Budget 2013: PUSHING THE LIMIT

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The federal budget for next year, announced in September, is seen by many as another in a string of election budgets. Penang Monthly looks at the viability of this latest balancing by the federal government of expenses and revenue. The increasing dependence on Petronas, it is noted, is cause for worry.

In Malaysia’s final national budget before the impending 13th General Election, the federal government is pushing its fiscal limits, aiming to satisfy international observers, business operators, civil servants and citizens from all backgrounds. What effect will this have?

In order to better understand the budget, we should first look at the sources of funds for the budget, and how these funds will be used.

The government budget consists of expenses such as government servants’ salaries (emoluments), subsidies, pensions and gratuities, supplies and services, grants and transfers, and debt service charges.

Revenue consists of taxes, indirect taxes and non-tax revenue. If the revenue is insufficient to meet government expenses, you have a deficit. The government then has to borrow money, either domestically or internationally, to meet its expenses for the year. Malaysia has been experiencing a budget deficit for 15 years since 1997.

Expenses

The government’s expenditure is divided into two components: operating expenditure and development expenditure. The operating expenditure consists largely of fixed obligatory payments as allocated by the government and Constitution such as emoluments and grants and transfers to the state and statutory bodies. The development expenditure is allocated to domestic social agendas, such as economic services (transport, public utilities), social services (education, health, housing) and security and defence. The allocation for development expenditure was decided in the 10th Malaysia Plan, a five-year economic plan for 2011 to 2015. This year, RM201.9bil will be allocated for the operating expenditure and RM47.8bil for the developing expenditure, totalling RM249.7bil1. Within this analysis, we will look at the budget components individually, irrespective of whether it is from the operating expenditure or development expenditure.

Locked-in expenses

Much of Malaysia’s budget is spent on locked-in expenses, which are commitments made by the federal government.

In Budget 2013, these stand at 52.9% of the budget, consisting of emoluments (23.5%), subsidies (15.1%), pensions and gratuities (5.4%) and debt service charges (8.9%).

Although the allocation of 52.9% is a reduction from the estimated proportion in 2012 (54.0%), the actual spending for locked-in expenses in 2013 may be higher than expected. This has happened in 2012, where the estimated actual spending for locked-in expenses has been higher than the budgeted allocation (50.6%). The spending in 2012 has had to take into account the salary revision for civil servants and bonuses that were announced within Budget 20132.

Although the government decreased sugar subsidy by 20 sen, it still comprises a miniscule percentage of the entire budget. Simply put, not enough has been done to restructure the government’s locked-in expenses.

In part, being the last budget prior to the next general election, the government is striving to satisfy all citizens from different strata. Civil servants will be credited one month’s bonus this year and another half a month’s bonus in 2013. Pensioners who served the government for more than 25 years will receive an additional RM100, increasing their pensions to RM820.

The much-needed subsidy rationalisation on fuel is still missing from this year’s budget, disappointing but understandable considering that it is an excruciatingly difficult policy to implement politically.

Catering to the middle income and Generation-Y

Previous budgets have, more often than not, allocated funding for the rural poor. Limited policies were implemented to address the middle income group, categorised by working adults with children. This year, there has been growing resentment among the middle class that not enough has been done for them, especially in terms of housing. Policies have been implemented in this budget in an attempt to address their concerns.

For example, the income limit for loans on the My First Home Scheme will be increased from RM3,000 to RM5,000 for individuals and RM6,000 to RM10,000 per couple. The federal government will also implement a 50% stamp duty exemption, applicable to property costing up to RM400,000, an increase over the RM350,000 the previous year.

The government recognised the importance of reaching out to Generation-Y, people known to be vocal in expressing their thoughts. Bantuan Rakyat 1Malaysia (BR1M) is extended to unmarried individuals age 21 years old and above earning below RM2,000. RM250 will be given out, covering 2.7 million people. RM250 will also be given to tertiary education students for books.

Such policies will help the government reach out to this generation, but will not distribute cash resources in the most efficient manner. For example, a 22-year-old tertiary education student who comes from a high income family and therefore would be able to afford his living costs will receive both the RM250 cash transfer and the RM250 book voucher.

Grants to state government versus grants to statutory bodies

Under the federal constitution, the central government is obligated to make payments to states on two items: the capitation grant and state road grant. The capitation grant is calculated based on the population of a state, with the first 100,000 receiving RM72.00 per 2013person, the next 500,000 receiving RM10.20 per person and so on. The state road grant allocates funds based on the number of roads as well as maintenance costs.

Statutory bodies consist of public institutions such as libraries, universities, museums and state development corporations. In Budget 2013, the money allocated to statutory bodies is 2.2 times more than the allocation to state governments. This highlights the power that the central government holds relative to the individual states.

Deficit and borrowings

Budget 2013: Why the hype on the budget deficit?

