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Malaysia Economy And Relationship Of Fiscal Policy Economics Essay

Our study investigates the importance of fiscal policy in economy of any country. There are a lot of variables that have relationship with fiscal policy and shows impact on economical growth. In our paper we have analyze the fiscal policy of Malaysia (Asian country) from 2010-2012 by referencing the past of Malaysia economy late in 1970s.

Executive summary

Fiscal policy describes two governmental actions by the government. The first is taxation and second action is government spending. This paper explores the stabilization properties of fiscal policy in Malaysia using a model incorporating nonlinearities into the dynamic relationship between fiscal policy and real economic activity over the growth cycle. Government of Malaysia participation in the economy expanded further in 1980-82 as it pursued an expansionary countercyclical fiscal policy aimed at stimulating economic activity and sustaining growth to ride out the effects of the global recession. The countercyclical policy led to “twin deficits” in the government’s fiscal position and the balance of payments. Malaysia ran persistent fiscal deficits throughout the 2000s, averaging just above 5% of GDP from 2000-05. By 2007, the fiscal deficit had fallen below 4%, but with the onset of the financial crisis, the collapse in growth and the ensuing fiscal stimulus measures, the deficit shot back up to 7.1% of GDP in 2009 and 5.8% in 2010. In 2011 and 2012 Malaysia fiscal policy will help them to construct better options for rural areas development and their major income for government revenue is income taxes.

our findings are supported by past literature on Malaysia economy and relationship of fiscal policy to other variables.

Literature review

Fiscal policy, the government decides how much to spend , what to spend , what to spend for and how to finance its spending (Abel et, al ; 2001). Fiscal policy is defined as change in federal taxes and purchases that are intended to achieve macroeconomics policy objectives (hubbard & O Brien; 2010)

There are two models imply regarding fiscal policy of a country in economic point of view. Standard Keynesian model imply that fiscal policy should be countercyclical when bad times hits the government spending should increases and lower taxes by government to help economy spend it way out of recession. If policy makers following Keynesian model then there will be business cycle a positive correlation between taxes and output and negative relation between government spending and output. the second models tax smoothing imply that fiscal policy should be neutral all over business cycle and only respond to anticipated changes that affect the government budget constraints. by following this model all correlation will essentially zero Barro (1979). The equilibrium approach to fiscal policy summarize by David Aschauer (1988) and Robert Barro (1989).

The macroeconomics analysis effects of fiscal policy on economical growth because fiscal policy effects aggregate demand, the distribution of wealth and economy capacity to produces services and goods. Neoclassical approach emphasize on short term effect of different instruments of fiscal policy. Secondly, steady rate growth is driven by exogenous factor which are dynamics of population and technological progress.

In Asian courtiers the growth performance observation viewed as: growth declined and become stagnant significantly since 1985 and government expenditures are not inhibits full exploitation of growth potential of Asian countries.

Researched on theory and empirical literature shows effects of fiscal policy variables that are government expenditure programs and taxes on economic growth Gerson (1998). Survey focused that there is robust positive contribution of government expenditure ratio to growth Caseli et, al (1996). Abdullah et, al (2008) focused on Pedroni Cointrgartion method to show a long run relationship between fiscal policy and economic growth.

Several studies examined effectiveness of fiscal policy and argued in Keynesian times that fiscal policy will increases disposable income ad raise the private consumption but some studies emphasize that fiscal policy can have non Keynesian effects. Feldstein & Giavazzi Pangano (1982) give that idea and purpose that permanent government expenditure reduction may increase in income , thus increase current consumption and aggregate demand.

With reference to Ireland and Denmark studies they found that contractionary fiscal policy may have expansionary results. Blanchard (1990) finds that the initial debt level has an important influence on fiscal policy effect. Sargent (1999) argues monetary policy can be constrained by fiscal policy, if fiscal deficits grow large enough to require monetization of government debt. This argument emphasize that monetary policy is not independent of fiscal policy decision of government. By tight fiscal policy holds by government we can easy run a non inflationary monetary policy but with persistent budget deficit spending it is not possible to run a non- inflationary monetary policy.

Some researchers confirmed that there is relationship between fiscal policy and stock market (Arin et, al; 2009 , Afonso et, al ; 2011, silvia & iqbal ;2011). Regarding this Malaysia the relationship between fiscal policy and stock market index analyzed. This study was concluded by using co integration test to detect the existence of long run relationship and also need VECM vector error construction model for short run existence. the finding indicates that fiscal policy tools plays an important role in accelerating financial performance in Malaysia.

