This article first appeared in The Edge Financial Daily on November 1, 2018

KUALA LUMPUR: The government may raise the fiscal deficit target to between 3.5% and 3.7% of gross domestic product (GDP) this year in the upcoming Budget 2019 — as opposed to the existing target of 2.8% set by the previous government — according to Affin Hwang Capital Research.

However, this higher deficit is likely to be temporary given that the government has indicated it is still committed to fiscal consolidation in the long term, said chief economist of Affin Hwang Capital Research Alan Tan.

Then in 2019, the government may lower the deficit target to 3.3% to 3.5%, he said. As such, Malaysia’s sovereign rating should remain stable, preventing any significant increase in capital outflows, he added.

“Strong economic fundamentals supported by a current account surplus will support ratings,” Tan said, while pointing out that major global rating agencies currently have a triple A or A- stable outlook on Malaysia.

He added that the upcoming budget should provide more clarity for investors and is likely to be “mildly expansionary”, despite the need for more austerity and hints at new taxes to be introduced.

This is because a balance will have to be struck between prioritising economic growth, which is necessary to grow revenue via direct taxes, and maintaining fiscal prudence, he said.

Tan also said reducing operating expenditure (opex) may be unlikely, as some 90% of opex is sticky and difficult for the government to lower, as it covers social security areas such as healthcare and education, based on Affin Hwang’s calculations.

Although development expenditure has been slashed some 15% under the 11th Malaysia Plan to RM220 billion or RM44 billion a year from RM260 billion or RM52 billion a year, Tan said the investment figure will still be sufficient to support economic growth.

Meanwhile, the ringgit could strengthen to between 4.00 and 4.10 against the US dollar by the end of this year, on clearer policies from the new budget.

“Our base case is that the dollar will stablise against most major currencies this year if there is a rate hike in December, which would be in line with market expectations,” Tan said in a media briefing yesterday.

Domestic demand is expected to continue supporting Malaysia’s economic growth at the higher end of the 4.5% to 5% range next year, said Affin Hwang, which is maintaining a 5% growth target for this year’s GDP.

Even though the cancellation of several major infrastructure projects has dampened growth for the construction industry in particular, it only accounts for some 0.3 percentage point of GDP growth, the resesarch house said.

“There are still a lot of projects to bid for although they may be delayed, with the impact only being seen in the second half of 2019,” said Affin Hwang Capital Research senior associate director Loong Chee Wei.

Loong maintains a year-end forecast of 1,845 points for the FBM KLCI, citing continued strength in private consumption and a domestically-orientated economy.