BNP Paribas: Concern over Malaysia’s fiscal position warranted

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AGAINST the backdrop of flailing crude oil prices and a gloomy economic outlook, the Malaysian government is going to have to take tough decisions if it wants to meet its fiscal objectives, according to BNP Paribas SA.

With oil contributing a third to the nation’s coffers, the drop in oil prices has raised concern over Malaysia’s fiscal position. In 2013, the government derived 31% of its revenue of RM220.4 billion from the commodity.

The price of Brent crude has fallen more than 50% from US$115 per barrel on June 19 to close at US$57.33 per barrel on Dec 31.
 
BNP Paribas SA’s Asian economist Philip McNicholas concurs that much of the concern is warranted.

“By my estimates, if Brent crude averages below US$60 per barrel, we will see Malaysia breach its 3% deficit target [for 2015],” he says.

The government has targeted to bring down the fiscal deficit to 3.5% of gross domestic product (GDP) in 2014 and 3% in 2015. In 2013, the country’s fiscal deficit was 3.9%.

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But the effects, McNicholas says, are only a concern beyond 2015. “The drop in fuel prices will cause concern for any deficit target in 2016, that is when you will see the potential changes in Petroliam Nasional Bhd’s (Petronas) dividends emerge.”

According to him, if the present weak oil prices persist, it will mean a halving of the country’s net energy trade surplus to 3% of GDP.

“We have forecast a base case average for crude oil prices at US$77 per barrel for 2015, and this means that we are expecting Malaysia’s current account surplus to come in at 2% of GDP, compared with our 2014 forecast of 4%. In short, the current account is going to be under pressure,” he says.

“The Najib administration has been cutting development expenditure to meet budget goals, and reducing Malaysia’s fiscal sensitivities around oil prices has been quite challenging. Now that fuel subsidies are removed, a lot tougher decisions will need to be made to ensure fiscal stability.”

McNicholas thinks Malaysia could see more cuts in development expenditure in the face of fiscal challenges. “We’ve seen cuts of two to three percentage points of GDP since Najib took over.”

For 2015, the government has set aside RM46.76 billion or 17.2% of the budget as development expenditure. The balance RM225.18 billion or 82.8% is for operating expenditure.

This compares with 16% and 84% for development expenditure and operating expenditure respectively in 2014, 17.3% and 82.7% in 2013 and 18.6% and 81.4% in 2012.
 
McNicholas points out that personnel expenditure is now at 6% of GDP, the highest since the early 1990s. In 2007/08, personnel expenditure was at 5% of GDP, excluding pensions.

“It has been rising consistently, reducing fiscal flexibility. Ideally, you want to cut fat rather than muscle. It is a case of whether the government is going to cut back on civil servants’ bonuses or cut personnel spending on an aggregate level,” he says.

“The government has so far been able to take the relatively easier route, but now, it is going to have to take a tougher stance.”

BNP Paribas expects Malaysia’s fiscal deficit to come in at 2.7% to 2.8% in 2015, if there is a reallocation of government spending. Without any reallocation, the deficit forecast is 2.5%.

Where fiscal stability is concerned, the implementation of the Goods and Services Tax (GST) in April is a clear positive, although its effectiveness will be somewhat diminished due to the large number of exemptions provided, says McNicholas.

“It has set a firm [fiscal deficit] target, and the hope is, with the shift towards floating fuel prices and GST, Malaysia will have more reliable revenue sources rather than just rely on further expenditure-led consolidation,” he says.

Asean economic outlook

This year, Asean economies are expected to be affected by the decelerating growth prospects of the world’s second largest economy, China.

“While there should be a tailwind from lower crude oil prices, it will likely be offset by China’s economic slowdown and further weakness in Japan and Europe. These are key export markets and are going to weigh on the export sector,” says McNicholas.

He forecasts growth for developing Asia at 6.5% in 2015, while China will likely decelerate to 6.8%. “China’s main source of growth in recent years has been investment, but the effectiveness of this stimulus is a lot less than it was three to four years ago. As such, we expect the structural slowdown to continue.”

As it stands, the People’s Bank of China has already cut its GDP forecast for 2015 to 7.1%, compared with 7.4% for 2014. For the third quarter of 2014, China grew only 7.3% from a year ago — the slowest since 2009.

“China’s situation is going to reverberate, and we will see it manifesting in slower GDP growth for the rest of the region. Malaysia will be one of the most exposed to this,” McNicholas says, adding that his 2015 forecast for Malaysia’s GDP is 4.5%.

But the issue lies with Malaysia’s engine of growth. “The way the Najib administration has supported growth in the last few years was with off-budget investments where the government does not need to do the heavy lifting. A lot of the capital expenditure (capex) was by the non-financial community like Petronas and mass rapid transit, and that does not require budgeted funds,” says McNicholas.

“The issue now is that Petronas, one of the largest non-financial public enterprises in Malaysia, is likely to face cash flow pressures, prompting it to cut back on capex.”

Petronas has already announced that it will cut capex by 15% to 20% this year. It had originally planned to spend RM300 billion between 2011 and 2015, but this was based on oil prices of US$80 per barrel.

“So, we expect to see a deceleration from one of the drivers of private investment,” says McNicholas.

He adds that Malaysia will likely see new projects delayed as it faces a financial down-cycle, and banks will become less capable of extending credit for growth.
If oil and commodity prices remain sluggish, he warns that Malaysia could experience a much greater downside in investments.
 

This article first appeared in The Edge Malaysia Weekly, on January 5-11, 2015.