This article first appeared in Forum, The Edge Malaysia Weekly on June 4, 2018 - June 10, 2018

The sudden change in policy with regards to the Goods and Services Tax after the 14th general election last month was met with mixed reactions. Although “GST abolition” was one of the new government’s election pledges, not many had expected it to move swiftly to zero-rate all products and services under GST by June. It is indeed a pleasant surprise for many of us.

As expected, Malaysian consumers cheered the move to abolish the GST, which was partly blamed for the higher prices of goods and services after its implementation in 2015. According to some consumers, prices had started rising even before the GST took effect as businesses took the opportunity to raise prices in anticipation of higher costs (although many can claim back their input costs).

Statistics seem to support this. For instance, as at end-2015, about eight months after the GST came into effect, some consumer prices rose at a double-digit pace (for example, 14% and 15% for fresh vegetables and preserved fruits respectively), based on data from the Department of Statistics. While general food items climbed by only 3.2% in that period, prices of basic food items such as fresh fish and seafood rose by 6% to 7%.

Such marked increases were masked by a benign overall Consumer Price Index, which grew by just 2.6% in the same period. And as consumers grumbled about having to pay higher prices, some businesses illegally offered two types of charges to consumers — “with or without GST”. Now, with the zero-rated GST, as announced by the government, consumers are hoping that prices will start to decline in the near term.

But from the government’s perspective, it will no longer be enjoying the GST revenue that had filled its coffers in the past two years. Based on official statistics, GST revenue averaged circa RM43 billion per annum in 2016 and 2017, far more than the amount collected under the Sales and Service Tax (SST) regime in the preceding years. In 2013 and 2014, for example, revenue from SST only averaged RM17 billion per annum. To some extent, the GST had enabled the government to continue its fiscal consolidation efforts in 2016 and 2017 despite seeing its oil-related revenue falling as a result of a steep decline in crude oil prices in 2015 and 2016. Thus, Malaysia managed to lower the budget deficit to 3% of gross domestic product (GDP) by 2017.

Strictly from a sovereign credit rating perspective, the absence of GST revenue this year will be a negative factor for Malaysia. But this is already expected, as the standard mathematical “template” used by credit rating agencies would show a shrinking amount in the government’s coffers without this form of revenue. But the government insists that the loss in GST revenue can be compensated in a few ways, which would include a combination of higher crude oil revenue this year (due to higher global crude oil prices), a reduction in operating expenditure (opex), as well as a reprioritisation of selected mega projects.

If one were to make a guesstimate, these offsetting measures could partly cushion the impact of the loss in GST revenue. For instance, assuming that: (i) the Malaysian economy grows at a nominal rate of 7% to 8% this year, namely its median growth rate post-global financial crisis; (ii) extra revenue of RM7 billion to RM8 billion comes from higher global crude oil prices this year (compared with the US$52 per barrel assumed in Budget 2018); and (iii) opex is reduced by, say, 3% to 4%, this year’s budget gap could end up being RM44 billion after taking into account oil and electricity subsidies. Hence, the budget deficit may end up being 3% of GDP again this year, the same level as last year. No problem here.

But there are “buts” here and there in this scenario. First and foremost, credit rating agencies look beyond a one or two-year horizon in assessing a country’s fiscal landscape. Thus, a critical question would be — how would the fiscal path look like without GST beyond 2018? Of course, the positive point here is that the amount to be collected under the impending SST would likely be higher than the amount collected under SST in the previous years as there are now more taxpayers than before. The GST, in some ways, had unearthed some of those who never paid taxes before, and these businesses will continue paying taxes under the SST regime.

However, economists are still wondering if the impending SST could at least bring in a decent portion of the amount generated by the GST in the past two years. There are also questions about other revenue-generating measures that the government may introduce in the near term. After all, Malaysia’s revenue as a percentage of GDP had declined from 23% in the 1990s to 21% in the 2000s, and to 19% between 2010 and 2017. This is below the median of A-rated countries, which stood at over 35% of GDP last year. The government will likely touch on these points with the rakyat in the coming days.

Notwithstanding this, the reduction in opex will, to some extent, help maintain the government’s fiscal health going forward. Although chunky items such as emoluments, debt service charges as well as pensions and gratuities are difficult to slash, allocations for “supplies and services” and “subsidies” can be tweaked in order to lower opex in the future. In the past, the government had fiddled with subsidies to mitigate the growth of opex. Going forward, with increased transparency, the present government is banking on greater efficiency to help reduce opex.

Beyond fiscal issues, economists will also be watching prices to see if they would actually decline under the zero-rated GST regime. After all, this is the main objective of abolishing GST in the first place. Several quarters argue that it would have a neutral impact on consumer spending as prices may not decline as much as expected.

“Price stickiness” could be a challenge to policymakers as businesses may, for example, be reluctant to reduce prices due to their profiteering motive. For example, a restaurant owner who already built in GST charges in his prices may not have the incentive to lower his prices as his customers would hardly remember the prices of the different dishes served. By not changing the prices in the menu, he could make extra profits effortlessly. To avoid this, alternative mechanisms may be needed.

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

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