Fiscal space needs a boost

FOLLOWING the presentation of Budget 2026, we are now more aware of the government’s finances in terms of debt-to-gross domestic product (GDP) ratio as well as the ever-rising debt service charges (DSC).

As it is, the government is managing a tight ship due to the limited space that the government has in expanding its revenue base.

Since the introduction of the sales and service tax and other smaller taxes, the government seems reluctant to introduce new taxes or higher tax rates that could be detrimental to its political base, nor is it addressing subsidy reform in a holistic manner.

This column had highlighted before that the government had a few opportunities to be brave and bold in introducing tax reforms that could widen the tax base as well as reduce its spending inefficiencies, especially related to subsidies and leakages.

However, with Budget 2026 now tabled, the window for such reforms has closed as next year’s budget will likely be an election-year budget, as the nation heads towards the 16th General Election.

So, how does the government keep the economy going by continuously spending on development expenditure (DE) as well as other infrastructure development, both in the past and well into the future?

Firstly, as we continue to spend most of what we earn, the government’s operating surplus is almost negligible.

Hence, for DE, the government borrows to fund the required amount, as it does not earn enough revenue to cover it. Worse, the DE-to-GDP ratio – now at just under 4% – is also in danger of falling further.

The government’s debts are mostly raised via government papers under various statutory acts.

At the projected 64.3% and 64.5% statutory debt-to-GDP ratios for 2025 and 2026, respectively, based on the government’s nominal GDP growth and funding for the expected budget deficit, the government is at a critical juncture in terms of surpassing its debt ceiling of 65%.

To manage this ratio, the government must ensure that growth in statutory debt is slower than nominal GDP growth.

If economic growth falters – for whatever reason, be it domestic or international – the risk of surpassing the statutory rate is real and can be detrimental to Malaysia’s credit assessment by international rating agencies.

Outside official parameters

Other than statutory debt as well as offshore borrowings, the government also has exposure in the form of committed guarantees and financial obligations under the Public-Private Partnership (PPP) and Public Finance Incentives (PFI).

As at the end of June 2025, these amounted to RM390.5bil, of which RM237.1bil was in the form of committed guarantees and the balance of RM153.4bil as other liabilities under PPP/PFI.

This adds another 19.4% percentage point burden to the government’s debt-to-GDP ratio, which pushes the ratio closer to 84% to 85%.

The government, under the various legislative acts, also provides financial guarantees, which comprise some of the committed guarantees mentioned above and others, including RM53.7bil for the Public Sector Home Financing Board, almost RM40bil for Tabung Pendidikan Tinggi Nasional, RM11bil for Projek Lebuhraya Usahasama Bhd, and RM6bil for Pengurusan Air SPV Sdn Bhd.

This excludes committed guarantees given to state-owned Urusharta Jamaah Sdn Bhd of RM24.3bil and another RM14.7bil for other smaller committed guarantees.

Among the committed guarantees and financial guarantees that the government provides are those to Danainfra Nasional Bhd of RM87bil, Malaysia Rail Link Sdn Bhd of RM52.4bil, and Prasarana Malaysia Bhd of RM42.2bil as at the end of June 2025.

These are infrastructure-related developments that the government has carried out via debt-funded papers.

As most of these are also unprofitable and, in some cases, not operational just yet, the government not only provides the financial guarantees on the debt instruments that have been issued but also ensures that the interest payable is serviced promptly.

This is done via various capital injection methods as well as contributions derived from either operating expenditure (OE) or DE allocated in the annual budget.

Hence, while the official DSC is at 17.2%, the true DSC is much higher.

This brings into question the real cost of infrastructure development, as most of them are debt-funded, both as far as official DE is concerned, as well as those via special-purpose vehicles (SPVs) that are used to undertake major infrastructure works. This also means that while the government uses off-balance sheet funding, especially for infrastructure works, much of the interest or operating cost is derived from the annual budget, both from the OE and DE allocations.

Balancing act

It is unlikely that the government will resort to halting major infrastructure investment simply due to the debt-to-GDP ratio that is nearing the statutory ceiling limit, nor due to the increase in the DSC ratio as a percentage of expenditure.

Hence, the off-balance nature for the development of infrastructure projects will continue for the near future until and unless the government has the headroom from an improvement in its operating surplus, which can only come from higher revenue and lower expenditure.

Hence, to mitigate the risk of further deterioration in the total debt to GDP ratio as well as rising DSC, the government has no choice but to explore ways to raise its revenue and lower its OE.

Revenue drivers

While efforts like the full rolling out of e-invoicing, as well as greater enforcement on tax compliance and illicit trade, can provide the incremental growth in revenue, there is no better way to raise tax revenue than by having a comprehensive tax reform that will address Malaysia’s low tax-to-GDP ratio or even revenue-to-GDP ratio.

This will help Malaysia widen its tax base by raising the number of taxpayers.

As for corporations, a review must be carried out to not only lower Malaysia’s current high corporate tax rate of 24%, but also to tax breaks given to companies that have allowed them to reduce their tax liabilities.

In addition, the government ought to review the current single-tier dividend as well, especially for multinational companies that repatriate profits out to their home countries.

On the expenditure side, while emoluments and retirement benefits are sticky cost elements, the government ought to review its workforce needs in light of technological advancements and make greater efforts to reduce its substantial subsidy burden.

In conclusion, the government must create sufficient fiscal space to consistently allocate at least 4% of nominal GDP to DE annually, while reducing reliance on both DE and OE to sustain off-balance sheet items.