Determinants of External Debt: The Case of Malaysia

Over the past 30 years, Malaysia‘s external debt has been on an increase, with the increase closely linked to a number of economic factors. The changing quantities and qualities of external debt have become a national concern. Data related to the changes in dependent and independent variables between 1970 and 2013 was used in the study. The model was tested for unit root tests, cointegration test, vector error correction model, and Granger causality test. The cointegration test indicates there is one cointegrating vector. Moreover, two out of the four expectations were met in a significant manner through the long-run relationships. The government manage to reduce external debt by increasing GDP. But, the government increases capital expenditure by increasing external debt. This goes against the economic theory. In order to sustain debt, a government should increase capital expenditure in order to repay external debt. In addition, the possibility of sustaining the debt can be contradicted due to the fact that recurrent expenditure is also relied on external debt. Hence, Malaysia should find an alternative to gain money for recurrent expenditure instead of taking it out of the external debt fund. Based on the four explanatory variables, it is clear that the Malaysian government rely on GDP for the repayment of external debt. Where else, Granger causality test showed that only uni-directional relationships exist between the variables. Lastly, it is adviced that nationwide adjustment in policies is necessary in order to align growth with improvement in the determinants of external debt. Keywords: Malaysia, external debt, vector error correction model, causality.