People are asking me if the Malaysian government’s new 3.2% deficit ratio target is achievable. I have read in the news that several politicians are skeptical about the target. I do not remember who said that but I feel the sentiment is shared by many.
But the only way to really answer this objectively is to run a sensitivity analysis.
It is relatively easy to do a sensitivity analysis and I have done one last week under the assumption of no expenditure cut. That one shows how the deficit ratio would react if the government had not changed its budget under a range of NGDP and revenue assumptions. I think it somewhat presents the realistic worst-case scenario. The government said its fiscal deficit would have gone up to 3.9% of GDP in 2015 without any expenditure cut. I think that would come close to my expectation (4.0%-4.1%), which is based on no revenue growth (not unreasonable) and at about 4%-5% NGDP growth. I am not reproducing the table here because I do not want to confuse the readers. If you are interested in that sensitivity analysis, you should revisit the post.
But that sensitivity analysis does not indicate whether the new 3.2% target is realistic. To answer that, it requires a bit more moving parts added into it. One additional dimension is required to be exact.
I am doing that here by showing 3 cases of revenue change under a range of NGDP and expenditure assumptions (note the not-so-small difference from the above model). To cut through the graphics, I think the 3.2% fiscal deficit ratio target is achievable if revenue grows by about 2% (I said about because I am too lazy to run a differential equation).
Before that, some legends for the three charts at the bottom. The yellow-highlighted cells describe the would-be situations if the expenditure was not cut (yes, it is a funny coincidence that the government had planned to increase its expenditure by 3.2% from 2014 in the original budget). The red-highlighted cells show the deficit ratio under the January 20 revised budget expenditure figures (Under revised budget, expenditure would still grow 1.2%. So, please do not call this austerity).
Here is the deficit ratio if 2015 revenue does not change from last year. Achieving 3.2% target seems impossible under this scenario (I wrote impossible because it would require a very strong NGDP growth at a time the GDP deflator appearing weak. If government revenue is flat this year, then my projection for the deficit would be about 3.6%):
Things would look a bit better if the government revenue would grow by 1% this year, but it would miss the deficit target still as 9% NGDP growth is beyond our reach, given current constraints:
Under 2% revenue growth case, the 3.2% deficit ratio looks achievable:
So, after reading through this, do you think the 3.2% deficit is achievable?
Ultimately, your answer must rely on revenue and NGDP growth. I think the reasonable NGDP growth assumption is about 4%-5%. As for revenue, I am unsure at the moment. There are just too many moving parts that require further investigation but the original budget had it grown at 4.5%. It will definitely be lower than that this year.