My Say: Putting the brakes on fuel subsidies

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AS recently announced, the Malaysian government has commenced the determination of RON95 and diesel prices based on market prices effective Dec 1.

Initially, the announcement came as a surprise as recent news flow had been pointing towards a possible implementation of a multi-tier subsidy system to replace the current blanket fuel subsidy. However, considering the complications of implementing such a multi-tier system, the total removal of fuel subsidies looks more practical.

The big break this time does not come from the significant drop in global oil prices alone. It is also supported by other regional developments — the recent 30% increase in fuel prices in Indonesia, it can be argued, is far more serious than what the Malaysian government intends to implement. More importantly, at this level of crude oil prices, the prices of RON95 and diesel in the next few months may either be the same or be close to prevailing prices.

That’s a relief for both the government and consumers. While consumers do not wish to see new pump prices bore holes in their pockets to maintain their spending patterns, the government also wishes to avoid seeing overall consumer spending dropping significantly in order to sustain its targeted headline GDP growth and avoid any social distress.

Indeed, private consumption, which accounts for roughly 52% of GDP, is a critical pillar of the economy. Therefore, managing economic shocks is particularly critical at a time when the domestic economy is already decelerating, as evidenced by domestic demand statistics in the past few quarters.

From the government’s perspective, the move will finally solve one of its major headaches in managing operating expenditure. And this will be extremely positive from the perspective of Malaysia’s sovereign rating, which in July 2013 was tainted by the negative outlook assigned by one of the international rating agencies.

The government can now show the world that it walks the talk when it comes to rationalising subsidies. It sends an important message on its efforts to do away with blanket subsidies, which have proved to benefit mostly the rich, and redistribute this aid to those who deserve them most. This implies greater efficiency in managing operating expenditure. As such, the budget deficit target of 3% of GDP by 2015 looks achievable.

Managing Malaysia’s operating expenditure deserves special attention. Its rate of increase has accelerated to 10.9% in the 10 years to 2013 on a compound annual growth rate basis, surpassing the pace of revenue growth of 8.7% during the period. Subsidies were the main culprit, growing from merely RM2.7 billion in 2003 to RM43.3 billion in 2013. Out of the total, fuel subsidies accounted for 54% in 2013, providing benefits mostly to the high-income group.

Another positive point for the government is that savings from fuel subsidies can be used to buffer against the possible drop in its total revenue as a result of lower oil prices. Our crude estimates suggest that every US$1 drop in crude oil price, if sustained for over a year, will trim oil revenue by RM450 million to RM500 million, assuming Petronas keeps handing over  roughly the same amount of dividends to the government as it has done in the past few years.

Oil revenue accounted for roughly 29% of total government revenue in 2013, thus the overall impact on government revenue cannot be underestimated, especially as economic growth is likely continue to moderate, and in the process, reduce the contribution of other components of government revenue (for example corporate and individual taxes).

Notwithstanding these, some developments may need to be closely monitored. For one thing, the impact on inflation, while theoretically positive at this juncture, cannot be underestimated. With pump prices beginning to move in tandem with global crude oil prices, any hint of a sustained upward pressure in prices will likely induce businesses to start pricing in its impact, and they will ultimately pass them on to consumers.

While theoretically this should not happen, anything is possible when it comes to passing the cost burden to consumers, especially if the Price Control and Anti-Profiteering Act 2011 is not strictly enforced. This is one of the greatest challenges to the authorities.

Secondly, the process of ensuring that the savings from the subsidy reform are channelled to assist the needy will require constant monitoring and improvement. A comprehensive and proper database on the target groups will be key to ensuring the benefits are channelled to those who need it most.

As a whole, the government’s move to finally do away with fuel subsidies is positive in the long term. It addresses the fiscal aspect, which has constantly been under scrutiny, while providing a good opportunity to give better support to the needy. It also takes away consumers’ addiction to blanket aid given by the government all these years.

Notwithstanding this, short-term repercussions should not be underestimated as a big chunk of households are earning less than RM5,000 per month, a level which leaves one struggling to live in big cities. As such, the authorities should prepare themselves to face such challenges.

Nor Zahidi Alias is chief economist at Malaysian Rating Corp Bhd. Views expressed here are his own.

This article first appeared in The Edge Malaysia Weekly, on December 8 - 14, 2014.