ECON-templation: Generous subsidies patch one vulnerability but could create another

This article first appeared in Forum, The Edge Malaysia Weekly, on July 18, 2022 - July 24, 2022.
ECON-templation: Generous subsidies patch one vulnerability but could create another
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Many Malaysian consumers and businesses rely on government subsidies to alleviate cost pressures faced in their daily undertakings. However, the use of subsidies as a market intervention mechanism has long been a subject of intense debate. This comes amid concerns about the long-term fiscal burden, productivity of spending and economic implications from the reprioritisation of resources.

The unusually high global commodity and food prices this year have once again cast a spotlight on this issue, at a time when the Malaysian government announced it was projecting total subsidies and related social assistance to hit a record high of nearly RM80 billion this year (see Chart 1). Having been under severe pressure due to the Covid-19 pandemic over the last two years, the implications of these additional costs borne by the government — both direct and indirect — should not be ignored.

First, let’s take a look at the direct cost. The enlarged subsidy bill will add more pressure to the government’s stretched fiscal position, which has taken a heavy beating over the last two years (see Chart 2). The massive stimulus spending during the pandemic had seen the overall deficit almost double to RM98.8 billion in 2021 from RM51.5 billion in 2019. The fiscal deficit-to-GDP ratio jumped to 6.4% last year — the widest gap since 2009. Given the massive subsidy spending this year, it has become more challenging to achieve Budget 2022’s narrower deficit ratio target of 6%.

Another implication of the high subsidy bill is the indirect opportunity cost incurred. Given the limited fiscal space this year, non-critical spending that does not provide immediate results would inevitably have to be realigned or repurposed. This could possibly mean money initially earmarked for more productive developmental spending would have to be redirected to fund the subsidy bill. Some examples of expenditures that could end up on the chopping board are education, healthcare or infrastructure development, all of which have typically long gestation periods, with benefits only seen across a multiyear horizon.

One may wonder whether these realignments on expenditure really matter. Wouldn’t the delay be acceptable so long as it is eventually carried out down the line? Not necessarily.

Like the concept of the time value of money, we are missing out on the opportunity to “grow the cake” with every delay, to use a colloquial term. In the absence of any intervention policies, the longer the delay, the smaller the slice of “cake” that can be shared across a growing population will become over time. This indirectly means permanent lower economic development and income levels across households, relative to our initial true potential.

Malaysia’s long-term economic potential has already been challenged over the last two years due to the pandemic. Overall economic output has yet to catch up to our pre-pandemic path due to the recurring lockdowns over the last two years (see Chart 3). This continued underfunding of capital investments (see Chart 4) and prolonged delay of development projects do not bode well for long-term economic growth and could further postpone our recovery timeline.

Given the intention to resume our medium-term fiscal consolidation path, this also begs the question — will there be enough resources to recover the ground lost during the pandemic years?

Admittedly, policymakers are not in an enviable position as they are caught between a rock and a hard place. Based on a recent survey by the International Monetary Fund, more than half of the 134 countries surveyed had announced at least one measure in response to higher energy and food prices. Removing subsidies is perhaps not an option at this point, given that the risk of inflation shocks could potentially derail Malaysia’s recovery momentum.

Regardless of what has been done, the more important focus now is to reinforce reforms to minimise the “side effects” as a result of this diversion of resources. This includes growing the revenue base and reducing the fiscal burden by implementing a phased transition to targeted subsidies. This will bolster Malaysia’s ability to spend more on economic development and recover the potential growth that was lost. In addition, promoting income-boosting policies — especially among households at the lower end of the income spectrum — would provide a more sustainable solution over the longer term. The hope is that as a larger share of society “graduates” from its dependence on government aid, the smaller the burden the government will need to bear.

Woon Khai Jhek is a senior economist and co-head of economic research at RAM Rating Services Bhd

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