Academic journal article International Journal of Business and Society

Is Malaysia's Current Account Balance Sustainable? Evidence from Inter-Temporal Solvency Model

Academic journal article International Journal of Business and Society

Is Malaysia's Current Account Balance Sustainable? Evidence from Inter-Temporal Solvency Model

Article excerpt

ABSTRACT

Sustainability of Malaysian current account balance is examined in the framework of international inter-temporal solvency model over the period from 1980:q1 to 2012:q2. The paper is significantly different from previous studies in this field in two ways. First, it uses the most recent quarterly data on current account balance. Second, this is the first study of its kind that uses Lee and Strazicich (2004) unit root test with structural break, which is fundamentally different from similar unit root tests (such as Zivot and Andrews, 1992 and Perron, 1997) in the formulation of null hypothesis with structural break. According to inter-temporal solvency model sustainable current account should exhibit mean-reversion property. Using various unit root tests, including Lee and Strazicich (2004) this paper finds that Malaysian current account does not satisfy the solvency condition and hence unsustainable. Further anatomy of data (by splitting the data into pre- and post-reversal sub-periods) indicates that the results do not exhibit any significant improvement over the whole sample. Data in both sub-periods exhibit nonstationary behavior. These results call for active policy agenda at macro level to get the current account balance at a sustainable level.

Keywords: Current Account, Unit Root, Structural Break

(ProQuest: ... denotes formulae omitted.)

1. INTRODUCTION

Current account balance, particularly current account deficit (CAD), is one of the widely researched areas in international macroeconomics. The focus of these research studies has been the sustainability of CAD, because it is consistent with the sustainability of external debts and it reduces the possibility to go bankrupt (Holmes, 2006). Temporary CAD is not considered to be a serious problem as it represents the reallocation of capital to countries where productivity of capital is highest. However, persistent deficit for an extended period is a more serious problem that the policy makers and academics are equally concerned about. It tends to increase domestic interest to attract foreign capital. Servicing accumulated external debt implies lower living standard of current generation (Wu et al, 1996; Baharumshah et al., 2003) and imposes excess burden on future generations (Holmes, 2006). However, there is conflicting views on whether policy-makers should take corrective actions to get the CAD on a sustainable path. Some argue that government should take measures to reduce CAD to achieve sustainability, while others argue that in efficient market CAD reflects the optimal decisions of borrowers and lenders, so intervention is unwarranted (Belkar et. al., 2007). Despite this argument, concerns both from academic world and policy-makers have been to reduce CAD, as markets are not always efficient and therefore do not reflect optimal decisions of lenders and borrowers.

In this paper we study the sustainability of Malaysian current account balance. Until the Asian financial crisis in 1997, Malaysia mostly experiences deficit in its current account balance (see Figure 1). This was mainly because of its heavy reliance on foreign saving for its high domestic investment (Ismail and Baharumshah, 2008). However, after the Asian financial crisis Malaysia experiences sharp reversal in its current account balance. In q4:1997 current account balance was -1.69 percent of Gross Domestic Product (GDP), whereas this figure rises to 15.24 percent of GDP in q4:1998.1 Since then Malaysia has been recording persistent surplus in its current account. This sharp reversal was due to the significant depreciation of ringgit, which results in falling imports and rising export (Gan and Soon, 2003; Ismail and Baharumshah, 2008). However, continuing surplus may also result from inefficient financial intermediation, leading to low investment and other distortions. From international perspective, current account surplus in one country may reduce demand and output in other countries if they are in liquidity trap and thus affect them adversely (Blanchard and Milesi-Ferretti, 2011). …

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