This article first appeared in Forum, The Edge Malaysia Weekly on May 4, 2020 - May 10, 2020

The recent plunge in global crude oil prices has shaken the economies of oil-producing countries around the world.

Precipitated by a rapid drop in global demand in the wake of the Covid-19 pandemic and the price war between oil producers, the dramatic decline saw the price of Brent falling to less than half of its level in January. Indeed, prices slipped through the support level of US$30 per barrel in mid-March and fell below US$20 per barrel in the third week of April, a level that was in recent years simply unthinkable.

The impact on countries’ fiscal positions — should oil prices remain low for a considerable period — will be pronounced this year. Malaysia, for instance, is expecting its budget deficit to rise to around 4.7% of its gross domestic product this year due to falling revenue as well as rising expenditure to support the economy through various stimulus packages.

This is because its initial revenue projection assumed an average Brent crude price of US$62 per barrel for 2020. It is worth noting that Malaysia’s oil-related revenue contributed an average of roughly one-fifth to the government’s coffers in the past five years. Hence, a rapid and sustained decline in crude oil prices will naturally bring down oil-related revenue for the country. This, however, will be partly mitigated by the reprioritisation of some government expenditures.

Drilling down to the state level, we can also expect states that receive oil royalties to face challenges if crude oil prices remain low for an extended period. For example, Sarawak, Sabah and Terengganu will likely 

see their revenue come under pressure as crude oil prices fall by more than half their levels a few months ago.

History shows that the fiscal balances of states like Sarawak, Sabah and Terengganu moved in tandem with global crude oil prices. Such movements would also tend to affect annual state expenditures.

When global crude oil prices were strong, Malaysia’s oil-producing states were blessed with healthy revenues compared with other states. For example, revenue as a percentage of GDP in all three oil-producing states (Sarawak, Sabah and Terengganu) stood at 4% to 6% between 2014 and 2018. This is way above the median for other states, which stood at around 1.3% of GDP during the period.

Similarly, the fiscal balances of oil-producing states were generally stronger than that of other states. Sarawak and Sabah, for instance, registered average fiscal surpluses of 0.8% and 0.1% of GDP between 2014 and 2018 respectively, compared with an average deficit of 0.1% of GDP for other states.

However, with plunging oil prices, challenges are mounting. Experience between 2014 and 2016 showed that fiscal balances of oil-producing states were affected when crude oil prices halved within two years. For instance, Sarawak’s fiscal surplus fell two-thirds in 2015 to RM1 billion from RM3.1 billion in the earlier year. This was not surprising as its revenue fell 22% within the period.

Similarly, Sabah’s fiscal balance shrank to RM1.4 million in 2015 from almost RM38 million in the preceding year due to the collapse in crude oil prices. This decimation came on the back of a 23% decline in revenue within 

a year, again due mainly to weak crude oil prices. However, the price rebound of almost 50% in subsequent years managed to push back its fiscal surplus to over RM60 million in 2018.

Terengganu shared a similar fate in 2016. Its revenue shrank 28% within a year, doubling its fiscal deficit to around 0.8% of the state’s GDP from 0.4% in the prior year. However, the turnaround in crude oil prices in subsequent years raised the state’s non-revenue receipts (mainly comprising Bayaran Tunai Petroleum from the federal government) by 31% in 2017. That led to a positive turnaround in the state’s fiscal position that year.

Although blessed with rich oil and gas resources, Sarawak, Sabah and Terengganu remain prudent in their fiscal spending. A case in point: their annual expenditure generally reflects oil and gas price movements. As a result, even if their fiscal balance does turn into a deficit, it remains at an acceptable level. For example, Terengganu prioritised its expenditures and reduced them by 14% in 2015 and 21% in 2016. Sabah also trimmed its overall expenditures by 22% and 4% in 2015 and 2016 respectively. As for Sarawak, it reduced expenditures by 7% in 2016.

If history is any guide, oil-producing states would likely turn cautious in their expenditures if crude oil prices remain in the doldrums. This, however, does not mean that there will be massive cutbacks in crucial expenditures as the development agenda remains on top of the list in most states. Reprioritising expenditures would be their key strategy.

On the brighter side, all three oil-producing states can partly resort to past surpluses in their consolidated funds for their expenditures. Sarawak, for example, registered a consolidated surplus of around RM23 billion in 2018. Sabah has around RM4 billion while Terengganu has about RM155 million.

Each state also has other sources of revenue. For Sarawak, its annual dividends and investments in the financial market had contributed a commendable amount each year, averaging RM3 billion per annum between 2014 and 2018, according to reports by the National Audit Department. Sabah’s sales tax revenue from crude palm oil represents roughly 25% of the state’s revenue during that period. Terengganu has additional revenue of between RM300 million and RM450 million per annum, on top of the Bayaran Tunai Petroleum. It also has the advantage of low indebtedness vis-à-vis other states. Hence, there is not much pressure for it to use its revenue to service its debt.

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

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