EVEN before the Covid-19 pandemic, the federal deficit was brought down progressively for eight successive years from 6.7% of gross domestic product (GDP) in 2009 (after the 2008-09 Global Financial Crisis or GFC) to 2.9% of GDP in 2017 before resetting to 3.7% of GDP in 2018 and 3.4% of GDP in 2019.
The recession inflicted by the Covid-19 pandemic and extraordinary stimulus spending have widened the deficits to 6.2% of GDP in 2020, 6.4% of GDP in 2021 and 5.8% of GDP in 2022 and is expected to reduce slightly to 5.5% of GDP in the 2023 budget before the dissolution of Parliament.
Shrinking current operating surplus is a worrying trend
It is equally worrisome that the government’s current account balance (federal revenue collected netted off against operating expenditure) has been shrinking and getting stretched by the years since the 2008-2009 GFC.
Operating surpluses have been dwindling from RM11.7bil per year in 1997-2010 to RM2.2bil per year in 2011-2018 and shrunk sharply to RM1.3bil per year in 2019-2021.
It is estimated to narrow further to RM517mil 2022.
In Budget 2023, the operating surplus is projected to narrow to RM230mil in 2023. It must be noted that the budget has not been approved by Parliament due to its dissolution on Oct 10, 2022.
The shrinking operating surplus was due to unsustainable growth in operating expenditure, which had increased by 87.8% to RM284.7bil in 2022 from RM151.6bil in 2010.
This was almost outpaced by the growth in federal revenue collection (78.6% from RM159.7bil in 2010 to RM285.2bil in 2022).
Three major components of operating expenditure had increased substantially in 2010-2022: Emolument (85.4% to RM86.5bil in 2022); pension charges (149.1% to RM29.1bil in 2022); and debt services charges (175.9% to RM43.1bil in 2022).
Malaysia has been incurring the 26th consecutive year of overall deficits since 1998.
With the fast-shrinking current account surplus, structural adjustment policies are needed to prevent an occurrence of twin deficits in both operating account and overall account of the federal government.
In 1986-1987, the government had incurred twin deficits in both accounts.
What are the consequences of having twin deficits in the federal budget?
Twin deficits in both operating and overall accounts could undermine investors’ confidence in the government’s financial discipline management as it really spends beyond means.
The financial consequences are not only more borrowings to meet larger deficits but also negative sovereign rating metrics.
What can the government do to avoid twin deficits?
While we reckon that the Treasury has an internal rule to maintain an operating surplus, it is getting more challenging now as revenue is stretched to meet unchecked operating expenditure.
The operating expenditure to federal revenue ratio had increased to almost 99% in 2008-2023 compared to 83.6% in 1997-2007.
To ensure a healthy surplus in the operating account, the government has to strengthen its capacity to collect tax revenue by pursuing tax reform strategies with certain distinct features:
> Implement multi-pronged tax reforms to ensure sustainable revenue, moving away from being overly-dependent on oil-related revenue.
> A broad-based consumption tax, such as the goods and services tax, excises and customs tariffs, underpinned by simple tax legislation.
> On the tax collection efficiency, use a range of digital technologies, data sources and analytics to increase tax compliance, improved efficiency and reduced opportunities for tax evasion and leakages.
E-invoicing adoption is one such example of using digital tools to facilitate compliance and track fraud quicker and more efficiently.
> Simplify the tax system and curb exemptions.
Curbing exemptions can also reduce the tax system’s complexity while boosting revenue by broadening the tax base.
A simpler tax system with a limited number of rates is critical to fostering taxpayer compliance.
> Expenditure rationalisation and cuts, including subsidy checks on ever rising recurrent operating expenditure.
In terms of improving fiscal sustainability, the universal subsidies of fuel, gas and electricity should be replaced by a targeted subsidy, using the national data system to identify those eligible for support, reducing drastically the cost of subsidies while protecting the poor.
Cash assistance should be made conditional with pension reforms shifting towards defined contribution.
> The development expenditure allocation for the expansion of the country’s productive capacity must be closely scrutinised, tracked and assessed to ensure the accountability of spent public funds and for the distribution of growth and economic dividend.
High and rising debt is a source of justifiable concern
Debt is a two-edged sword. If it is used prudently and in moderation, it expands productive capacity and increases economic growth.
But, if we borrow excessively and used it imprudently to fund unproductive sectors, it will be disastrous.
For a country, too much debt and liabilities not only impair the government’s fiscal sustainability, but also its ability to service debt.
The persistent deficits mean a growing federal debt over the years.
Over the period of 2008 to 2022, federal government debt had grown by an estimated 9.4% per annum to reach RM1.08 trillion (63.1% of GDP) at end-December 2022 (RM1.04 trillion or 61% of GDP at end-June 2022) from RM306.4bil or 39.8% of GDP at end-2008.
It is estimated to rise further to RM1.18 trillion or 65% of GDP at end-2023.
The substantial increases in net debt averaging RM95.7bil per year in 2020-2022 was due to extraordinary cumulative net deficit spending totalling RM285.9bil.
As at end-June 2022, total debt and liabilities of the federal government stood at RM1.4 trillion or 82.9% of GDP.
High and rising federal debt makes the economy more vulnerable to rising interest rates and, depending on how that debt is financed, rising inflation.
The growing debt on an unsustainable course and its size may limit the government’s fiscal ability to fight future economic downturns.
The growing debt burden also raises borrowing costs, slowing economic growth and national income, and increases the risk of a fiscal crisis or a gradual decline in the value of government securities.
The federal government’s debt service charges bill at 16.9% of total operating expenditure (RM46.1bil) in Budget 2023 is under pressure in relation to total revenue of 16.9%, which is higher than the 15% threshold in accordance to international best practices.
If the debt level is not stabilised, the interest bill will rise significantly, given rising bond yields.
It is hoped that the tabling and enactment of the Fiscal Responsibility Act (FRA) will reduce rising public debt and achieve fiscal stability.
The FRA will set minimum standards for fiscal transparency and accountability and requires the government to maintain debt at a sustainable level and reducing the overall fiscal balance.
Lee Heng Guie is Socio-Economic Research Centre executive director. The views expressed here are the writer’s own.
