DEBT is a double-edged sword.
On one hand, it is an effective tool to promote economic development and enhance living standards if used wisely and in moderation. On the other hand, the effects can be detrimental and lead to financial ruin if it is used in excess and not well-managed.
Prime Minister Datuk Seri Anwar Ibrahim has revealed that the federal government’s debt and off-budget liabilities have reached RM1.5 trillion, exceeding 80% of the country’s gross domestic product (GDP).
Excluding off-budget liabilities, the federal government debt-to-GDP ratio as at end-June 2022 stood at 63.8%. This is still below the government’s self-imposed statutory limit, which stands at 65%, up from 55% prior to the Covid-19 pandemic.
Economists say there has been a significant increase in federal government debt during the pandemic as the government had to borrow to finance its budget deficit and implement expansionary fiscal plans to lift the country’s economy out of the downturn.
Voicing his concern about the government’s financial sustainability, Anwar, who doubles as Finance Minister, has pledged to gradually lower the country’s debt and narrow the fiscal deficit. He implied that the action would be reflected in the revised Budget 2023, which would be tabled next Friday.
On this note, Malaysia University of Science and Technology (MUST) economics professor Geoffrey Williams tells StarBizWeek that he expects the revised Budget 2023 to involve a better balance so that extra debt is not necessary.
“Generally, I think the government will simply try to stop the debt from rising further rather than reducing it overall,” he says.
Williams opines that there is no urgency for the government to reduce debt per se, but there is an urgency to manage debt better and recognise the risks that come with it.
“Actually, Malaysia’s debt ratio is relatively low. In Singapore, it is 130%. And although the deficit ratio has risen recently, it is still manageable. If GDP rises faster than the debt level, then the ratios will fall, and provided the financing costs can be paid, there is no particular risk to fiscal stability,” he explains.
How much is too much?
According to Bank for International Settlements’ (BIS) working papers, the threshold for government debt is around 85% of GDP. For household debt, the threshold is around 85% of GDP, while for corporate debt, it is 90%.
Debt beyond these thresholds can be a huge drag to a country’s economy in the longer term.
While Malaysia’s government debt is relatively low, its debt financing costs at around RM45bil each year are “expensive”, according to Williams.
“This is an issue: the financing costs at around 15% of government spending takes money from other priorities,” he points out.
“The other risk is the contingent liabilities, which the government quite rightly likes to include in the calculations. If these were taken into the debt management office of the Finance Ministry, they could be managed better,” he says.
For instance, the RM42bil National Higher Education Fund Corp or PTPTN loans could be monetised over 10 years at only 0.2% of GDP, and this would remove all of this debt and the associated risks, Williams notes.
Bank Islam Malaysia Bhd chief economist Firdaos Rosli points out that as a developing economy, Malaysia needs a comfortable fiscal space to boost its economic frontier through capital formation and productivity growth.
“More importantly, we need the right fiscal buffer to improve government’s ability to respond to future economic shocks without impacting the country’s sovereign rating,” he stresses, noting that the present public debt level may not sit well with the government as the fiscal room to push for higher growth is limited.
Managing priorities is key
On public debt management, Firdaos believes it is crucial to be clear on the area of concern, whether it is debt or liabilities, or both.
“If the debt is the concern, the logical thing to do is to find ways to redeem government bonds earlier than their maturity dates, assuming that holding them will only get costlier to service in time. The government may have to exercise a high level of fiscal discipline by not rolling over mature bonds. Sovereign debt rollover is a global norm, and I am unsure whether governments pursue premature bond redemption,” he says.
“If it is the liabilities side of the government’s balance sheet, we must be precise about which item is costlier to service in time. It is imperative to know whether the items are producing the intended multiplier as well. But if it is both, then we must prioritise which item is more urgent to pare down,” he adds.
In pursuing such policy, however, the government also needs to consider the unintended consequences, particularly on whether it would weigh on revenues and economic growth, says Firdaos.
“Overall, the revised budget should provide the clarity on the government’s revenue strategy, which includes tax and non-tax revenues. This is important, not only due to pandemic-related spending, but also the increasing government expenses as the nation ages, while the labour market remains anaemic,” he says.
“It is clear that the goods and services tax, or GST, is not going to return in the upcoming revised budget, but the market would still be keen to know the government’s fiscal path in restoring Malaysia’s fiscal buffers. If not the upcoming budget, the 12th Malaysia Plan (12MP) mid-term review should give us a better sense of the government’s overall fiscal priorities,” he adds.
