This article first appeared in Forum, The Edge Malaysia Weekly on May 29, 2023 - June 4, 2023

Policymakers, economists and experts have recently been talking about our government debt level.

As at the end of 2022, the federal government debt-to-gross domestic product (GDP) ratio stood at 60.4%. Including the off-budget or contingent liabilities, our total public debt had reached RM1.45 trillion or 80.9% of GDP.

What are the implications once total public debt exceeds 80% of GDP?

The good news is our debt level is still very much below that which is often associated with debt default. The bad news is our debt is at a level that is often associated with slower economic growth. In other words, it is at the level when debt stops being useful and becomes harmful.

First, the good news.

Research from hedge fund Hirschmann Capital shows that since 1800, some 51 out of 52 countries with gross government debt greater than 130% have defaulted, either through restructuring, devaluation, high inflation or outright default. Currently, Japan is the only example of a country avoiding default despite having government debt greater than 130% of GDP.

The evidence shows that excessive indebtedness acts as a drag on growth. Though Japan has not defaulted on its debt, the country has experienced economic stagnation and numerous recessions over the years. Essentially, Japan has been weighed down by three lost decades until now.

Our total public debt is just above 80% of GDP, so it is safe to say that we are still far below the level that is associated with default.

However, this does not mean that a country won’t default at a much lower level. For instance, Argentina defaulted on its government debt in 2001 when its debt-to-GDP ratio was only 62%.

It is worth noting that Argentina was considered a model for successful economic policy for most of the 1990s. However, it defaulted on its debt in 2001, after three years of negative economic growth though its debt-to-GDP was only 62% and its budget deficit was 6.4%. It did not help that the country was on an extravagant public spending spree and there was a lack of tax reform.

Many economists argued that the crisis was due to Argentina’s peg to the US dollar. However, the San Francisco Federal Reserve Bank opined that the main reason was Argentina’s persistent inability to reduce its high public and external debts which made the economy vulnerable to adverse economic shocks and shifts in market sentiment.

Next, the bad news.

There are numerous studies on the relationship between the public debt threshold and slower economic growth. In other words, when public debt surpasses a certain threshold, it might slow economic growth.

The findings of the World Bank, European Central Bank (ECB), the Bank for International Settlements (BIS) and academia essentially indicate that when public debt is in the range of 65% to 85% or above, it might slow economic growth. Our public debt is currently at the upper end of the range.

For instance, the World Bank found that the threshold for this to happen is 77% of total public debt-to-GDP. If debt is above this threshold, each additional percentage point of debt costs 0.017 percentage points of annual real growth. For the emerging countries, the threshold is lower, at 64%. If debt is above this threshold, each additional percentage point of debt costs 0.02 percentage points of annual real growth. The cumulative effect on real GDP could be substantial.

The BIS found that debt improves welfare and enhances growth at moderate levels. However, once debt is beyond a certain level, it is a drag on growth. For government debt, the threshold is around 85% of GDP. The immediate implication is that countries with high debt need to address their fiscal problems quickly and decisively.

Researchers for the ECB found that a government debt-to-GDP ratio above the turning point of 90% to 100% has a deleterious impact on long-term growth. Moreover, the negative growth rate effect of high debt may start from levels of around 70% to 80% of GDP.

Another confirmation that our government debt has hit the tipping point comes from local research. Siew-Peng Lee and Yan-Ling Ng found that a rise in public debt is associated with a drop in GDP. They also found that government consumption has an adverse impact on economic growth. Their research covered the period from 1991 to 2013. In 2013, the direct government debt-to-GDP was slightly below 55%. However, the authors did not spell out the debt threshold at which the effect of government debt turns negative.

In the end, it can be seen that it boils down to how debt is deployed. If debt is used to support the economy’s productive capacity, the debt-to-GDP ratio should have declined or even remained constant as the economy expanded significantly over the years. More importantly, debt must be deployed without leakage or wastage.

In the case of Malaysia, our government debt-to-GDP ratio has risen significantly, from about 30% in 1997 to about 80% in 2022 (including contingent liabilities).

Meanwhile, the average annual real GDP growth has slowed, from 7.2% in the decade from 1991 to 2000 to 4.6% in the decade from 2001 to 2010 to 4% in the decade from 2011 to 2020 based on Department of Statistics data.

Why does it matter?

Slower growth can cause a structural unemployment problem as the country is unable to absorb the increase in the labour force. As a result, workers find it hard to get jobs, thus exerting downward pressure on salaries.

In summary, a public debt crisis is not imminent in Malaysia. However, our debt level is at the stage where adverse effects start to appear. Though more debt might give a temporary boost to the economy, it will slow down economic growth in the long term. This is consistent with the law of diminishing returns.

Ching Poy Seng is a private investor. He was previously a researcher at an international business school and Asia-Pacific director at multinational companies. 

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