In the 1970s Malaysia government played a key role in economy. Malaysia economics performance was impressive in late 1980s as well as 1990s with real growth of 8% per annum. This growth was due to expansionary monetary and fiscal policies compounded by FDI. Malaysia economy was in financial crisis in 1997/98 and faced minus 4% in growth with fast depreciating domestic currency and liquidity. By stabilization measures the real output lifted an post annually of 5% – 6% in 1998. As global economic constrained continued to persist the 1999-2003 budgets maintained an expansionary stance, with authority’s conscious of the need to maintain debt sustainability. The countercyclical fiscal policy implemented was effective in supporting economic recovery and sustaining domestic demand in 2001. Malaysia was able to record a positive growth rate by supporting effective fiscal policy. Federal government expenditure in Malaysia was allocated for 2 major purposes namely operation purposes and development purposes. Operation purposes are for upgrading and improve productivity as well as for long term economic growth. The largest component of operating expenditure is emoluments, subsidies, supplies and services. By improving subsidies is to reduce of burden of society to poor and disadvantages groups. Allocating budgets for development purpose to upgrade rural areas and low income households which have significant role in sustaining growth. The government development expenditure growth is faster than operating which is 7.1 % compare to 8.5% for development expenditures. the main source of government revenue is tax collection and non- tax revenue to finance its expenditure to improvement for prospect of country as well. The income tax is major tax in Malaysia (economic report ministry of finance 2010-2011).

In September 2011 the Malaysia credit rating slipping from A+ to A by providing an ominous sign. The Malaysia does not have track record of practicing fiscal discipline, as in two last decades the Malaysia gas had federal budget deficits even in good times of growth. Malaysia’s continually large government investments, spanning over more than a decade, are a rating constraint.

In 2011 the second quarter was unhappy one for Malaysia as manufacturing sector growth rate of 2.1% against growth rate of 5.5% in the first half of 2011. Manufacturing sector was dealing in slumping demands for Malaysia exports from the US, Japanese and Europeans markets. Globally growth was expected to drop by 3.1% for 2011 and china was by 0.2%, under all situation Malaysia decision to increase approvals for manufacturing investment of MYR 16.4 million. For 2nd quarter of 2011 and it is stinking when comparing to 2nd quarter of 2010. Malaysia forecasted a growth rate of 5-6% for 2011 but it was 4-5% in 2011. The consequences of lack of fiscal discipline will surface should the global economy take a turn for a worse. First victim will be federal government deficit that is started from 2008 crisis in Malaysia. At that time debt to GDP ratio was 54%.

Following the strong expansion in 2011, the growth of both private consumption and investment is projected to soften in 2012, as both income and capital expenditure in the external-related sectors of the economy are affected by the slower global growth. 2012 budget of Malaysia economy will support private consumption. The public sector will remain supportive with higher capital expenditure by both federal government and non financial public enterprise NFPEs on 2012.

Fiscal policy in 2012 is geared towards stimulating domestic economic activity and providing support to the economic transformation plan. A challenge for the Government in 2012 is to continue providing support to domestic demand by aiming the weakening external sector while ensuring that the fiscal position remains sustainable. In this regard, greater emphasis has been placed in the 2012 Budget on generating growth through private sector investment and consumption. RM2.5 billion is allocated in the 2012 Budget under the PPP Facilitation Fund to facilities the private sector in initiating various catalytic projects. Secondly it wills Introduction of various tax incentives to facilitate the development of high-impact projects in targeted sectors. These incentives are provided for projects in Kuala Lumpur International Financial District (KLIFD), Iskandar Development Region (IDR) and other regional corridors which are expected to have large multiplier effects on economic activity. The third initiative involves attracting foreign investments and participation in the economy through further liberalization of the 17 services sub-sectors that allow up to 100% foreign ownership. This initiative is expected to enhance the competitiveness of the domestic services sector which has been identified as one of the key drivers of economic growth. The Federal Government fiscal deficit is expected to narrow from 5.0% in 2011 to 4.7% of GDP in 2012. Revenue collection is expected to improve and thus supported by better tax administration and higher compliance in tax submission and collection. Total expenditure continues to remain supportive of growth with an allocation of RM181.6 billion for operating expenditure and RM49.2 billion for development expenditure.

With respect to fiscal policy of Malaysia, The Government continues to face the challenging task of striking a balance between fiscal consolidation and the need to support initiatives to transform the country into a high-income economy. The Government will remain committed to fiscal consolidation. A successful implementation of the ETP economic transformation programs and all other reform initiatives are expected to ensure sustainable growth which will enhance tax revenues, thus contributing to the efforts to strengthen the fiscal position of the Government.


This study examined some of the fiscal policy issues and challenges confronted by developing countries like Malaysia in using countercyclical fiscal policy to ameliorate the impact of the global financial crisis and revealed a rich diversity both in terms of the size and composition of fiscal stimulus and the challenges which are confronted.We concluded that fiscal policy is one of the most important instruments of government economic policy. The long run impacts of fiscal policy are not o theorical perspectives but also for implication of policy makers. A strong commitment to fiscal sustainability is very critical for macroeconomics stability as well to ensure a long term run growth for economy. By emphasizing its fiscal position Malaysia continuing enjoys the fiscal policy flexibility. Malaysia may not be maximizing the bang for buck of fiscal policy through policy ill discipline during boom times by expanding fiscal expenditures. The government, as part of the fiscal prudence policy, will closely monitor its spending. Over the medium term, its fiscal position will be consolidated as the economy recovers and is able to expand at its own momentum. The pace of consolidation will be guided by developments in external demand and domestic economic developments, with a focus on medium-term public debt sustainability considerations. The electoral-economic connection in Malaysia is strong, and elections are accordingly important determinants of fiscal policy choice in this rapidly developing nondemocratic state.

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