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Sustainability of Malaysian current account balance: Evidence from ardl bounds tests approach

ABSTRACT:Malaysia has been experiencing sustained current account surplus during post-Asian crisis period. Although current account surplus is not as harmful as deficit, it cannot be sustained forever. Moreover, if the surplus is caused by bad reasons, such as, insufficient social insurance, inefficient financial intermediation, then it is reflected in deteriorating external competitiveness through more depreciated real exchange rate. Therefore, examination of current account sustainability is of crucial importance for the long-run health of the economy. Previous studies on Malaysian current account sustainability produce diverse results and leave it as an unsettled issue open to further research. In this backdrop this paper investigates the sustainability of Malaysia’s current account balance for the period 1970 – 2010. This paper employs inter-temporal budget constraint to understand the behavior of exports and imports of Malaysian economy. Autoregressive Distributed Lag (ARDL) method is applied to examine the long cointegrating relation between Malaysian exports and imports plus interest on external borrowing. Advantage of employing the ARDL method is that it does not require the variables to be integrated to the first order. This method can be applied to a set of stationary and nonstationary variables. The paper uses annual data over the periods 1970 – 2010. Export, import and Gross Domestic Product (GDP) data are in current US dollars. Interest payment on long-term external borrowing in US dollars is used as a proxy for interest on net foreign debt. Estimation results indicate that these two variables are cointegrated, which implies that Malaysia’s current account is sustainable in the long run. Strong sustainability requires the coefficient of cointegrating vector to be one. In addition to ARDL method, coefficient of cointegrating vector is estimated by two other methods, namely, fully modified OLS (FMOLS) and dynamic OLS (DOLS). All three estimations show that the long-run coefficient is greater than one. This indicates that in the long-run export increases more than import plus interest on external borrowing. Therefore, if the excess export earnings in the long run cannot be utilized productively current account surplus may not sustain. It is, therefore, concluded that Malaysian current account is weakly sustainable. This findings call for policy intervention at macro level to make efficient utilization of excess saving to boost economic growth through promoting social insurance, facilitating efficient financial intermediation and encouraging private investment.