Firdaos also opines that the government should pursue nominal GDP growth targeting to reduce the public debt ratios. Estimating that the statutory debt level in 2022 has improved to 57.7% of GDP amid a stellar domestic growth performance, he argues that with fading base effects and weaker domestic growth expected in 2023, Malaysia needs policies that can promote aggregate demand in the immediate term.“The government also needs to invest in improving the country’s production capacity to stimulate growth in the medium to long term. This is crucial to restore and sustain investor confidence, and thus, support strong economic growth moving forward,” he says.
Consolidation actions needed
Meanwhile, Socio-Economic Research Centre executive director Lee Heng Guie argues that reducing persistently high levels of government debt and liabilities should be a key policy priority.
“Policy convergence towards sound fiscal balance sheet and sustainable debt levels are paramount to regain fiscal buffers and increase economic resilience.
“In the absence of credible fiscal action, the fiscal space and downward debt adjustment would be much more constrained not only by higher committed expenditure, but also to meet mounting ageing-related spending pressures, environmental change and higher future costs of public debt,” he says.
Echoing Williams’ statement, Lee notes that high debt-service charges, estimated at 16.9% of total revenue in Budget 2023, will narrow the government’s fiscal space as interest expenditure rises in the coming years. “It is important to make a commitment to credibly reduce public debt levels as low as possible and the debt-to-GDP ratio and retaining the debt brake,” he stresses.
Williams points out that fiscal consolidation does not necessarily mean cutting spending or increasing taxes. “More efficient procurement can cut costs and release funds for priority areas without cutting overall spending. Changes in spending priorities can also make spending more effective without cuts. Alternative funding such as public-private partnerships can also make spending go further without cuts,” he explains.
“Similarly, more efficient tax collection can improve revenue without raising taxes. Reforms to the entire system can also increase revenues without higher taxes. Also, we know that lower taxes are a positive incentive to economic activity and can increase revenue even if tax rates are lower,” he adds.
The original Budget 2023, presented last October, projected government revenue to be RM272.6bil against a total expenditure of RM372.3bil, which implied a deficit of 5.5% of GDP. Of the total revenue, 21.6% was expected to come from petroleum-related sources, while sales tax and service tax would account for 11.8% and direct taxes (such as personal income and corporate taxes), 50%.In strengthening its fiscal position, according to Williams, the government can consider responsible privatisation to dispose of non-essential assets to generate income, which can then be used to pare down debt.
“Privatisation of parts of the asset base such as a share of Petroliam Nasional Bhd or selling land directly or land use concessions can also raise money through privatisation processes,” he says.
In addition, the government can also take measures to reduce crowding out the private sector, Williams adds, noting this will open up economic activity and promote growth which drives government revenue without increasing taxes.
“Prudent retirement of debt and monetisation of contingent liabilities can also be used as part of the debt management process to reduce debt and reduce default risk. This basically means printing small amounts of money each year and using it to pay the debts. It is not inflationary if done slowly,” he says.
Crucial to the Malaysian context is the constant insistence on anti-corruption measures to cut out waste and theft from government spending, Williams argues.
“It is not known how much of the debt has been caused by past corruption but it is likely to be huge,” he points out.
Government debt aside, Williams believes it is more urgent to address the high private debt – household and corporate – in the country.
Household risk contained
According to Bank Negara, Malaysia’s household debt-to-GDP ratio had reverted closer to pre-pandemic levels at 84.5% as at end-June 2022 after easing from 89.1% as at end-December 2021.
It is still among the highest in the region, behind that of South Korea, whose household debt-to-GDP ratio is more than 100%, as well as Taiwan and Thailand at around 90%.
The bulk of household debt in Malaysia comprised loans for the purchase of residential properties at 59.4% of the total RM1.4 trillion in the system as at end-June 2022. This was followed auto loans at 12.6%.
The central bank points out that lending standards remaining generally prudent, especially among banks, to ensure asset quality. It further notes that the share of more-risky borrowers with a debt-service-ratio of more than 60% remains fairly stable at 24% of total household borrowers, or 32.6% of total banking system loans.
Household impairment and delinquency ratios increased marginally, but remained low and within expectations at 1.2% and 0.6%, respectively, as at end-June 2022.
An analyst, however, points out that rising interest rates and costs of living amid a modest economic growth or downturn in labour market conditions could raise household loan default risk.
