This sobering projection was reached based on the debt sustainability analysis (DSA) framework developed by the International Monetary Fund (IMF) and the World Bank.
As of August 2023, total federal government debt stood at RM1.147 trillion or 62% of GDP with 97.4% denominated in ringgit while the remaining 2.6% was in foreign currencies.
Based on the DSA, Malaysia’s debt-to-GDP ratio is estimated to trend down from 63% in 2023 to slightly below 60% in 2028 under the baseline scenario.
The baseline scenario assumes a real GDP growth rate of 4.5% from 2023 to 2028, as well as 4.3% in revenue growth, 1% in non-interest expenditure growth, and an average interest rate of 4.2%.
However, the study finds that if the current fiscal policy remains unchanged, the country’s debt level will reach an alarming level by 2028 based on two respective scenarios.
In the first scenario, called the constant primary balance scenario, the debt-to-GDP ratio will touch 70% by 2028 if the fiscal deficit stays constant at 2.5% of GDP for five years.
In the second scenario, called the historical scenario, the debt-to-GDP ratio will grow to 67.7% of GDP under the assumption that fiscal deficit averages at 2% of GDP, and an average economic growth of 4.2% and interest rate of 4%.
The debt-to-GDP projection in both scenarios will exceed the 65% statutory debt limit imposed by the government.
Malaysia’s statutory debt ceiling was raised from 55% to 60% in late August 2020, and then again from 60% to 65% in 2021, in the aftermath of the Covid-19 pandemic.
In 2020, the fiscal deficit amounted to 6.2% of GDP, rising to 6.4% in 2021. It dropped to 5% under the revised Budget 2023 tabled in February.
Shock analyses
The study also conducted several stress tests to evaluate potential impacts of various macro-fiscal shocks on the country’s indebtedness level.
Among the concerning scenarios is the real GDP growth shock scenario, which assumes that real GDP contracts by 5.5% in 2024 before rebounding gradually in subsequent years. In this scenario, the debt-to-GDP ratio is forecast to peak at 77.8% in 2025 and decline to 73.5% in 2028.
This exceeds not only the country’s 65% statutory debt limit but also the 70% threshold set by the IMF and the World Bank under the DSA framework.
Another critical scenario is the primary balance shock scenario, which may occur in the event of another pandemic crisis. The ensuing fiscal measures to manage the crisis would cause the fiscal deficit to surge to 3.8% of GDP, and the debt-to-GDP to peak at 68.5% in 2025.
On the other hand, it appears that Malaysia is relatively able to withstand an exchange rate shock scenario – if the ringgit depreciates around 30% annually – due to the low share of foreign currency denominated debt.
Apart from that, a real interest rate shock – simulated at a rise of 230 basis points annually – will also not affect Malaysia’s debt level significantly as a result of fiscal consolidation efforts such as the reduction in the share of short-term debt.
“The DSA illustrates that higher economic growth and fiscal surplus are the two main determinants which could swiftly reduce the debt-to-GDP ratio. In this regard, expediting the implementation of planned fiscal reforms and enhancing debt management strategies are pertinent.
“These initiatives contribute towards improving fiscal soundness, ensuring debt sustainability and alleviating vulnerabilities of the country in the medium- and long-term,” the report said.