Yet again, the government will incur a budget deficit. This time, it will be reduced from 4.5% in 2012 to 4.0% in 2013.

Malaysia has run budget deficits in 41 out of 44 years from 1970 to 2013. Although Malaysia has progressed from a developing country to a middle income country as a result, running excessive amounts of budget deficits carries enormous risk. The turmoil in PIIGS3 shows that funding of budget deficits can become severe during periods of distress and low investor confidence.

In Budget 2013, money is allocated to promote domestic investment, enhance Malaysia’s education through the Blueprint 2013-2025 and allocate more 1Malaysia clinics throughout the country. New items in this year’s budget include the introduction of business trusts as an option for capital financing, a deduction in investments made by angel investors to provide more funding for young entrepreneurs and the establishment of 1Malaysia Internet Centres for the urban poor. All these initiatives will build the country’s capital and human stock.

On the other hand, certain items raise the question whether the capital borrowed to finance the budget deficit was put to good use, with the government allocating money to GLCs for CSR programmes, the allocation of RM200 rebate on smartphones for youths aged 21-30 (the government is considering capping the age limit at 404) and the allocation of RM100 to all primary and secondary school students. The allocation for CSR to Felda, a GLC, is even more debatable, as the company has been a public listed company since June 2012, debuting as the second largest IPO in the world in 20125. “Surely it can fund its own CSR programmes?” many ask.

The rebate for smartphones is also not well-allocated or thought through, as it is entirely possible for people to abuse the policy by buying smartphones at a lower price and selling them for higher. Those with existing smartphones may take the rebate as an opportunity to simply change their phones.

Malaysia government debt – foreign risks not substantial, but needs to be monitored

Additional finances are raised through borrowing, either via the domestic or foreign market. Malaysia’s domestic debt is rather secure as the majority of it is held by domestic institutions, such as the Employment Provident Fund (EPF), public enterprises and Bank Negara Malaysia. The proportion of foreign investors was below one per cent most years prior to 2003, but shot up to 22.5%6 in 2011. Although this is an indication that the Malaysian government’s debts are in demand by foreigners, the government also has to beware of the risks of capital repatriation by foreigners.

The proportion of foreign debt borrowed by the Malaysian government is low, standing at only four per cent of its total debt in 2011.

The risk imposed by foreign debt towards the government’s financing is thus low relative to the risk of foreign investors holding Treasury Bills or Malaysian Government Securities.

Interest-bearing government, weak debt-to-GDP ratio

Internally, interest payments due to the government debt can be diverted to areas that need development, such as building roads and infrastructure in less developed areas.

With the European sovereign debt crisis and US government bonds suffering from poor investor confidence and relatively low interest rates respectively7, investors are looking for alternative markets. Asia is poised to be the next growth engine for the world economy, and Malaysia is one of the destinations for investors.

The average interest rate that investors can expect from the Malaysian government’s debt was 3.9%8 in 2011. This is higher than the interest rate of US bonds and lower than some Euro denominated bonds. Nonetheless, the Malaysian government’s debt has also come under the scrutiny of international credit rating agency Fitch. Malaysia’s debt is estimated to stand at 53.7% of GDP by the end of 2012, just a few percentage points away from its self-imposed ceiling of 55%. (The government raised the ceiling from 45% in July 2009 to accommodate fiscal stimulus due to the 2008 world financial crisis.)

Internally, this implies that the government may adjust the debt ceiling again to cater to the amount of debt relative to GDP. On the other hand, it is aware that any further increase in debt-to-GDP ratio may see a downgrade by credit rating agencies, which will result in a loss in confidence from foreign investors and drive up the interest rate on debt. Italy, for instance, saw its 10-year bond yield reach seven per cent in November 2011, due to its high debt levels.

Numerically, the current debt-to-GDP ratio shows that the government is still abiding by the law it put in place. A look at Malaysia’s foreign debt shows that it includes non-financial public enterprises (NFPE), such as Malaysia Airlines and Malaysia Railway (KTMB). Debt held by NFPEs is not included as part of government debt. Although these NFPEs are managed independently, given the strategic nature of these companies, it is likely that the government will need to take over the debts of these companies if any of them falls into financial distress, increasing the total government debt.

The ratio is also dependent on the final GDP in 2012 and 2013. Although domestic demand will help spur GDP growth in Malaysia in 2012 and 2013, Malaysia’s overall growth is still dependent on the unstable world economic situation as it is an open economy and a trading nation. The debt-to-GDP ratio hovering close to 55% puts the government in a precarious position, reducing its resilience to external economic shocks.

