CRUDE OIL PRICES had already fallen 15% since mid-June to US$90 levels (RM294.3) when Malaysia announced its recent 20 sen per litre petrol subsidy cut from Oct 2. By the time Budget 2015 was tabled on Oct 10, oil prices had tumbled by a fifth in four months to US$85 levels. Now, crude oil is nearer to US$80 a barrel. 

Some experts are beginning to see US$80 levels as “a new normal”. Others, however, wonder if prices would indeed stabilise at current levels and slip lower from here, or move higher again in spite of forecasts of lower global oil consumption ahead. Already, there are reports of the oil-producing OECD countries possibly having an emergency meeting to discuss the weak oil price that will hit their coffers and budgets instead of waiting for their next scheduled meeting on Nov 27.

Whether or not Saudi Arabia and other major oil producers will cut production to prop up prices, the broader concern is the state of the global economic recovery and its impact on growth for export-dependent countries like Malaysia.

Whatever happens, one thing seems rather certain: with Malaysia determined to cut its fiscal deficit and rationalise blanket subsidies, Malaysian consumers shouldn’t bet on paying cheaper prices for RON95 petrol or diesel, which the government in early October said would still be between 28 and 32 sen a litre pricier at the pumps without government subsidy. 

What’s more worrying than the possibility of pricier petrol at the pumps, though, is the possibility of Malaysians actually paying cheaper prices at the pump without subsidies. This would happen if oil prices fall further, some economists say. 

Tapis, which fetches roughly US$10/bbl (per barrel) premium to generic crude oil and is the benchmark used for Petronas’ oil prices that has lower sulphur content, was at US$86 levels at the time of writing.

Citi Investment Research’s economist Kit Wei Zheng calculates that Malaysia’s fuel subsidy bill for 2015 could be halved from his estimate of RM19.3 billion under Budget 2015, if the current Tapis oil prices of US$90/bbl are sustained for the whole of 2015. 

“Assuming unit elasticity of RON95 prices to Tapis crude, a US$28/bbl drop in Tapis crude from the earlier assumed price of US$100 to US$105, to US$72 to US$77/bbl, would completely eliminate fuel subsidy,” Kit writes in an Oct 16 note, adding that historical data suggests a 1% change in Tapis crude price results in a 0.7% change in Petronas’ revenue.

Kit reckons that Malaysia will still benefit if Tapis stays at US$90/bbl on average for the whole of next year.

Based on his calculations, Tapis at US$90/bbl would only cause Malaysia to lose RM4.6 billion of the RM59.7 billion petroleum revenue assumed in Budget 2015 — only half to one-third of the fuel subsidy savings of RM10 billion to RM15 billion. Even with the recent subsidy cut, the subsidy bill for RON95 petrol, diesel and LPG for 2014 was still expected to be RM21 billion for this year, the government says.

“Thus with Tapis at US$90/bbl, the positive net fiscal impact of oil could cut [Malaysia’s budget] deficit to 2.1% to 2.5% of GDP [versus the current 3%], all else being equal,” Kit says.

Not everyone is as optimistic, though, because Tapis oil prices could well tumble further. If nothing else, there will be an indirect spillover effect on the prices of another export commodity, crude palm oil (CPO), which would lose its appeal as a biofuel feedstock should the petroleum price stay low.

In spite of Malaysia’s petrol subsidy bill rising from RM1.6 billion for the whole of 2002 to some RM2 billion a month currently, Malaysia was a net beneficiary of higher oil prices as it is a net oil exporter, economists say. It fact, it was only in June, when oil prices climbed amid the Iraq crisis, that Bank of America Merrill Lynch’s regional economist Chua Hak Bin singled out Malaysia as being the only net beneficiary among Asian economies whose growth is likely to be lifted by higher oil prices that makes up a third of its revenue.

Malaysia is believed to have assumed an oil price of US$100 per barrel for Budget 2015, down from US$110 per barrel for Budget 2014. 

RHB Investment Research executive chairman Lim Chee Sing, for one, reckons it may be tougher for Malaysia to achieve its 3% budget deficit targets in 2015 should oil prices remain at US$80 levels, all else being equal. He calculates that every US$1 per barrel drop in crude oil prices would cost the government about RM650 million in revenue, excluding the potential savings from fuel subsidies.

“Increasing government revenue would be a challenge under an environment of falling oil prices, which is projected to account for 28% of government revenue next year,” says Lim to the question of whether it was really that tough for the government to reduce its budget deficit at a faster rate than planned and have a surplus way before year 2020.

