Malaysia’s debt: the misleading debt-to-GDP ratio

by Pak Sako
CPI Asia

This is the third part of a three-part CPI series on Malaysian debt. The first part, entitled, ‘Investigate Malaysia’s debts now‘ , surveyed the overall debt situation. The second part, entitled, ‘Malaysian government debt to approach RM1 trillion by 2020‘, looked at the trend in government debt.

This part critiques the debt-to-GDP ratio and questions Malaysia’s official debt figures.

An over-optimistic and misleading impression of debt results when the government puts its faith in one number, the debt-to-GDP ratio.

The current government-debt-to-GDP ratio for Malaysia of 53% is assumed as being within safe limits, below the 55% ceiling set by Malaysian policy.

Here it is argued that judging the nation’s debt condition primarily on account of this one indicator is wrong. A critical look at debt is required to understand the real situation and health of the economy.

Problems with the debt-to-GDP ratio

(i) It is an incomplete measure of the debt situation

he debt-to-GDP ratio is useful in providing an idea of a country’s debt level and potential capacity to repay debt, but it has discrepancies.

GDP, the value of goods and services produced in the country, is a crude measure that does not reflect the money actually available for servicing debt. Only part of GDP belongs to Malaysians and can theoretically be used to settle debt— the amount collected by the government as tax and the disposable cash that enters the savings of citizens.

More accurate indicators of debt would be government debt as a percentage of export earnings and government debt as a percentage of the government’s capacity to tax.

However these indicators too are imperfect. Clearly, not all of export earnings is cash that is available for debt repayment. Measuring debt as a proportion of government tax receipts is questionable when domestic debt is involved, since it implies that the government can tax its citizens to repay what it borrowed from the savings of the citizens themselves.

It is clear that “no individual indicator can provide an adequate measure of the complexity of a country’s debt problem” (K. Pilbeam,International Finance, 2006, p. 384). These indicators “neglect factors such as differing degrees of vulnerability to external shock, differing capacities to increase export earnings”, “differing future economic prospects of the economies”, or institutional and political factors.

(ii) Domestic debt matters

A study asked why countries default on foreign debt even though these debts seemed relatively small (C. Reinhart and K. Rogoff, 2011, ‘The forgotten history of domestic debt’, Economic Journal, Vol. 121).

It found that large domestic debt is linked to external debt defaults. This helps explain why “emerging market governments tend to default at such stunningly low levels of debt repayments and debts-to-GDP”.

Unlike external debt defaults that grab headlines, the study found that defaults on domestic debt— money borrowed by governments from the savings of its own citizens (pension funds etc.)— have been numerous, but are hidden. This finding raises the question of whether governments cheat when it comes to repaying what is owed to its citizens.

The Malaysian government’s external debt is about RM17 billion, but its domestic debt holdings are substantial. At the end of 2012, domestic debt stood at RM485 billion and accounted for 97% of total Malaysian government debt, and 66% of all Malaysian government and private sector debts.

Government debt is predicted to almost double to close to RM1 trillion by 2020, following the historical trend and forecasts suggested by the IMF (see ‘Malaysian government’s debt to approach RM1 trillion by 2020’, Center for Policy Initiatives, 25 February 2013).

Can the Malaysian government default on its domestic debt? The debt-to-GDP ratio gives no clue.

(iii) The debt-to-GDP ratio is only as good as its underlying numbers

The debt-to-GDP ratio is only as meaningful as the debt and GDP values used to calculate it.

Malaysia’s current GDP figures may not be reflecting long-lasting or sustainable growth.

GDP numbers may be artificially high when we rapidly draw down on natural resources, such as petroleum reserves and forests, without regard for future generations, or stimulate all sorts of economic activities even if they are unproductive and have questionable returns for the public.

Therefore using unsustainable GDP figures to calculate the debt-to-GDP ratio understates the seriousness of our debt situation.

There is also suspicion that the Malaysian government’s debts are higher than what is being revealed.

Questions have been asked about the government’s hidden debts, such as ‘contingent liabilities’ (see ”Hidden debt” edges M’sia beyond 55pct limit’, Malaysiakini, 27 September 2012). Contingent liabilities are difficult to trace, less transparent and its existence may pose a greater risk than the official debt size alone.

