The State of the Nation: Malaysia has room to pump-prime, revise 3% fiscal target for 2020

This article first appeared in The Edge Malaysia Weekly, on August 5, 2019 - August 11, 2019.
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FINANCE Minister Lim Guan Eng, who is slated to table Budget 2020 on Oct 11, has said that meeting the country’s fiscal consolidation targets will be “challenging” on the back of the US-China trade war but added that the government will do its best in balancing that with growth.

Experts, however, believe that Malaysia has leeway to revise the 3% fiscal deficit target pencilled in for next year, given the need to prop up economic growth, bolster confidence and stoke investments to future-proof the country’s economy.

Dr Yeah Kim Leng, Professor of Economics at Sunway University Business School, notes that the 3% deficit target for 2020 in the medium-term fiscal framework (MTFF) — mentioned when Budget 2019 was tabled last November — “is not cast in stone” and “can be varied within limits to respond to changes in economic conditions and expectations”.

“To counter the anticipated slowdown in global trade and output, it is pragmatic to revise the target, raise spending and implement other counter-cyclical policies within prudent limits that assure investors while maintaining the country’s creditworthiness. It’s a fine balancing act. Given the country’s track record in macroeconomic management and the current administration’s commitment to fiscal discipline and financial integrity, there is greater confidence that the right appropriate balance can be struck in Budget 2020,” says Yeah, formerly chief economist and managing director of RAM Ratings.

Julia Goh, senior economist of UOB Malaysia, shares this view. “We think there should be some fiscal flexibility to manoeuvre, especially when growth risks intensify. This shows the country’s commitment to ensuring stable growth prospects, which is necessary to anchor investor confidence and domestic business sentiment, without which businesses may be even less willing to spend and [which would] exacerbate the slowdown. Equally important is that the government remains transparent and responsible in its fiscal plan,” she says.

To be sure, growth will only be strong if businesses are confident about investing more money in the economy and consumers have the capacity to spend. While Malaysia’s household debt ratio of 82.1% of gross domestic product last year remains above that in several developed countries, the ratio is down from as high as 89.1% of GDP in 2015, thanks to a growing economy.

Private expenditure — basically consumption spending and investments by households and businesses — contributed 72.8% to GDP growth in 2018 and remains a key driver of the economy, though growth rates are projected to slow from last year.

Public expenditure (consumption and investment), which was projected to decline by 1.8% this year, contributed about one-fifth to GDP last year. The overall decline between 2015 and 2018 stems from a slide in public investment exceeding the increase in public consumption, official data shows.

 

Room for tax cuts, pump-priming?

Since 2012, Malaysia has had barely 1% of government revenue left after paying salaries, pension, debt service charges, subsidies and other operating expenses — leaving little choice but to borrow for development spending.

The right public expenditure mix should see greater priority given to infrastructure and social spending rather than recurrent expenditure and poorly targeted subsidies, says Lee Heng Guie, executive director of Socio-Economic Research Centre, an independent non-profit think tank of the Associated Chinese Chambers of Commerce and Industry of Malaysia.

“Fiscal consolidation and deficit correction policies based on unproductive spending cuts and rationalisation to save cost will help to reduce the debt-to-GDP ratio without hurting growth,” says Lee, who is of the view that the government “will work to meet a 3% fiscal deficit target for 2020 without hurting the economy”.

“The fiscal stance is expected to be somewhat expansionary in terms of development expenditure, focusing on spending on priority sectors such as education, utilities, airport upgrades, healthcare, housing, industrial development, tourism and SMEs (small and medium enterprises),” adds Lee, who believes that some targeted tax measures and incentives will be given to support capital investment in technology-related sectors.

The government, he notes, will have additional capacity to do so as it does not need to pay this year’s one-off RM37 billion Goods and Services Tax (GST) and income tax refunds next year.

“Budget 2020 policies must also prioritise revitalising private investment, especially domestic direct investment in new and existing economic clusters, leveraging the application of smart technology. These include E&E (electrical and electronics) in the manufacturing sector, agro-food, aerospace, digitalisation, seamless transport and logistics, tourism, and selected services sub-sectors,” says Lee.

