Can Budget 2016 strengthen Malaysia against external economic headwinds?

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Budget 2016 has been touted as a people’s budget. We decided to examine if it is capable of weathering external economic headwinds.

In the past year or so, the Malaysian economy has been affected by two main external headwinds: the fall in commodities prices dented the country’s finances, while the possibility of the US increasing its interest rates caused some repatriation of foreign investment funds, affecting investment climate and the Ringgit’s value against major currencies.

Budget 2016 includes many plans for action, including nine high-impact projects worth RM6.7bil. However, can it strengthen Malaysia’s defences against external headwinds, given that the US Federal Reserve has hinted that interest rates are projected to rise?

Overall projection from Budget 2016

The budget deficit is expected to be 3.2% of GDP in 2015 and will reduce marginally to 3.1% of GDP in 2016. Economic growth is expected to be four to five per cent in 2016. The expected revenue in 2016 is RM225.7bil, while the expected expenditure is RM267.2bil; thus, the expected shortfall is RM41.5bil.

Crude oil contributes to the government’s coffers predominantly from petroleum income tax, export duty from petroleum, petroleum royalty and Petronas dividends. Perhaps to alleviate the concerns of foreign investors and rating agencies that Malaysia’s government revenue is dependent on crude oil, Budget 2016 has projected significantly lower contribution from petroleum-based revenue.

Table 1 shows crude oil-based revenue is expected to fall from RM64bil in 2014 to RM29.4bil in 2016. This is equivalent to 29% of total government revenue in 2014 and 13% of total government revenue in 2016. As the figures in petroleum income tax and export duty for 2016 are largely similar to those for 2015, Budget 2016 is implying that the underlying crude oil prices in 2016 are largely going to be similar to those in 2015.

However, Petronas dividends are expected to fall RM10bil to RM16bil in 2016. This might be due to the reallocation of resources towards the RM18bil investment in the Refinery and Petrochemical Integrated Development Project in Pengerang, Johor, also announced in Budget 2016.

Petroleum-based revenue estimates are largely conservative since they are based on 2015 crude oil prices. Nevertheless, should crude oil prices rebound strongly and/or should the Ringgit depreciate further in 2016 while Petronas dividends increase, then the projected deficit might be lower.

Table 2 shows that to buffer the RM11.4bil fall in petroleum-based revenue and the RM4.8bil and RM2.6bil losses in the Sales and Service Taxes respectively, an additional RM6bil revenue will come from Company Income Tax and RM12bil from the GST. Evidently, the GST has firmly become an important tax generator for the federal government.

The increase in Company Income Tax of 8.9% looks optimistic as it is higher than the four to five per cent economic growth in 2015 and 2016. The higher contribution from the GST is also optimistic since the 11th Malaysia Plan projects private consumption to grow at 6.4% only. Therefore, the 8.9% growth in GST revenue (taking into account the Sales and Service Taxes in 2015) could be due to stricter tax collection. Having said this, private expenditure in 2015 could have been lower, especially in the second and third quarters of 2015 immediately after the introduction of the GST on April 1, 2015. Hence, by 2016 consumers would have gotten used to the GST and should be more willing to spend.

Impact factor 2: Vulnerability to financing cost due to reliance on foreign debt financing

Table 3 shows that over the years, federal government debt has grown from RM502bil (51.6% of GDP) in 2012 to RM627bil (54% of GDP) in Q2, 2015, according to Bank Negara. If one includes the debt guaranteed by the federal government, the debt would have increased from RM625bil (64.4% of GDP) in 2012 to RM803bil (69.1% of GDP) in Q2, 2015.

Prime Minister Najib Razak tabling Budget 2016.

With the projected deficit of RM41.5bil in 2016, federal government debt is expected to grow to RM669bil (54.8% of GDP, assuming five per cent GDP growth) by next year.

The interest rate that Malaysia pays on its debt in the past three years has been manageable. However, Table 3 shows that it has been rising from a financing cost to debt ratio of 3.8% in 2013 to four per cent in 2016. This low level is probably influenced by the low interest rate environment in the developed world as well as the absence of change in Malaysia’s sovereign credit rating. Besides, foreigners have been investing significantly in Malaysian debt. Out of RM627bil of federal government debt (excluding guaranteed debt) in Q2, 2015, RM198bil of debt is owned by foreigners. On an international basis, this 31.6% foreign ownership is a high proportion.

So, Malaysia is vulnerable to foreign capital repatriation as a result of actual or expected increase in US interest rates or downgrades in credit rating. Should any of these change, Malaysia may be forced to pay higher interest rates to borrow. This happened recently in August and September, when the yield on government debt increased.

Moreover, it is unlikely that the guaranteed debt amount from Bank Negara would have included debt from 1MDB. Should the 1MDB debt be included as part of Malaysia’s debt, then the total debt burden and financing cost would be higher; investors’ confidence would be affected negatively.

Impact factor 3: Lower foreign exchange reserves

Bank Negara foreign exchange reserves have fallen significantly to US$94.1bil as of October 15. Therefore, Bank Negara’s provision of the Ringgit-Renminbi credit swap facility for local banks is positive. This will reduce the country’s reliance on US$-denominated trade, since China is a major trading partner. However, given that investors’ confidence in the Ringgit is driven mainly by political risk as well as the uncertainty surrounding 1MDB, it is unclear whether the use of Ringgit- Renminbi swap will restore confidence.

Conclusion

Budget 2016 has tried to allay investors’ and credit agencies’ concerns about Malaysia’s fiscal balances. There is a significant move away from petroleumrelated revenue towards Company Income Tax and the GST. As the growth assumption in these two taxes looks optimistic, it should help weather some external threats. If crude oil rebounds strongly from the current price, Malaysia’s fiscal balances may surprise on the upside, assuming there are no leakages. However, the overall debt amounts, especially off-balance sheet debts and interest payments, remain areas of concern.


We will address Budget 2016’s impact on businesses and households in a separate article. 

Lim Kim-Hwa, PhD, is CEO and head of Economics at Penang Institute, fellow in Finance and Financial Reporting at University of Cambridge and associate chartered accountant of the Institute of Chartered Accountants in England and Wales.



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