East Coast floods weigh on public finances

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ALREADY facing pressure from plummeting crude oil prices, the government will have more outlays to absorb to rebuild flood-affected areas in the East Coast. However, government expenditure on rebuilding is less of a concern than falling crude oil prices.

Prime Minister Datuk Seri Najib Razak has already announced the allocation of

RM500 million to aid flood victims. Additionally, the government will allocate more funds on an ongoing basis to repair damages to educational institutions, government buildings, mosques and other infrastructure.

Another RM96 million has been set aside to repair 93 collapsed hillslopes along federal roads in Kelantan, Terengganu, Pahang and Perak.

According to Maybank Investment Bank Research (Maybank IB) chief economist Suhaimi Ilias, the necessary funds can be tapped from the RM2 billion contingency funds allocated under Budget 2015.

Malaysia’s estimated cost of floods is about RM1 billion to RM1.5 billion annually, according to studies by the Department of Irrigation and Drainage and Malaysian Meteorological Department. Recall that the floods in late 2006 cost the government RM1.5 billion.

A local Malay daily reported that the damages this time around are expected to be over RM1 billion. Kelantan’s Flood Disaster Operations Committee estimates the state’s damages at some RM200 million, while in Terengganu, a total of RM134 million has been estimated for road repairs.

“Nonetheless, against the whole Malaysian economy which is in excess of RM1 trillion, we think the headline impact is manageable, especially since the worst-affected states like Kelantan are not industrial states where the losses would have been bigger,” Suhaimi tells The Edge.

While the impending expenses and lower oil revenue will make it challenging for the government to hit its 3% budget deficit target for 2015, economists do not expect the floods to drastically derail public finances.

Maybank IB, for one, is maintaining its budget deficit forecast at 3% to 3.5% of gross domestic product (GDP) for this year. For 2014, Malaysia’s budget deficit is expected to come in at 3.5%.

“We think achieving the 3% budget deficit target for 2015 is challenging mainly due to the crude oil price situation,” Suhaimi says, adding that missing the 3% target will be understandable given the severity of the flood situation and the subsequent repair bills.

On the other hand, Brent crude oil prices have tumbled more than 50%, from last year’s high of US$115 per barrel on June 19, to close at a US$57.33 per barrel low last Wednesday.

Oil makes up some 31% of government revenue — RM220.4 billion in 2013 — and is budgeted at roughly US$100 per barrel. This means the value of estimated income from oil has been halved at present prices.

“Realistically, we think the government should aim to ensure that the budget deficit this year is not weaker than last year’s, which is expected to be around 3.5% of GDP,” Suhaimi says.

As long as the target is not missed by more than one percentage point, it should not trigger a ratings downgrade or negative impact on Malaysian financial markets, according to Dr Yeah Kim Leng, dean of Malaysia University of Science and Technology’s School of Business. Yeah was previously group chief economist of RAM Holdings Bhd.

“From an expenditure perspective, [the government’s spending on flood repairs] is positive for economic growth, but negative to the fiscal balance. On top of that, it is quite likely that if revenue does not increase sufficiently, the government will have to cut back on other development spending,” says Yeah.

As long as Malaysia can sustain GDP growth at 5%, he believes that the fiscal deficit will not attract much negative sentiment.

Maybank IB is also maintaining its GDP forecast for Malaysia at 5% and is expecting to see a surge in consumer spending in the first quarter of 2015 as victims replace damaged household items before the implementation of the Goods and Services Tax (GST) this April.

Yeah points out that for consumers, the fall in oil prices will likely offset the inflationary impact of GST. He expects consumption growth to be maintained at 2014’s level at some 6% to 6.5%.

Minimal impact on listed companies

For the business community, manufacturing and industrial production have been somewhat spared as most of the worst-hit areas are not industrial, but rather agricultural centres.

The impact on output will thus be relatively insignificant, says Yeah, although oil palm plantations there will see some damage.

Checks with the Palm Oil Refiners Association of Malaysia reveal that palm oil milling and refining machinery are not easily damaged by flooding (see story on Page 28). Also, the affected states are major rubber producers.

The Ministry of Plantation Industries and Commodities, at a briefing last Wednesday, estimated that rubber production will fall by 30% in Malaysia and Thailand due to the floods. About 69,000 of 140,000 rubber smallholders in Pahang, Kelantan, Terengganu, Kedah and Perak are affected, over a total area of about 133,000ha.

The plantation sector aside, Malaysia’s public-listed companies are not materially affected by the floods, Maybank IB says in a Dec 30 note.

While the research house did not change its call on any of the stocks under its coverage due to the floods, it highlighted Tenaga Nasional Bhd’s potential net profit drop. Nonetheless, Maybank IB says the combined electricity sales in Kelantan, Terengganu and Pahang make up less than 10% of the utility giant’s revenue.

“Every 10% impact on sales in these three states for a 10-day block will lower revenue by RM118 million, we estimate. This would impact our financial year ending August 2015’s (FY2015) net profit forecast by 1.1%. Elsewhere, its assets are mostly insured since floods are almost an annual recurrence,” says Maybank IB.

Banks, consumer and retail stocks also might see some economic loss, the research house adds. Financial institutions will also defer flood victims’ loan instalments.

Federation of Malaysian Manufacturers president Datuk Saw Choo Boon tells The Edge that the manufacturing industry has a small presence in the East Coast, and even the plants operating in that part of Peninsular Malaysia are located far from the affected areas.

“So far, there are no complaints from the manufacturers. They managed to continue their production, although there were small drops in attendance rates. However, given that the flood happened during the holiday period, some plants had already decided to reduce or close production anyway,” he says.

Latitude Tree Holdings Bhd’s financial controller, Fong Toh Wai, confirms that the furniture maker’s manufacturing plants in Kuala Berang, Terengganu, were not hit by the floods. While the attendance rate for the past couple of weeks was slightly below the average of 95%, Fong says it has been business as usual.

“However, looking at the situation now, we expect our attendance to revert to the average by this week,” he tells The Edge.

Latitude Tree has operations in Malaysia, Thailand and Vietnam. Malaysia contributed 17.85% to group revenue in 2014, while Thailand made up 3.45% and 78.7% came from Vietnam.

Bina Puri Holdings Bhd executive director Matthew Tee Kai Woon tells The Edge that its two projects in the East Coast are still in the early stages, and thus the floods do not have any material effect on the group. The projects are Sentosa Residence, which has a gross development value of RM190 million and is located in Kubang Kerian, Kelantan, and the Kuantan Waterfront Resort City, with a GDV of RM304 million.

 

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