Tuesday, October 18, 2011

Budget 2012: Some Simple Debt Math

From a little mole:

Malaysia Is On Course To Breach The National Debt Limit
By Anwar Ibrahim

…Dato’ Seri Najib should also share the widespread sentiment of concerns over the rising level of national debt, instead of making a mockery of it through BN controlled media.

The national debt level is governed by various acts of parliament that impose a debt ceiling for the government. In accordance with Act 637 Loan (Local) Act 1959 (revised 2004) and Act 275 Government Investment Act 1983, the combined loans raised locally should not exceed a ceiling of 55% of the nation’s GDP. Act 403 External Loans Act 1963 (revised 1989) limits the external loans exposure to RM35 billion at any particular time.

On top of the debt ceiling imposed by the acts, the national treasury also follows strict guidelines to strengthen the fiscal discipline, even before my tenure as the Finance Minister. For example, the proposed operational budget for a particular year should never exceed the revenue projection. Likewise, loans raised by the government should strictly be used for developmental budget.

Thus, the public debate on the alarming national debt level has become a legal issue of national significance as Dato’ Seri Najib’s administration is in serious danger of breaching the national debt ceiling and is complicit to conceal the fact from the public.

Bank Negara Malaysia’s latest report (updated 14 October 2011) shows that the national debt stands at RM437 billion for the period ended 30 June 2011, with a breakdown of RM421 billion of local debts and RM16 billion foreign debts. This translates to a 51% local debt-to-GDP ratio as governed by Acts 637 and 275, which allows for approximately RM33 billion additional debt to be raised by the government. This is clearly not adequate to finance the remainder of 2011 expenditure and the RM46 billion deficit to be funded through additional debts announced in Barisan Nasional’s Belanjawan 2012.

The rakyat is also well aware that the 5%-6% growth projection used in 2012 budget is unrealistic and it is likely that his administration will have to rely heavily on debts to fund his election promises…

I had no idea we had a national debt limit – seems a strange thing to bring up now since the debt/GDP ratio was well past that level from 1983-91. There’s also a semantic problem here, as the Treasury defines the “national debt” to mean combined public and private external debt, and not government debt.

But all that aside, what’s the risk of a breach in the next year and a half or so? It depends on how pessimistic you are.

First let’s deal with this year’s funding requirements. As at 2Q 2011, the government has collected about half of the projected revenue and has spent about 40% of projected expenditure. The net funding requirement for the second half of the year is RM48 billion, and the current level of cash is RM27 billion (all rounded up). Assume that the government wants to hold a “normal” level of cash – mean for the sample period 2000-2011 is around RM20 billion – and doesn’t resort to foreign debt offerings. That gives a net increase in government debt for the second half of the year of around RM41 billion, or a total of around RM462 billion. That translates to a domestic Debt/GDP ratio of around 53%.

No problem so far.

Next year’s increase in debt is expected to be around RM43 billion, which would put the total debt figure at RM505 billion – that’s a lot of money to owe, right? But what would it take to breach the debt limit? It gets a little complicated from here, so you might want to skip to the table at the end.

First some assumptions:

  1. I’ll take the base case as the middle of the government’s forecast of 5%-6% (5.5% real GDP growth);
  2. We need to use nominal, not real GDP, so you have to estimate the deflator as well. The mean of the annual log change in the GDP deflator over the past 11 years is 2.8% with a standard deviation of around 0.4%. I’ll take the mean as the base case, and a 2 S.D. range around that for different inflation scenarios;
  3. I’m assuming that the government expenditure plan stays fixed under all conditions (not a reasonable assumption since policy is endogenous, but you have to start somewhere);
  4. Revenue on the other hand will be sensitive to changes in GDP – an elasticity calculation shows revenue varies approximately 1.1% for every 1% change in nominal GDP (all standard tests check out except heteroscedasticity – in practice, adjustment for that means just larger standard errors);
  5. I’m assuming that the government maintains its external debt at RM16 billion.

Here are the results (top row is the GDP deflator, left column is real GDP growth, bold denotes the debt ceiling threshold):

Real GDP Growth  2% 2.8%  3.6%
0% 0.585249 0.578393 0.571652
0.5% 0.58095 0.574167 0.567496
1.0% 0.576697 0.569985 0.563384
1.5% 0.572489 0.565846 0.559313
2.0% 0.568324 0.56175 0.555285
2.5% 0.564203 0.557697 0.551298
3.0% 0.560124 0.553685 0.547351
3.5% 0.556087 0.549714 0.543444
4.0% 0.552092 0.545784 0.539577
4.5% 0.548137 0.541893 0.535748
5.0% 0.544223 0.538041 0.531958
5.5% 0.540347 0.534228 0.528205
6.0% 0.536511 0.530452 0.524489

Looking at the numbers, under the base case of 2.8% inflation, a breach of the debt ceiling would only occur if real GDP growth falls to around 3.0%. The higher the inflation rate, the lower the GDP growth rate that can sustain debt below the ceiling – the opposite is true.