He adds that Malaysia needs “a new economic and growth narrative to convince Malaysians, domestic and foreign investors that Malaysia has what it takes to become a competitive and high economic dividend investment destination”.

“Creating expectations of future economic growth and investment prospects is a crucial role for the government. Fiscal policy alone is insufficient to empower economic growth and investment. It must be coordinated with other equally important elements — the easing of the cost of doing business, a competitive tax regime, an investment-friendly business environment (3Cs: Clarity, Consistency and Continuity) and a supportive regulatory landscape as well as an efficient public delivery service,” says Lee.

It is worth noting that Malaysia last cut its corporate tax rates by 1% to 24% starting assessment year 2016 — lower than the 25% in South Korea, Japan, Indonesia and Myanmar but above the 20% in Taiwan, Thailand, Vietnam and Cambodia. The corporate tax rate in Singapore is 17% and its top individual income tax bracket is 22% compared with 28% here. Malaysia accords a 17% concession rate to SMEs or resident companies with a paid-up capital of RM2.5 million and below on the first RM500,000 chargeable income.

Corporate tax accounted for 30% of federal government revenue last year while personal income tax made up 15%.

Apart from tax cuts and targeted tax incentives to get the desired investments to future-proof Malaysia’s economy, some economists have called for a higher minimum wage and an increase in income transfers to the lower-income group, where the propensity to spend is higher.

One way of doing this without hurting business confidence is for the government to provide, say, a matching increase of RM50 to the minimum wage — perhaps extending it to all salaried workers earning near or below the prevailing median monthly individual salary, which stood at RM2,160 in 2017 (RM2,260 median for 7.3 million urban dwellers and RM1,400 median for 1.4 million individuals in rural areas). Giving RM50 a month to these 8.7 million people would cost the government about RM5.2 billion a year — a consumption boost for the economy, potentially doubling the impact of the RM5 billion reportedly allocated for Bantuan Sara Hidup cash transfers this year.

While opinions on the absolute numbers that should be spent on pump-priming may differ, the ability to maximise the desired multiplier effect on the economy depends on the efficiency of government spending — which increases when there is no leakage from corrupt practices.

Goh opines that the government should consider establishing guidelines on expenditure that are consistent with projected revenues and anchored to the debt thresholds. “This will help enhance fiscal transparency and strengthen the credibility of debt thresholds.”

Yeah says the government “needs to articulate a clear economic vision and direction supported by well-defined strategies and priorities, so that investors do not have to grapple with policy uncertainties”.

“Administratively, it should continue to focus on removing red tape, regulatory barriers and restrictive business practices while reducing the cost of doing business and incentivising industries to upgrade, innovate and invest in new areas identified in the economic plan and strategies,” he adds.

Yeah is confident policymakers have enough flexibility to bolster growth.

“There is increasing recognition worldwide that there has been excessive reliance on monetary policy, especially the use of negative or near-zero interest rates and massive liquidity injection by central banks in advanced economies to support economic growth and financial markets. In this new landscape, countries that resort to fiscal measures despite some slippages in deficit and debt levels are not likely to be overly penalised by adverse reactions from investors and financial markets. It is therefore reassuring to investors that the Malaysian government will not be blindsided by the deficit target. Rather, it will step in to support growth should it falter,” says Yeah, who is an external member of Bank Negara Malaysia’s monetary policy committee.

Based on the MTFF, Malaysia’s fiscal or budget deficit — basically the amount of debt-funded spending needed, on top of spending everything the government earns every year — was projected to fall from 3.7% of GDP last year to 3.4% this year before reaching 3% next year. In absolute terms, the 3.4% deficit for 2019 was estimated at RM52.08 billion.

Only six of 14 economists expect Malaysia’s fiscal deficit to be 3% next year, according to Bloomberg data at the time of writing. The rest are forecasting 3.2% to 3.5%, with the median at 3.2% next year, down from 3.4% for 2019.