Because such debt can be kept hidden, “it is questionable whether many governments face sufficient incentives to reduce the use of contingent liabilities” (T. Ito and A.K Rose (eds.), Fiscal Policy and Management in East Asia, 2007, p. 285).

The Malaysian government’s contingent liabilities are not fully known but are growing (see IMF Country Report No.13/51, February 2013, pp. 12, 22). Although Malaysia is not alone in its failure to account for this openly and transparently, it is important to take action to reduce the use of contingent liabilities before they reach a dangerous level and overwhelm the country’s fiscal capacity.

Another type of debt not captured by the usual debt-to-GDP ratio is household debt. The above-mentioned IMF report says that Malaysia’s “household debt is high, as is bank exposure to households (55% of bank credit)”, and “growth in credit to households remain in double digits” (p. 9).

If these other debts are taken into account, the debt that the Malaysian government is exposed to breaches the 55% ceiling.

Also worrying is the evidence that Bank Negara Malaysia’s statistics is giving conflicting information about Malaysia’s true total debt.

In one part of Bank Negara’s Quarterly Bulletins, Malaysia’s domestic and external debts, both private sector and government, are provided and total up to RM695.4 billion for 2011 and RM737.6 billion for 2012.

Elsewhere in these bulletins, there are indications that Malaysia’s total debt is much higher:

“Malaysia’s total external debt declined to RM257.2 billion… as at end-December 2011… and remains small as a share of total debt (12.7%)” (BNM, Quarterly Bulletin, fourth quarter 2011, p. 134).

“Malaysia’s total external debt declined to RM252.8 billion at end-December 2012… and accounted for only 14.5% of total debt” (BNM, Quarterly Bulletin, fourth quarter 2012, p. 146).

Simple calculations show that the total debts implied here are RM2.025 trillion for 2011 and RM1.743 trillion for 2012.

The total-debt-to-GDP ratio becomes 230% for 2011 and 184% for 2012.

Given that government debt is currently around two-thirds of total debt, a speculative estimate of the government-debt-to-GDP ratio gives us the figures of 115% for 2011 and 92% for 2012.

These are crisis-level percentages.

(iv) The debt-to-GDP ratios of different countries cannot be directly compared

It is sometimes simplistically argued that Malaysian debt level is healthy because other countries tolerate higher debt-to-GDP ratios than Malaysia’s without adverse effects, or that Malaysia’s debt-to-GDP ratio is similar to that of other countries that are doing economically well.

This is fallacious thinking. A well-regarded study on sovereign debt has found that debt thresholds are importantly country-specific (C. Reinhart, K. Rogoff and M. Savastano, 2003, ‘Debt intolerance’, Brookings Papers on Economic Activity, Vol. 1).

Comparisons with countries such as Japan, Germany and Australia, which may have similar or higher debt-to-GDP ratios, can be erroneous.

These countries may have far more ‘leg room’ to take up larger debts.

For instance, Japan and Germany have the capacity to innovate, create homegrown technology and export without undermining their resource base. Australia, with a population size that is close to ours, has immensely large and important mineral deposits.

Malaysia lacks world-beating innovative capacity (hence the ‘middle income trap’), is reliant on limited resources (oil reserves and land area), and suffers brain drain. Malaysia may not be as equally geared as some other countries to assume the same proportion of debt for this and other reasons.

More accountability is needed on debt

The Malaysian government appears to have carte blanche in procuring debt. The ordinary citizen is left in the dark about debt levels and debt policy.

A more democratic approach is required given that debt has a critical effect on the people’s wellbeing. Debt amounts and debt policies should be brought under parliamentary scrutiny. Critical debt decisions could be put to public referenda.

Transparency is required. The government must clarify how it intends to repay the money that it has borrowed from the savings of its citizens, and at what rates and by when. The government is obliged to inform its citizens about the use that is being made of borrowed money. The government must reveal the full extent of the government’s debt holding and the annual interest payments that are being made on it.

In a genuine democracy, the people must be able to evaluate how much absolute debt they would be willing to collectively shoulder.