The consensus forecast for next year appears to be around 4.0%-5.0% real GDP growth. If that turns out to be near realisation, then we’re in no danger of breaching the debt limit, assuming its enforceable at all.

Obviously, changing the assumptions would change the numbers:

  1. The government has the latitude to double external debt – that would drop the threshold to just 1% real GDP growth in the base case of 2.8% inflation.
  2. It could hold a lower cash balance, which cuts the base scenario threshold by 0.5% to 2.5%.
  3. Or it could do both, which means under the base scenario growth needs to drop below 0.5% before the threshold is crossed.
  4. Finally, it could cut expenditure as well, which would mean the debt threshold will only be crossed if the economy actually falls into recession.

Then again, what could really be the kicker is if global growth takes off again next year, in which case we’re arguing over nothing. There are signs that growth is actually picking up again – domestically, the economy in 3Q had already begun to accelerate slightly. I think that should be expected – the type of crisis the global economy went through means a volatile and slow recovery. We’re as likely to overshoot in growth as to undershoot.

A last point:  whether we breach the debt limit or not is really moot – it’s not at a dangerous level, 90% plus is denominated in Ringgit, most of the debt is held domestically, and there’s plenty of domestic liquidity to absorb a much greater increase. I think in terms of priorities, there are much more important things to talk about and fight over.


  1. Anwar has never been known to know much about the economy. When he was finance minister, eveyrtme reporters asked him about the economy, he would revert to "our fundamentals are strong". Sometimes he would say, "our fundamentals are very strong". Beyond the fundamentals, he was fundamentally happy to be riding on Mahathir's weakness for him at that time.

    Thank God for currency controls in 1998, instead of going the IMF way as Anwar had been advise to take us, our fundamentals remain strong. Except Anwar still wouldn't know what that means.

  2. wonder how much Anwar was paid for publishing the said article. RM1?

  3. @bro Rocky,

    There's some decent econs advisers in PR. Maybe the problem is they're all in DAP.

  4. Anwar can't even differentiate bw national debt and federal government debt. Just like he can't differentiate male and female, front door- back door, wan azizah and china doll, truth and lie etc. Macam ni nak jadi PM?

  5. am not an anwar fan, but too much debt is simply bad. of course, there are good debt and bad debt. based on our current system, most of our debts are bad debts due to leakage, non productive investment, white elephants, holiday, etc...

    if our country's debt is used for hiring better professors regardless or race, building good infrastructure and maintaining them, invest is 'workable' ports, invest in 'efficient' airports and more then it is good debt... sadly, this is not the case

  6. kiki,

    Based on bro satD's impressive research (read his link folks, it's worth your time), the government is only allowed to borrow to fund the development budget - roads, utilities, schools, human capital development etc.

    But even if you take the government spending holistically, remember that RM33 billion is going to be spent on subsidies next year, equivalent to 75% of the expected borrowing requirement.

    Granted there's wastage, but that is endemic to any government. I don't know that our government is any better or worse than any other.

  7. The debt numbers should include all govt guaranteed loans.Otherwise its so easy to set up 100% govt owned ABC Co n borrow wateva is needed eg 1MDB,PKFZ,MRT Co,Prasarana etc.

    And its also wise to look at our revenue streams.As it is a major contributor is non-renewable oil.

    Going fwd on a worse case scenario when we are nett oil importers and the non viable govt funded projects comes back to roost. .don't think our financials will be very strong.

    Simply,our opex is too big n devt expenditures non optimal.The rest are just numbers.

  8. Debt data on NFPEs are listed in each year's Economic Report. Since they're legally separate entities, and any borrowing they do can only be used for the specific projects they run, it's not standard accounting practice to consolidate them (the only exception is Khazanah).

    In any case, guarantees are contingent liabilities not defined contractual legal obligations to pay. Moreover, we're discussing the government's actual debt level vis-a-vis the legal debt limit issue raised by DS Anwar.

    "Going fwd on a worse case scenario when we are nett oil importers..."

    This is only relevant if we continue to subsidise petrol, diesel and gas use.