The State of the Nation: Limit the uncertainty over oil price assumption

This article first appeared in The Edge Malaysia Weekly, on December 3, 2018 - December 09, 2018.
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IT was barely two months ago (in late September 2018) that some pundits were talking about oil seeing US$100 again. At the time of writing, the talk is of oil at US$50, and Brent crude oil had skidded below US$60 — down over 30% from as much as US$86.29 a barrel on Oct 3. And who’s to say for certain where prices will be after production cut talks at the Organization of the Petroleum Exporting Countries (Opec) meeting in Vienna on Dec 6 as there are other global factors at play.

With hindsight, it is easy to say Budget 2019 should have had an assumption of Brent nearer to US$60 instead of US$72. What we now see as a more conservative figure would have made it easier to address questions on whether Budget 2019 would need to be recalibrated should oil really skid to US$50 a barrel.

Having a stabilisation fund of sorts would have made it easier for policymakers too, but more on this later.

“At the moment, there will be no [Budget 2019 recalibration] even if crude oil prices drop to US$52 per barrel or [rise above] US$72,” Finance Minister Lim Guan Eng told reporters on Nov 15, citing price volatility on the back of geo­political factors.

Yet, the oil price question is valid, with oil-related revenue making up 30.9% of federal government revenue and 17.1% of gross domestic product in 2019. The 30.9% includes a RM30 billion special dividend from Petronas, which is also paying a RM24 billion dividend for 2019 from its net cash pile of over RM110 billion.

Petroleum-related revenue would have made up 19.5% of federal government revenue in 2019 — if the RM30 billion Petronas special dividend used to repay RM37 billion in excess tax owed by the previous administration were excluded. That is below 21.7% in 2018 and the average of 34.6% between 2009 and 2014.

To be sure, it does not help that two national budgets were revised in the past five years and let’s not even talk about those supplementary budgets.

Still, as Budget 2019 was tabled a month ago on Nov 2, there are those who reckon that the market should have at least given it three months until January — incidentally when Budget 2015 and Budget 2016 were revised.

Recall that the situation post-Budget 2015 was even worse as the fall was not just in oil price but also the ringgit, which weakened against the greenback from 3.20-levels in October 2014 to 3.60-levels in January 2015 and 4.20-levels in October 2015. Not only was the oil price assumption for Budget 2015 (tabled in October 2014) revised from US$100 a barrel to US$55 a barrel in January 2015, the late 2014-early 2015 floods also required more public expense.

Budget 2016 also saw the oil price assumption changed to US$30 to US$35 a barrel from US$48 a barrel and, at the time, the guidance was that for every US$1 change, there would be a RM300 million difference to the government’s coffers.


Oil price threshold for budget formulation

We know that the government, in September, set up a Public Finance Committee and Tax Reform Committee to step up fiscal reforms — not just in revenue generation and increasing efficiency and productivity of public sector spending but also in terms of governance to prevent leakages.

While details from the committee workings have yet to be disclosed, the 2019 Fiscal Outlook report mentions the possibility of setting an oil price threshold for budget formulation to help the government be more prudent in determining the right level of spending while balancing the need to sustain economic growth.

“If the oil price breaches the threshold, any additional revenue must be put into a stabiliser fund within the Consolidated Fund. The reserve will provide fiscal space for the government to mitigate adverse effects of economic crisis, including cushioning revenue loss,” reads the report.

It also mentions how legislation is more effective than administrative guidelines in ensuring compliance as well as the importance of having responsible fiscal principles, medium-term fiscal targets and high standards of fiscal reporting to give clarity to stakeholders on fiscal policy direction.

A good fiscal governance framework not only takes into account domestic and global economic performance and outlook but also the objectives of the nation.


Three-pronged approach to fiscal sustainability

Malaysia is already undertaking a comprehensive review of the tax system and collection, with the Tax Reform Committee also tasked with rationalizing the tax policy and streamlining numerous tax incentives to narrow the tax gap and improve efficiency while exploring new sources of sustainable revenue.

“Malaysia’s tax revenue as a share of GDP is about the same level as [those of other] Asean countries. However, less than 20% of the 14 million workforce and 1.1 million business establishments are paying income/corporate tax. In addition, there are more than 100 types of tax incentives mainly related to pioneer status, investment and reinvestment incentives, which limit tax revenue collection,” the report reads.

Corporate tax contributed 29.2% — while individual income tax contributed 13.1% — to the federal government revenue of RM220.4 billion last year. Both are collectively expected to contribute about 45% to federal government revenue next year, excluding the RM30 billion special Petronas dividend.

For sustainable fiscal reforms, governance and revenue-related measures need to come with expenditure reforms, including re-engineering the public delivery system to be more efficient. There also needs to be a more targeted subsidy and social assistance, needs-based development projects and improved cost structure.

There are early signs that government expenses are being reined in with zero-based budgeting, and the prioritising and scaling down of projects.

Excluding the RM37 billion in excess tax owed by the previous administration in 2019, operating expenditure would have decreased RM12.6 billion year on year to RM222.9 billion. The year-on-year decline in opex would still be RM8.8 billion if one were to exclude the RM3.9 billion excess tax refunds this year.

Total expenditure for 2019 is also estimated to fall RM9 billion year on year.

Revenues are also lower year on year as the government stopped the Goods and Services Tax (GST) from June 1 and replaced it with the Sales and Services Tax (SST) on Sept 1.

Excluding the RM30 billion special dividend from Petronas, total federal government revenue would have declined RM4.6 billion to RM231.8 billion, on lower interest and investment income, despite higher tax collection, according to federal government revenue estimates.

It is worth noting that the estimates, released with Budget 2019, had only assumed a RM1 billion dividend from Khazanah Nasional Bhd — this is half of what was paid in 2018 but more than the RM600 million paid in 2016. There could be room for upside following Khazanah’s decision to sell a 16% stake in IHH Healthcare Bhd to Japan’s Mitsui & Co Ltd for RM8.42 billion — a deal which still leaves Khazanah with a 26.1% stake while pushing up Mitsui’s stake to 32.9%. Khazanah may also see more value unlocked from other investments that have done well, including those across the Causeway under its subsidiary M+S Pte Ltd.

Federal government revenue may also see upside from other Budget 2019 measures, for which potential revenue had yet to be worked into budget estimates. The airport real estate investment trust, for instance, could raise RM4 billion.

The government has said that there will not be any fire sale of its assets to maximise value for the country. It has also said that whatever new tax measures it introduces will be weighed against its benefit to the economy, as the government’s coffers also benefit if the people and businesses make more money.

Measures that could provide more sustainable income flows are what investors and economists are really looking out for, although news of potential higher one-off incomes would help buy some patience. Confidence can also be built by showing sustainable cuts in spending without compromising growth and by a clearer game plan to pare down debt, observers say.

In the meantime, clear data-backed communication can go a long way during uncertain times.


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