If Malaysia keeps the absolute deficit amount at about RM52 billion next year, the country’s fiscal deficit would still be about 3.3%, assuming GDP grows between 4% and 5%, back-of-the-envelope calculations show. That theoretical 3.3% may not be the 3% indicated last November but would still be below the 3.4% fiscal deficit figure that Malaysia aims for this year.

Incidentally, UOB’s Goh expects the fiscal deficit to be 3.3% next year, premised on GDP growth of 4.5%.

“We expect the government to remain on a fiscal consolidation path, albeit at a gradual pace that still offers support for the economy,” she says, describing the 3% fiscal deficit target for 2020 as “a tall order” amid a challenging external landscape and headwinds to growth.

“Despite the relatively sanguine outlook based on high-level macro data, channel checks suggest that there are weak spots in certain segments, particularly the SMEs and informal sectors,” adds Goh, who expects a mild uptick in second quarter GDP growth of 4.7% — above the 4.5% in 1Q2019 — on the back of higher crude palm oil and gas production, stable manufacturing output and retail spending in April-May. A lower base effect from 2Q2018 also offers some support.

Malaysia is slated to release its 2Q2019 GDP data on Aug 16. Bloomberg consensus shows that the forecasts from 11 economists range from 4% to 5%, with the median at 4.5%.

Even rating agencies seem willing to cut the country some slack. S&P Global, for instance, is forecasting a fiscal deficit of 3.2% next year.

“We expect the government to remain on a gradual consolidation path over the medium term, though progress may be somewhat slower than what is programmed. We’re forecasting the deficit at 3.2% of GDP next year to account for some of the uncertainties in the global macroeconomic backdrop, as well as constraints on the revenue side,” Andrew Wood, director of sovereign ratings at S&P Global in Singapore, tells The Edge.

“A significantly higher than programmed deficit would likely be credit negative, insofar as it may jeopardise the government’s progress in reducing its indebtedness,” he says.

Wood is keeping a close watch on Malaysia’s reliance on petroleum-based revenues, which has increased since the zero-rating of the GST in June last year. “Including the special dividend from Petronas, the revenue proportion of petroleum-related revenues is nearly 30% this year. If such a level were to persist, this could increase volatility in the government’s revenues, potentially undermining fiscal consolidation efforts.”

If Malaysia were to tap Petronas for another round of special dividend to supplement government revenue next year, would it be tolerated? What would be a good level to show that the country is not dependent on oil-related revenue?

“We expect total reliance on petroleum-related revenues to decline to below 20% of total revenues after 2019. To the extent that the government is able to establish a more diverse revenue programme, this may help to limit volatility and strengthen the sustainability of its fiscal position over the medium term,” says Wood.

When affirming Malaysia’s A- rating with a Stable Outlook recently, Fitch Ratings said Malaysia should be able to meet its 3.4% fiscal deficit target this year. “Political pressures and growth headwinds could motivate the government to increase its current spending, but we believe that if it does so, it would seek additional revenues or asset sales to contain the associated rises in the deficit and public debt,” it said in its July 18 statement.

Fitch expects Malaysia’s GDP growth to slow from last year’s 4.7% on “worsening external environment, but to hold up well at 4.4% in 2019 and 4.5% in 2020”. This is at the lower end of Bank Negara’s growth projection of between 4.3% and 4.8% for this year.

If the economy can grow at least 5% a year in the next three years, Malaysia can reduce its debt-to-GDP level to 54% by 2021 even if debt remains at around RM1 trillion, back-of-the-envelope calculations show. To reach 54% of GDP by 2021, debt needs to fall to below RM900 billion, on top of having economic growth of at least 4% — reflecting the importance of having sustained economic growth while the country works on paring its debt.

Whatever next year’s deficit figure may be, the government needs to get its development priorities right and clearly communicate its desire to facilitate economic growth, encourage private investments as well as invest in people, technology and infrastructure that will help future-proof Malaysia’s economy.

 

 

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