Investment is indeed a crucial driver of economic growth, as it generates employment opportunities and raises the standard of living. It is the role of the government to create a favourable business environment that attracts investments, both from domestic and foreign investors.
Indeed, Malaysia’s share of foreign direct investments in the ASEAN region has decreased significantly from 24 per cent in 1977-1997 to just 8 per cent in 2000-2020. The failure to properly address underlying structural weaknesses that have persisted for years, all of which have made Malaysia increasingly less competitive as an investment destination.
As a result, the country suffered deindustrialisation. As investments declined, successive governments have sought to boost economic growth with short-term fixes.
These included encouraging domestic consumption without corresponding income growth, which only led to falling savings rates and rising household debts.
Raising government spending to stimulate demand and growth, à la Keynesian theory, is also largely a myth. Yes, it works in the short term but it is not sustainable and there are costs. To a certain extent, this is a weakness of all democratic governments.
Most are, in effect, practising BNPL (buy now pay later) economic policies, that is, win over voters now, pay later. But snowballing debts must be repaid. And this is where Malaysia now stands — on the edge of a precipice. There is no sugar-coating it.
The table shows a summary of the financial situation of the public sector — total government revenue, operating expenses, debt servicing costs and development expenditures. (This would be similar to the profit and loss statement and capex (capital expenditure) of a company, but bearing in mind that the government uses cash accounting instead of the accrual method of accounting.) These are the actual historical figures for 2014 to 2021 plus the budgeted 2022 numbers as well as my projections for 2023-2025 (based on the average rates of change between 2014 and 2019, before the distortions due to the COVID-19 pandemic).
The most ominous statistic, based on the country’s current trajectory, is the expected current balance deficit in 2023 and critically, its widening trend in 2024 and beyond.
A current balance deficit means that revenue is insufficient to cover operating and interest expenses. If we were to look at Malaysia as a corporate body, the Federal Government Bhd would be making net losses.
While Malaysia has run fiscal deficits every year since the Asian Financial Crisis (AFC), the government has always only had to borrow to finance development expenditure (capex). But my projections show that the country, by 2023, will have to borrow to service its debts!
The thing is, once a company has to borrow to make interest payments, debt servicing costs will snowball — with more and more borrowings required to cover higher and higher interest expenses.
Lenders will then surely demand higher interest rates (to compensate for rising risks) and finally, stop lending altogether. At that point, the company will be insolvent. A country will have more room to manoeuvre but make no mistake, there will be very serious fallouts.
How did we end up in this looming debt spiral?
It is noted that Malaysia has generally had sufficient revenue to cover all operating expenses, including interest, except for two years in 1986 and 1987. However, since around 2008, expenses have grown at a faster rate than revenue, leading to smaller current balance surpluses compared to the earlier years.
As a result of dwindling current balance surpluses, Malaysia has had to rely more and more on borrowings to finance development expenditures. And as the total amount of debts grew, so did debt servicing expenses.
In the five years before the pandemic (2014-2019), interest expenses grew by 7.8 per cent per annum on average, the fastest clip among all other major expense line items. And remember, this was the period when globally, interest rates were in decline.
In other words, the cost of borrowing was dropping, making debt cheaper. This trend has now reversed and interest rates are moving higher, at least for the foreseeable future.
The data shows that debt servicing as a percentage of revenue has increased from an average of 12 per cent in 2014-2019 to 16.7 per cent in 2020-2022. This means that a larger proportion of government revenue is being used to service the debt and this percentage is expected to continue to rise in 2023 and beyond. The current course that Malaysia is on is not sustainable.
What can (and cannot) be done?
When expenses are greater than revenue, the answer would be (1) increase revenue and/or (2) reduce expenses. The latter could be through a combination of steep cost-cutting measures and debt restructuring, for instance, lowering the interest costs. How probable is either action?
Government revenue, the biggest chunk of which is derived from various taxes (direct and indirect), has grown at a far slower rate than GDP over the past six years (2014-2019) — at 3.8 per cent per annum on average, compared with 7 per cent nominal GDP growth. We attribute this to the country’s narrow tax base, low-income levels and stagnating corporate earnings growth.
Meanwhile, only 16.5 per cent of the country’s 15 million-strong workforce pay income tax, that is about 2.5 million (or less than 8 per cent) out of Malaysia’s 32.7 million population. This is a very small base. Plus, there is a limit to how much higher personal income tax collection can go, especially if the country is not creating enough high-paying jobs.
According to a report by the Organisation for Economic Co-operation and Development (OECD), Malaysia’s tax -to – GDP ratio stood at 11.4 per cent in 2020, below the Asia-Pacific average of 19.1 per cent. The highest tax-to-GDP was 16.1 per cent in 2012.
Raising taxes to pay for higher expenses does not promote investments or savings
But even if it could be done, finding additional tax revenue to pay for higher operating expenses is a bad option. In my opinion, higher taxes will simply lead to an uncompetitive business environment. It does not promote investments or savings.
Therefore, the best solution is for the government to reduce expenses. Cutting expenses, especially on wastage, however, has proved to be equally daunting over the years. This is perhaps less surprising.
The democratic form of government can be a double-edged sword. Elections, at regular intervals, can prevent unchecked accumulation and abuse of power. But few, if any, populist governments have the political will to make the hard decisions that inflict pain on voters. Populist policies, on the other hand, are often short-term solutions that are not beneficial to the country in the long run. As mentioned above, most democratic governments practise BNPL economic policies. This is a fundamental challenge for all democracies — and quite possibly one of the biggest weaknesses of this form of government.
Malaysia has extensive subsidy programmes, including petrol and numerous food products. There have been talks of replacing (or reducing) the current blanket subsidies with more targeted subsidies for lower-income households. Again, is this politically palatable?
For the same reasons, there is zero chance of a smaller civil service or a cutback in salaries, emoluments and pension payments in the foreseeable future. We are seeing more populist policies, such as direct cash transfers to the people, to boost popular support.
If the reality is limited options for increasing revenue and cutting expenses, then more government borrowings appear inevitable. This is, in fact, what has been happening over the past few years. But we are very close to, if not already at, the point where we can no longer afford to kick the can down the road without serious consequences.
Crowding out private-sector investments
It is also worrying that the percentage of government bonds bought by foreign investors has decreased over the past few years, and more government issuances are taken up by domestic institutions. In particular, the banking sector and, to a lesser extent, local institutions such as the Employees Provident Fund and Kumpulan Wang Persaraan Diperbadankan, are holding an increasingly large percentage of government bonds.
As the government absorbs more of the available domestic pool of savings, it leaves less and costlier funding for the private sector. That means fewer investments, which as I have pointed out repeatedly, is THE most important driver of future economic, productivity and income growth.
Source: Bank Negara Malaysia and Ministry of Finance
