Budget Deficit and the Federal Government Debt in Malaysia

*Mohamed Aslam and Raihan Jaafar*

### **Abstract**

In general, most countries in the world, particularly developing countries, are facing significant budget constraints, in which the collection of tax and nontax revenues is less than the government's total expenditure. Therefore, borrowing either from the local capital or international capital markets is made. Borrowing increases government debts. The budget deficits and the growth of the government debt are the major factors that determine the health of macroeconomics. There is a solid consensus among economists mainly on the effect of budget deficits on macroeconomics in terms of crowding out private investment, increasing interest rates, expanding money supply and escalating consumer price and in certain extent affect exchange rate. Government bonds issued to finance budget deficits are also in question as part of the net wealth of private sectors. On the other side, there is an agreement that the budget deficits financed by the issuance of bonds will crowd out private investment through increasing interest rate. This paper plans to investigate the impact of budget deficits on Malaysia's economy. Cointegration test and vector error correction models are used to examine the impact of budget deficits on certain macroeconomic variables.

**Keywords:** budget deficits, federal government debt, VECM, Malaysia

#### **1. Introduction**

In general, a persistent deficit in the government budgets would be a paramount issue to macroeconomic stability to any countries. Theory suggests that persistent and large budget deficits lead to a harmful effect on major macroeconomic fundamentals. In particular, massive budget deficits result in high interest rates as the government's demand for funds and this consequently conflicting with private sector demand for investment financing, thereby discouraging private investment expansion. The implications of high interest rates would affect severely residential construction, business investment in plant and equipment and consumer spending on durable goods by such a fiscal policy and along with non-accommodative monetary policy. Moreover, the budget deficits may affect interest rates via the channel of reduction in savings or deposits in the banking system.

Federal government debt relates to how much a country owes and is owed by a central government which acts as the liability of the nation. Changes in the government debt over time reflect the outcome of government deficits, for example when government spending exceeds its tax collections. When its tax collections are exceeded, it has a budget deficit, which it then finances by borrowing from the

private sector or from foreign governments. In other words, budget deficit occurs when government spending exceeds its revenue; meanwhile, federal government debt is the accumulation of the deficits. Budget deficit and federal government debt are interrelated as they affect each other, for example deficit affects the debt by selling bonds. When the bonds are sold, it increases the money; this transaction is defined as public debt because these bonds are sold to the public. Another example is the way debt affects the deficit; in the long-run, debt that is owed by the federal government reduces tax revenues and increases the deficit further.

The budget deficits run by the government around the world particularly since 2008 which tackle the effect of global economic crisis had accelerated the growth of government debt and accumulated the debt which had reached critical level. As there is a continuous growth of debt, creditors may become concerned about the government's initiative to repay it. Over time, these creditors will expect higher interest payments to provide a greater return for their increased perceived risk as it is widely known that higher interest costs dampen economic growth. As interest rates rise, it becomes more expensive for a country to refinance its existing debt. The management of debt by way of service payment is the sum of the principal payments and interest actually paid in foreign currency, especially as foreign currency tends to affect exchange rates.

There has been a strong interest in the behaviour of public debt, particularly since the impact of Asian financial crisis and the global financial crisis. During those periods Malaysia budgets deficits financed by increasing debts, i.e., issuing of bonds. The issue of Malaysia's government debt became significant in the public interest especially after the dramatic increase of government debt in the year onwards of 2009. The government gross debt has climbed up from 41.2% of GDP in 2007 to 52.8% in 2009 and further increased to 54.5% in 2015. The large increase in government debt, especially during the recent years, might be related to the Vision 2020 in which it envisioned to make Malaysia as a developed and highincome country by the year 2020. The main objective of this research is to review the Malaysian federal government's debt and budget deficit during the period of 1985–2018.

However, both the traditional macroeconomic policies failed producing outstanding economic performance. The budget deficits implemented had increased the gov-

*Malaysia: real economic growth rate, unemployment rate and inflation rate (%).*

*Budget Deficit and the Federal Government Debt in Malaysia*

*DOI: http://dx.doi.org/10.5772/intechopen.91457*

In the 1990s, the Malaysian total outstanding government debt reached an alltime high of 80.7% and a record low of 31.8% in 1997. Malaysia's government debt to GDP averaged 50.2% from 1990 until 2018. Since the debt approaching to 55%, therefore, the government should control her spending before the debt affecting the government fiscal position. The government self-imposed debt ceiling has been raised multiple times from 40% in 2003 to 45% in 2008. In 2009 it rose to 55%, and currently the limit still stands at this figure. It seems that Malaysia federal government debt level has been increasing much faster than the GDP growth; the statutory borrowing ceiling has been raised by 15% of GDP within 6 years, 2009–2017. Malaysia has breached its own self-imposed debt limit. However, even though the ratio of debt to GDP approached the limit, the Ministry of Finance claims that the debt is still manageable. The high level of debt may limit the development and

Uncertainties of the national debt service payment create discouragement, and ultimately, they form difficulties in the pursuit of economic reform [1]. The government spending must be paid by running the government in deficit and borrow-

government chooses to run in the budget deficit, the government must eventually raise their taxes to make interest payments in the future. In other words, the more spending made by the government, the higher the taxes will become; no matter if it

ing the money from the public or by raising today's taxes. However, if the

ernment debt thereafter.

**Figure 1.**

**Figure 2.**

is today or in the future.

**107**

objective of Malaysia's economic transformation plan.

*Malaysia: budget deficits, economic growth dan interest rate (%).*