Put another way, Malaysia is likely to benefit more if it is able to remove blanket fuel subsidies while being able to sell oil at a high enough price that does not disrupt economic growth. This ideal oil price, however, would differ according to the strength of economic growth and inflationary pressures, economists say.

As it is, the introduction of a new broad consumption tax — the Goods and Services Tax — from April 1 next year is expected to result in a spike in inflation to between 4% and 5% from about 2% to 3% this year before businesses and consumers adjust to a new normal.

Under stronger economic conditions, Malaysia can be more aggressive on its austerity targets to step up the building up of its reserves. But given a relatively challenging global economic outlook, RHB’s Lim reckons that “a gradual approach to reduce the deficit is still prudent”, pointing out that closing the 3% budget deficit in 2015 would mean the government needs to either raise its revenue by RM35 billion or lower its spending by the same amount. 

To put that revenue-spending gap into perspective, RM35 billion is 72.2% of the RM48.5 billion gross development expenditure and 15.7% of RM223.44 billion operating expenditure under Budget 2015.

Still, Lim says Malaysia needs to cut its operating expenditure and fast.

“At 95% of revenue for 2015, this is still too high for comfort even if it is coming down from 98.2% of revenue in 2014. Over-spending by coming out with two supplementary budgets every year since 2009 says it all. The government is already running 17 years of deficit with rising debt... it is simply not sustainable,” Lim says.

Even if Malaysia achieves its target of having a budget surplus by 2020, Malaysia would be have had 23 straight years of budget deficits — which simply means over two decades of spending more than it earns. [See chart on budget deficit since 1998]

What economists are against is not so much Malaysia’s budget deficit but the fact that the bulk of Malaysia’s spending is going into operating expenditure like emoluments and subsidies instead of development expenditure that could help Malaysia move up the value chain and escape the middle-income trap. (See chart on split between operating and development expenditure.)

Among its operating expenditure, emoluments and pensions are growing fast alongside better wages for civil servants. Prime Minister Datuk Sri Najib Razak has also said Malaysia will hire more teachers and nurses to fill schools and hospitals, should studies show there is need to do so. 

All that would add to the government’s emolument bill, which has made up between 30% and 40% of the government’s operating expenditure since 1990, for which the absolute amount has climbed from RM9.12 billion in 1990 to RM75.8 billion in 2013 and is estimated to reach RM81.9 billion in 2015.

The most unproductive item of Malaysia’s operating expenditure is the amount the country needs to spend on servicing its debts — a figure that has tripled from RM165 billion in 2002 to RM568.9 billion as at June 2014 or 52.8% of GDP. Including so-called contingent liabilities, Malaysia’s debt is over RM700 billion or more than 67% of GDP.

In fact, debt servicing charges alone are estimated at RM24.4 billion in Budget 2015, up 24.8% from RM19.5 billion in 2012. The RM24.4 billion means the government is spending RM2 billion a month or RM92 million a day just servicing its debt. 

 That RM24.4 billion — 13.3% of government revenue and 10.9% of the government’s operating expenditure — is enough to give RM840 cash to all 29 million Malaysians. That’s really not too shabby considering that BR1M payment is RM950 a year to households earning below RM3,000. It is also five times the RM4.9 billion BR1M is expected to cost in 2015.

Malaysia’s budget deficit will fall to 1% from 3% if there were no need to service its debt, back-of-the-envelope calculations show. Some economists suggest that Malaysia could reduce its budget deficit faster by cutting operating expenditure and sell some of its assets to pay off debt.

“Land, buildings, companies are some of the assets that Malaysia can sell to raise cash to pare debt… but execution is not as straight-forward, as there is the need to consider issues such as bumiputra equity,” an observer says. 

Whatever the case, Malaysia’s fiscal position will also improve should more Malaysians be able to command higher wages, because cash handouts are short-term safety nets that are not sustainable over the long run.

“Rising BR1M subsidy is not sustainable and not healthy for the country’s economic development. It creates a subsidy-dependency syndrome that will become more and more entrenched in the economy so much so that it will be difficult for the government to remove it in the future. This will create a major obstacle for the country to move up the value chain and grow out of the middle income trap, in my view,” Lim says.

While Malaysia will have the flexibility of raising its 6% GST rate to Singapore’s 7% or Indonesia’s 10%, to raise its revenue, economists say raising the rate too soon could lead to higher inflation and even hamper economic growth if businesses and consumers have difficulty adjusting. 

Even before the oil-related growth jitters, there are more economists who already agree with the lower end of Malaysia’s 5% to 6% economic growth forecast for next year.

This article first appeared in The Edge Malaysia Weekly, on October 20 - 26, 2014.

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