not the level in itself. In addition, the external debt amortization/exports of goods and services ratio, the level of external debt amortization, and a deteriorating GDP growth outlook are also key metrics to watch for sovereign rating downgrade risks. 

In the 1998-2001 period, the common characteristics of sovereign defaults, not that Malaysia is in this position currently, but just to illustrate where the stress in sovereign ratings emanates from broadly speaking, in Argentina, Ecuador, Russia and Ukraine there was a sudden jump in the public debt/GDP ratio. The level of gross public debt/GDP ratio is not the key trigger for a default. In Argentina, Ukraine and Russia, one year before the default occurred, the public debt/GDP ratios were 52%, 35% and 56% respectively. While in Ecuador, the comparable figure was around 64%. Hence, it’s the rate of change of the public debt/ GDP ratio that matters. 

  • This is an abridged version of the research note, dated May 12, 2023, authored by RHB group chief economist and head of market research Dr Sailesh K Jha and associate research analyst Wong Xian Yong. 

  • This article first appeared in The Malaysian Reserve weekly print edition