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The Public Finance and Fiscal Responsibility Act (FRA)enacted in 2023 forms the center piece legislation for fiscalreforms for the government. It is groundbreaking because atits heart is the dilution of the enormous powers of theMinister of Finance; it removes discretionary powers of theminister by imposing quantitative metrics on key fiscalparameters that only Parliament can change, it formalizes theFiscal Policy Committee and make specific provisions ondisclosures to Parliament.The dilution of the powers of the minister elevates the role ofParliament, something that we would like to see otherministers do for the laws that they are responsible for.Legislation in Malaysia has historically contained specificlanguage granting ministers with discretionary powerswhich has been a source of many abuses. The 1MDB scandalwould not have been possible with the FRA, or at the veryleast, it would be uncovered so much earlier.
The FRA sets numerical ceilings for annual budget deficits, total federal government debt andtotal federal government guarantees issued. The only floor it defines is on developmentexpenditures; it requires that the Development Expenditures in the annual budget be no less than3% of GDP. The concurrent imposition of these four limits defines a trade-off that the FederalTreasury must grapple with. The government must keep to a maximum level of deficit, 3% of GDP,in the budget, yet spend no less 3% of GDP for development expenditures.
Why these constraining constraints? Because this is what reforms mean. The starting point hereis that by 2023 when the FRA came into effect, total federal government debt was RM1,173 billion.Debt servicing expenses in 2023 was RM46.3 billion which was larger than the total personalincome tax collected that year, RM37.8 billion. Beyond that, there are also liabilities incurred fromthe guarantees extended to public entities totaling RM326 billion at the end of 2024, some of theserequiring the treasury to service the debt thus eating into the annual budget. The FRA forces thegovernment to decide on trade-offs; a smaller deficit requires either higher revenues or lessexpenditure, or some combination that obtains the targeted deficit. We cannot go on the existingtrajectory without risking a sovereign downgrade which would be disastrous for the economy.
The 13th Malaysia Plan(13MP) to be tabled in the current sitting of Parliament represents thedevelopment expenditures plan of the government for 2026 – 2030. The operating expendituresin the budget which is dominated by emoluments, pension payments and debt servicingexpenses—taking up 60% of the total amount—do not add new capacity to the economy. Itrepresents the cost of maintaining current capacity. It is development expenditures that adds newcapacity to the government, to do more things, better things. From a national accountingperspective, development expenditures represent public investments. From an economicperspective, we would like to see such public investments inducing much larger amounts ofprivate investments. It is currently at 1:3 which must improve further.
Optimally, we would like to see public investments having long tail effects—their effects linger;they generate economic benefits beyond the current year they are expended. And if we have sucheffects every year, we obtain over-lapping effects over the years which would make for anefficient and effective fiscal spending.
However, fiscal resources are limited, very limited. Given the state of where the fiscal situation is,total revenues collected by the government is sufficient to just cover operating expenditureswhich therefore means that almost every ringgit spent for development expenditures has to beborrowed. The FRA itself imposes both limits on annual deficits and accumulated debts, so thereis only so much that can be borrowed and allocated for development expenditures.
If the last few years is a reflection of reality, we see that annual development expenditures to bebetween 4 to 5 percent of current GDP, well above the FRA floor. In Budget 2025, it was RM86billion or 4.1% of GDP. Suppose nominal GDP grows at 7% over the next five years. That willtranslate into an aggregated five-year development expenditure of some RM500 billion, theapproximate size of 13MP. Simple extrapolation will obtain a nominal GDP of 2.9 trillion in 2030with a development budget of RM122 billion. Assuming, of course, there are no structural shiftsespecially in the external environment which is appearing to be unlikely.
That notwithstanding, as long as nominal GDP is growing faster than the deficit, we will be withinthe FRA metrics, and that should be the overriding policy objective. The imperative is therefore:how to be more productive? Which translates into how to be more competitive? Which begs thequestion: where should government spend to improve productivity and competitiveness? Whilebeing disciplined fiscally. What are the kinds of development expenditures that increases thecapacity of government to deliver its services in a manner that will deliver benefits over a longperiod?
Central to determining where government should spend fiscal resources on is the demarcationbetween public and private goods which is a more pointed consideration given scarce resources.Public resources should only be allocated to the provision of public goods which are essentiallythose things that have spillover effects, externalities in economics parlance, that generate socialbenefits when the externalities are positive or social costs when they are negative. An educatedpopulation, a healthy well-trained workforce, a safe and clean environment and functioninginstitutions are examples of social benefits arising from the provision of adequate and qualitypublic goods. Of course, policy should minimize social costs.
The government would do well to prioritize its development expenditures for the next five yearson basic public goods: on improving the quality of education and training institutions, ensuringadequate levels and quality of associated infrastructure, access to state of the art of technologyincluding facilitating life-long learning, improving the provision of and access to health services,ensuring public safety, conservation and protection of the environment; basic services thatimprove overall quality of life. The government should revert to the bottoms up assessment ofwhat is needed. Let the demand side of the fiscal equation determine the supply side. In theaggregate, the government footprint in the economy, as measured by the annual budget, isestimated to be just over 20% of GDP for 2025. That is the size of the fiscal policy lever. The overallpublic sector footprint is however larger as government also owns or control companies. Inofficial documents accompanying annual budgets, the consolidated public sector includes ‘nonfinancial public corporations’ (NFPC) which are companies owned by the federal governmentsuch as Petronas, Prasarana, KTM as well as companies where government-owned entities likeKhazanah has control over including publicly listed entities such as Telekom, Tenaga and Axiata.
This expansive view of the ‘public sector’ can sometimes blur the lines between who does whatfor whom. Direct fiscal resources at the Treasury and those in the balance sheets of these NFPCsare not fungible. They have distinct roles that should be clarified, not blurred. I am also wary ofso called privately financed initiatives (PFIs) as well as Public-Private Partnership arrangementswhich will require a thorough re-evaluation. Malaysia, Inc has blurred the line between whoprovides private and public goods; by and large that has been to the detriment of the public sector.It is the government that typically ends up saddled with debts and obligations which has furtherimpaired its overall fiscal capacity.
There will be calls for “government to lead” in investments, and by that they mean governmentinvesting in businesses the way government did via the various policies in the past; be it in theheavy industry policies that saw government investing heavily in automotive, motorcycles, steelproduction, electrical appliances or wafer fabrication during the information technology period or biotechnology or simply creating funds using debt to invest in businesses such as 1MDB. Noneof these made any money or generate any returns, financially or economically.
While there are compelling reasons for economic transformation, government leads via buildingcapability and capacity, developing safety nets for those caught in the transition, and providinginvestors and businesses with institutional integrity to obtain their confidence. Of course,government can use tax policies to reward the desired investor behavior. Government should notuse scarce fiscal resources, development expenditures funded by debt, to start or fund businesses.
Conclusion
Which brings us back to fiscal policy and the necessary and painful fiscal reforms. Being thedevelopment expenditures of the government, the 13MP is a part of that. The government andthe beneficiaries of its largesse, households and firms, must learn to live with constraints andredefined priorities which is the only way to be more productive and therefore, more competitive.A good outcome.
