Macroeconomic dynamics and sustainable balance of payments in Malaysia

In recent years, Malaysia has experienced a notable decline in its current account surplus, a departure from historically robust figures. Simultaneously, there has been a substantial decrease in both Foreign Direct Investments (FDI) and Foreign Portfolio Investments (FPI). These developments have coincided with slow economic expansion, the depreciation of the Malaysian Ringgit, a significant decline in exports of goods, and rising fiscal deficits. The observed trends emphasize the need for a thorough analysis of Malaysia's Balance of Payments (BOP) to better understand these dynamics and their broader macroeconomic impact. The study's first objective is to investigate the effect of fiscal deficit on the current account balance. The second objective examines the impact of FPI on macroeconomic variables, while the final objective explores the influence of exports, capital, and relative prices on GDP growth using the Balance of Payments Constrained Growth (BPCG) model. This analysis relies on quarterly data from 2008 to 2022, covering variables such as Gross Domestic Product (GDP), Gross National Income (GNI) per capita, FDI, FPI, the current account balance, exports, and imports of goods from the Department of Statistics Malaysia. Other data sources include Bank Negara Malaysia for interest rates and money supply (M2), the Ministry of Finance Malaysia for fiscal deficit data, the Bruegel database for Real Effective Exchange Rate (REER) figures, and the OECD and selected national statistical offices for world GDP data. The first objective, using the ARDL model, assesses the impact of the fiscal deficit, GNI per capita, and REER on the current account balance. The findings support the Ricardian Equivalence Hypothesis (REH), showing fiscal deficits do not affect the current account, as they are offset by strong income and a favourable exchange rate. This contrasts with the Keynesian twin-deficit hypothesis and highlights Malaysia’s external stability despite fiscal imbalances. The second objective, addressed through a Vector Autoregression (VAR) model, reveals that FPI positively affects key macroeconomic variables, including GDP, interest rates, REER, money supply (M2), and exports. Notably, interest rates and M2 show the most significant impacts, with coefficients of 0.034 and 0.024, respectively. The third objective, utilizing the BPCG model, examines the influence of exports, capital, and relative prices on GDP growth. The findings suggest that Malaysia does not face growth constraints, with these variables serving as key drivers of economic performance. Nonetheless, the actual average growth rate of 4.6% is substantially lower than the model's projected potential of 7.3%, indicating the existence of underutilized growth capacity within the economy. The study’s findings underscore the importance of policy strategies focused on stabilizing the exchange rate, promoting robust GDP growth, sustaining export momentum, and enhancing FDI and FPI inflows. These efforts are essential to strengthening Malaysia’s economic resilience and sustaining the BOP.

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