This article first appeared in The Edge Financial Daily on November 12, 2018
KUALA LUMPUR: While the government has raised its fiscal deficit target for 2018 to a higher-than-expected 3.7% of gross domestic product (GDP), local economists think this is unlikely to result in a credit rating downgrade for the country by global rating agencies in the near term.
This is because the top three global rating agencies — Fitch, Moody’s and S&P Global — will be assessing Malaysia up to the tabling of Budget 2020 next year, following the government’s midterm fiscal framework, economists The Edge Financial Daily spoke to said.
Affin Hwang Capital Research chief economist Alan Tan said he foresees the reset in Malaysia’s fiscal balance, the RM30 billion one-off special dividend from Petroliam Nasional Bhd (Petronas), and other measures the government has announced will support the improvement from 2018’s fiscal deficit of 3.7% to 3.4% next year.
“Despite certain comments [by the rating agencies] on Malaysia, we believe that [from] now until the next budget, if the current government continues to maintain its medium- term fiscal consolidation path, I believe the risk of [a] downgrade is relatively small,” said Tan.
Notably, the government has announced its commitment to maintain a path of fiscal consolidation to achieve a deficit of 3.4% in 2019, 3% in 2020 and 2.8% in 2021 respectively.
Going forward, Tan said the government had to provide the rating agencies an assurance that it could follow fiscal commitment and discipline by achieving the set target deficit.
“What has been reset has been reset; the government now has a clean sheet of paper. Hence, it has to show fiscal discipline and build a strong reputation to provide that assurance to the rating agencies.
“It is about sustaining the consolidation path and improving it every year, up to 2021. Forget about the balanced budget because the government is already moving away from that, but focus on the consolidation path to improve the fiscal deficit position,” said Tan.
He also stressed that from a rating agency’s point of view, concerns only arise if the government shows an even larger budgetary deficit next year, where fiscal deficit grows beyond the projected 3.4% of GDP.
UOB Global Economics & Markets Research senior economist Julia Goh said the silver lining that the rating agencies should consider is the government’s efforts in restoring public finances and containing fiscal slippage, improving transparency and governance standards, and its focus on inclusive growth amid higher fiscal targets.
“This is a temporary diversion and we do not think it steers away from the path of fiscal consolidation,” said Goh.
Goh also highlighted the country’s peaceful political transition as another factor that should be taken into consideration. The new government has also chosen to take the higher road by tackling legacy issues, despite the fact that it feeds into a higher deficit.
“The underlying budget, if we strip off the tax refunds and special Petronas dividend, suggests that [the] total expenditure [allocation] has been reduced by 4.4% mainly due to prudent efforts to cut operating expenses. This effectively pegs the fiscal deficit at 2.9% of GDP, which is not that bad,” said Goh.
The budget, she noted, has also been adapted to be in line with Pakatan Harapan’s manifesto. “Spending on fuel subsidies and cash aid has been fine-tuned to be more targeted, which is fair,” Goh commended, adding that the budget also showed some innovative measures, which reflected a willingness to “think out of the box” and make the best out of a difficult situation.
Look at economic growth
Having a budget deficit is not desirable but it is acceptable, said MIDF Research chief economist Dr Kamaruddin Mohd Nor, “as long as the government is committed to ensure prudence in its expenditure and [that] its spending is channelled towards productive economics activities”.
On that note, he observed that most of the country’s deficit now is due to development spending, and that Malaysia still has an operating surplus.
An expansionary fiscal policy also helps ensure that the economy remain competitive, he said. He also noted that the growth trajectory as well as policy measures to boost domestic growth are both key features for sovereign assessments too.
Hence, he said boosting development spending will create vibrant economic activities and provide an impetus to growth, while the stable labour market and people-friendly assistance will boost domestic consumption.
Tan concurred with Kamaruddin’s view. Tan said despite having lower revenue collection from the abolition of the goods and services tax (GST), it really means “putting more money into consumers’ pockets”. The tax refund of RM37 billion to businesses will also generate economic activity as businesses can use the money returned for expansion, he added.
Hence, Tan is of the view that the 4.9% GDP growth foreast for the following year is realistic, with the global GDP outlook seen at 3.7%. “The current government has to be very supportive of economic growth through domestic demand. There is a need for a detailed strategy [to show that] the government has enough revenue to cover operating expenditure to give an operating surplus position,” said Tan.
He also highlighted that by sustaining economic growth going into 2019, coupled with revenue from direct taxation, the government will be able to achieve the projected fiscal deficit of 3.4% of GDP in 2019.
Vulnerability in shifting dependence back to direct taxation
However, Tan highlighted the vulnerability that the country had to face by shifting its revenue dependence back to direct taxation — namely corporate income tax and personal income tax — from indirect taxation. Direct taxation fluctuates with economic performance and should oil prices fall below the government’s expectation of US$70 (RM292.60) per barrel, he said.
Notably, sovereign rating agencies have highlighted their concerns about Malaysia being overly dependent on its oil revenue.
As such, Socio-Economic Research Centre executive director Lee Heng Guie said it is imperative that the government comes up with more sustainable sources of revenue.
It is the responsibility of the newly formed Tax Reform Committee to identify these more sustainable revenue sources that will not significantly dampen the investment climate or overly burden the business sector and households, and to also create a broader tax base, Lee added.
And asking Petronas for the special dividend to pay its GST refund obligations is not something the government will continue to do, unlike what Moody’s was concerned could happen when it changed its outlook for Petronas’ credit rating to negative from stable, Lee said.
Moody’s said last week the change in the outlook was to reflect its view that Petronas’ financial profile may deteriorate if the government continues to ask it to keep dividend payments high, especially if oil prices decline.
Period of adjustment ‘inevitable’
Ultimately, if the government can uphold its fiscal responsibilities, it will lead to more cost savings, said Lee, citing savings Putrajaya had already secured in the renegotiations of two mega infrastructure projects — the light rail transit 3 and the mass rapid transit 2.
There are still RM19 billion worth of projects that are being renegotiated, as mentioned under Budget 2019, he added. “These one or two years of adjustment are inevitable as the government has to reconstruct the budget to put it in a better shape to achieve a healthier balance sheet to then support the economy,” Lee added.