“Households have less money to spend as income growth is slow, while cost of living is rising. And with increased interest rates, highly leveraged households, especially those with flexible-rate loans, could face further repayment pressure,” the analyst of a local bank says.
“This also implies that private consumption could come under pressure, as households become ‘poorer’ and spend less on goods and services. This could ultimately weigh on the country’s economic growth,” he adds.
Bank Negara raised the overnight policy rate last year – which is the rate on which commercial banks based their deposit and lending rates – four times, at 25 basis points each, from a record low of 1.75% to 2.75% currently.
Noting that many households have increasingly become vulnerable due to the prevailing economic climate, the analyst says, the revised Budget 2023 will likely include measures that could alleviate some of the challenges and hardships faced by the rakyat.
He acknowledges that the authorities have done their level best to support vulnerable households, who face financial challenges amid the uneven economic recovery and rising cost of living, pointing to various debt rehabilitation and recovery programmes in place such as the debt management programme and financial management and resilience programme under the Credit Counselling and Debt Management Agency. Bankruptcy action remains the last resort for banks after all other efforts are exhausted, he notes.Separately, Firdaos expects Malaysia’s household debt-to-GDP ratio to improve further thanks to the solid economic growth in 2022.
“The latest nominal GDP came in at 15.7% in 2022 compared with 9% in 2021, powered by sturdy private consumption. To address household debt in a sustainable manner, perhaps the government should look at our share of labour compensation to GDP. The latest official statistics show that the ratio decreased from 37.1% in 2020 to 34.8% in 2021 amid a high unemployment rate.
“This suggests the ratio has gone back to around the 2015 level (35%). The challenge now is to bring it back to closer to the target of 40% as per the 12MP target,” he says.
Corporate debt pressure
Meanwhile, the non-financial corporate debt-to-GDP ratio had moderated to 104.4% as at end-June 2022 from 109.7% as at end-December 2021, Bank Negara data shows.
The improvement is mainly due to stronger economic growth, with the GDP expanding 6.9% during the first six months of 2022, as compared to a slight contraction in the second half of 2021.
Nevertheless, annual growth in loan disbursements in nominal terms to the business sector remained significantly high at 23.6% in the first half of 2022, as compared to the pre-pandemic average of 2.5% from 2015 to 2019. In 2021, annual growth in loan disbursements was 27.1%.
Bank Negara reveals that the high loan disbursements reflected the higher working capital needs among corporations amid stronger business activities and elevated cost pressures, while larger corporates with strong financials continued to tap on the corporate bond market for funding.In total, the primary issuance of all corporate debt in Malaysia increased 34% to RM153.1bil in 2022 from RM114.3bil in 2021. This year, corporate bond issuance is expected to normalise to between RM110bil and RM120bil, according to Malaysian Rating Corp’s projection.An analyst points out that the high corporate debt level could pose a downside risk to the country’s economy.
“It is understandable that businesses have taken on more debt to tide through the downturn during the Covid-19 pandemic. But for over-leveraged companies that are still languishing, this could be a problem, as their debt-servicing ability declines,” the analyst explains.
“As it is, there are still many economic headwinds ahead such as rising geopolitical tensions, higher operating costs, slowing growth and tightening financial conditions. They could put further strain on companies’ finances, and pose a negative impact on banks and the financial sector if the risks were not contained,” he adds.
Bank Negara’s report shows that business loan impairments as at end-June 2022 edged up slightly to 1.1% of the total banking system loans, or 3% of total banking system loans to business, from 1% as at end-December 2021. The uptick was driven mainly by borrowers in the construction, mining and quarrying, and wholesale and retail trade sectors, the central bank reveals. According to Bank Negara’s recent sensitivity analysis, which assumed further tightening of financial conditions, including a depreciation in the ringgit by up to 10% and an increase in average corporate bond yield by more than 200 basis points, business impairments could rise to 6.9% of business loans (or 2.5% of total banking system loans) by end-2023 under an extreme adverse scenario.
Nevertheless, even at that rate, it remains within banks’ own stress test expectations and buffer capacity to absorb losses, as indicated by the banking system’s post-shock capital ratio of 15.4% as at end-2023, the central bank says.
Debt may be part and parcel of life. But as past and recent economic crisis had shown, debt levels that are too high – be they in the government, household, or corporate sector – can ultimately be a drag to growth. As such, getting debt back to more reasonable levels is an important step to a resilient future
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