This article first appeared in The Edge Malaysia Weekly on November 27, 2017 - December 3, 2017

MOTORISTS generally welcome the government’s statement last week that should the retail prices of RON95 petrol and diesel exceed RM2.50 per litre continuously for three months, it will implement “appropriate measures” to reduce the adverse effect on the people.

Economists, however, are less sanguine, given that Malaysia had removed the blanket subsidy for fuel in December 2014 in favour of more targeted aid to rein in expenses and demonstrate better fiscal discipline. The country was supposed to save RM1.2 billion this year from switching from a monthly float system for fuel prices to a weekly managed float, and from the rationalisation of the cooking oil subsidy, according to the 2017/18 Economic Report.

Moody’s Investor Service analyst Anushka Shah, for one, reckons that an increase in subsidy, which affects the pace and degree of the projected fiscal consolidation measures, would render it as a “credit negative” for the country.

“We do not have clarity yet on what measures may be undertaken. However, to the extent that an increase in the subsidy reverses the degree and pace of fiscal consolidation that has been projected for 2018, and without offsetting measures, we would view their imposition as credit negative.

“Although a relatively high debt burden acts as a key credit constraint for Malaysia, the reduction of deficits each year since 2010 indicates that fiscal discipline has remained intact, even through oil price declines and a political cycle. A backtracking or reversal of past measures to remove the fuel subsidy — in place since 2014 — would add to strain on public finances,” she explains in an email reply to The Edge.

Moody’s credit rating for Malaysia was last set at A3 with stable outlook.

Anushka does note though that there may be an upside risk to revenue estimates through higher oil-related revenue collection if the price of crude oil increases. This is consistent with Second Finance Minister Datuk Seri Johari Abdul Ghani’s statement that measures to reduce the burden of higher fuel prices can be funded by the increase in revenue stemming from the rise in crude oil prices.

Maybank Investment Bank Research group chief economist Suhaimi Ilias estimates that every US$10 per barrel increase in annual average crude oil price will boost government oil and gas-related revenue by RM4 billion, excluding Petronas dividends. However, he opines that there are better options available than to reintroduce the fuel subsidy, even if there is extra revenue from crude oil prices.

“We should just make use of existing targeted financial assistance, namely BR1M, which can be raised to accommodate the impact (of higher fuel prices) on the low-income group, plus additional fuel subsidy for existing allocations provided for public and rural transport, rural air transport in Sabah and Sarawak, and maybe even special fares for LRT/MRT during periods of high retail prices to further encourage usage of public transport.

“The risk of the fuel subsidy is the perception of backtracking on fiscal reforms. Additionally, price subsidies by nature distort inflation numbers,” he says.

In Budget 2018, subsidies and social assistance amount to RM26.54 billion or 11.3% of operating expenditure. At RM6.8 billion, BR1M is the largest component of this category of expenses. Others include educational and scholarship assistance, subsidies for interest rates, electricity, rice planting, flour and liquefied petroleum gas, and the cooking oil stabilisation scheme.

Socio-Economic Research Centre executive director Lee Heng Guie, however, believes there is a case for reinstating the fuel subsidy if there is a sustained rise in retail prices as that would burden the low and middle-income households, and lead to expectation of higher inflation.

“I believe the government will not compromise on maintaining fiscal sustainability and stability.  The conditionality attached to the reinstatement — if petrol prices stay above RM2.50 per litre for three successive months — clearly underscores the fact that the government is managing the fuel subsidy judiciously without undermining the path of fiscal consolidation.

“Perhaps, a middle path can be achieved by capping the fuel subsidy at, say, 10 sen to 20 sen per litre if prices rise above a certain level. It should be cut by the same amount if prices fall outside the range,” he suggests.

Lee notes a tough balancing act between economic and political considerations when it comes to whether the extra revenue from higher oil prices should go towards a petrol subsidy or lowering the country’s fiscal deficit.

To him, any subsidised fuel programme should take into consideration income eligibility and engine capacity. After all, one of the arguments against the fuel subsidy is that it benefits the rich more. The practicability of implementing and administering such a system would also have to be considered, should such measures be undertaken.

Economists also want clarity on the exact mechanism that is being considered and whether the measures the government is looking at are temporary or a reversal of its previous stance of eliminating blanket subsidies.

“Will it be higher BR1M or will it be a targeted oil subsidy? And will these measures come at the expense of efforts to consolidate the fiscal deficit?” asks an economist.

United Overseas Bank (M) Bhd economist Julia Goh believes the government would have taken into account the anticipated higher revenue collection from crude oil prices staying above US$60 per barrel on the back of a robust GDP growth projection of between 5% and 5.5% next year.

“This implies room to allocate some extra funds to manage the rising cost of living while staying aligned with the 2.8% of GDP fiscal deficit target,” she says.

It is also worth noting that while the 2018 budget assumes crude oil price at an average of US$52 per barrel, global oil prices are now hovering above US$60.

Since hitting a year-low of US$44.82 per barrel last June, crude oil has been on an upward trend. It had already risen 41.8% from US$44.82 per barrel on June 21 to US$63.55 per barrel last Thursday.

Unsurprisingly, RON95 petrol has stayed above RM2 per litre since the last week of July while diesel breached RM2 per litre in the first week of August. More painfully for consumers, RON95 and diesel have climbed to RM2.38 per litre and RM2.25 per litre respectively in the last five consecutive weeks. In the last revision of the weekly managed float system for Nov 23 to 29, pump prices decreased slightly to RM2.30 per litre for RON95 and RM2.23 per litre for diesel.

Moving forward, the outcome of the Organization of the Petroleum Exporting Countries meeting on Nov 30 could determine the future direction of crude oil prices. “The foregone conclusion is to extend the production cut to 2018. Anything less will be negatively construed,” says Maybank IB Research in a report.

The research house has revised its expectation of crude oil price for next year to US$60 per barrel from US$55 per barrel previously while AmInvestment Bank Research has maintained its 2017/18 projection at US$50 to US$55 per barrel.

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