Determinants of subnational debt sustainability under fiscal centralisation: Evidence from Malaysian states

This study examines subnational debt sustainability in Malaysia under fiscal centralization, using panel data for thirteen states from 2004 to 2023. Although Malaysia is constitutionally federal, fiscal authority is highly centralized, leaving state governments with limited revenue autonomy and strong dependence on federal transfers. Political alignment between state and federal governments is included as a key institutional factor influencing access to transfers and borrowing approvals. A panel autoregressive distributed lag (ARDL) model estimated using the Pooled Mean Group (PMG) approach captures heterogeneous short-run dynamics while imposing a common long-run equilibrium relationship. Robustness checks using the Augmented Mean Group (AMG) estimator indicate that state debt is negatively affected by federal transfers and economic growth in the long run, while short-run debt dynamics respond mainly to economic growth shocks. The contributions of own-source revenue, expenditure pressures, and political alignment are not statistically robust and cannot be conclusively established. Less fiscally capable states, such as Perlis, Kedah, Kelantan, Terengganu, Sabah, and Sarawak, converge more slowly toward long-run equilibrium, reflecting institutional constraints and reliance on federal support. These findings highlight the macroeconomic and institutional implications of fiscal centralization, intergovernmental coordination, and state-specific fiscal capacity, providing policy-relevant insights for enhancing fiscal discipline in Malaysia’s quasi-federal system.