Revenue

Tax collection

The single biggest component of Malaysia’s revenue is company taxes. In 2012, it is estimated to contribute 26.1% of the government’s entire revenue collection. In Budget 2013, in an effort to spur businesses, certain sectors are given tax exemption, such as the oil and gas sector, with a 100% tax exemption for the liquefied natural gas sector for three years. There are also tax exemptions for R&D activity, with a 100% exemption for 10 years. Tax exemptions are also given to tour operators, childcare centres and pre-school education operators.

The government has not relied on personal income taxes in its revenue collection, taxing only a small base of people. In 2011, only 1.7 million of the total five million registered taxpayers paid income taxes9. In other words, six per cent of Malaysian citizens are paying for 11% of the government’s revenue in 2011.

There will be even less reliance on personal income taxes in the coming year. In Budget 2013, the personal income tax rate for the income band of RM2,501 to RM50,000 will be reduced by one per cent. This will relieve an estimated 170,000 taxpayers from their taxes10. It will also reduce the reliance on middle income earners to finance the government’s budget. Tax relief for parents with children pursuing higher education will be increased from RM4,000 to RM6,000.

By lightening the burden of businesses and individuals from revenue contribution, the government will have to look for alternative sources of income to maintain or increase its revenue. As part of the effort to cool down property prices, the real property gains tax (RPGT) was increased by five per cent for properties disposed within five years. The effort to slow down the property market should be lauded, but is it sufficient to curb speculation? Price increases for certain properties are more than 10% to 15%11.

The imposition of RPGT will bring in more revenue for the government. But it is not a stable form of revenue as the policy is dependent on the buoyancy of the property market and the number of transactions. The RPGT may also be reduced or revoked if the property market experiences a prolonged slowdown, which was what happened from April 1, 2007 to December 31, 2009.

Across the board, petroleum has been the highest contributor to Malaysia’s federal budget since 2004. In 2011, petroleum tax, Petronas’ dividends and royalties from petroleum and gas account for 34% of the government’s revenue. This is not inclusive of export duties on petroleum and gas. This shows the overreliance on Malaysia’s petroleum industry to support the government budget.

The large contribution to the federal budget diverts potential reinvestment into oil and gas production. As a non-renewable energy source, more exploration for oil has to be done to replace existing but depleting oil reserves. Although Petronas is a state-owned company, the government should be wary of taking advantage of its relationship with the company. In mid-2012, Petronas publicly commented that its profits should not be used to subsidise fuel, a significant portion of the government budget12.

Solution to the tax conundrum

In order to service debt and finance expenses, the government has to design a tax system that is fair and equitable, ensuring sustainability in its revenue collection. One method would be the implementation of the value-added tax (VAT) across all goods and services, which was supposed to be implemented in 2007. This is nonetheless a politically difficult system to implement, as it would impact low and middle income earners.

In Budget 2013, the official reason for the delay in implementation of a fair taxation system is because this transition has to be studied in an orderly manner. It is hoped that the government can construct a sound tax system before international and local critics look through the loopholes in Malaysia’s government financing yet again.

Conclusion

The government has pushed its limits in fiscal allocation by lowering the budget deficit and keeping the government debt to below 55% of GDP. Further fiscal reforms will have to be implemented in the medium term for future

fiscal flexibility. This is to prevent a downgrade by international credit rating agencies, which will impact the confidence of foreign investors and push interest rates on Malaysian debt up. This deficit is crucial, as it is used to finance the expenses of cash transfers, tax exemptions and subsidies in a bid to satisfy all levels of society.

Finally, how much will Budget 2013 impact voters? We’ll find out by June next year.


1
Some reports may state an allocation of RM251.6bil for Budget 2013, which is inclusive of RM1.9bil of contingency reserves.

2 Ministry of Finance Economic Report 2012/13, Public Sector Finance chapter.

3 Portugal, Italy, Ireland, Greece, Spain.

4 www.malaysia-chronicle.com/index.php?option=com_k2&view=item&id=41830:rm200-smartphone-rebate-rais-wants-to-raise-eligibility-age-of-youths-to-40&Itemid=2

5 “Felda Global world's 2nd largest IPO this year, opens at RM5.39”, The Star, June 28, 2012.

6 According to Ministry of Finance and Bank Negara data.

7 The US interest rate was hovering at four per cent in January 2008. By January 2009, it slipped to 0.25%, and has remained there since.

8 3.9% is calculated with this formula: debt service charges/(domestic government debt + foreign government debt)

9 www.internationalbusinessreview.net/SouthEastAsia/Features/tabid/284/vw/1/ItemID/1738/Default.aspx

10 www.treasury.gov.my/images/pdf/budget/bs13.pdf

11 www.themalaysianinsider.com/malaysia/article/budget-2013-band-aid-for-housing-woes-say-property-developers/

12 www.freemalaysiatoday.com/category/nation/2012/07/02/petronas-chafes-at-its-role-as-piggy-bank/


Ooi Pei Qi is a Singaporean currently working as an economic research analyst in Penang.



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