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Malaysia’s fiscal clean-up threatened by handouts

Malaysian prime minister Mahathir Mohamad has reportedly admitted that his party made “all kinds of promises” on the campaign trail because it did not expect to win in May’s general election. Now he is having to make good on those promises and that risks worsening Malaysia’s public finances. 

Credit rating agencies are wary after the government projected this year’s fiscal deficit at a five-year high of 3.7 per cent of gross domestic product, versus the previous government’s 2.8 per cent estimate, before shrinking to 3.4 per cent next year and to 3 per cent in 2020.

Mr Mahathir’s government defends the increase as reflecting a truer state of the country’s fiscal position than that presented by the previous administration. But enough populist measures are being rolled out to at least raise questions about the new government’s commitment to fiscal discipline. 

The rating agencies have cause to worry. Against a backdrop of a slowing Chinese economy and an intensifying US-China trade war, budget profligacy threatens to imperil Malaysia’s economic outlook and the government’s pledge to push through reform. 

Happy households

Malaysian consumers are feeling upbeat for now. Our third-quarter consumer survey, which was conducted in September, showed they remained optimistic about their spending and borrowing, even after the introduction of a Sales and Services Tax (SST) in September.

Our Consumer Borrowing Index rose 0.6 points to 63.1, while our Discretionary Spending Index rose by 1.9 point to 73. Although the FTCR Household Income Index for Malaysia fell 3.4 points to 66.3, it remained comfortably in optimistic territory.

Mr Mahathir made good on one of his campaign pledges in June and replaced the Goods and Services Tax (GST) — a broad-based tax which imposed a levy on every stage of the production process — with the narrower SST in September. In between, Malaysian consumers enjoyed a de facto three-month tax holiday. 

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The government will also increase the monthly minimum wage across the country from January and refund RM37bn ($8.8bn) to companies and individuals next year from income tax and GST overpayments. 

Rising consumer confidence was reflected in the 8 per cent year-on-year increase in household spending in the second quarter — the biggest jump in three years — despite lower than expected GDP growth.

Private consumption makes up about 55 per cent of Malaysian GDP and will remain an important driver of growth next year because the government is postponing, or cancelling outright, major investment projects. Officials expect private consumption to expand 6.8 per cent in 2019, moderating from 7.2 per cent this year. We believe the target is achievable, supported by policies such as lower consumption taxes and higher disposable income for low wage earners.

Private consumption growth should also be supported by moderate inflation and a relatively healthy labour market. Unemployment stands at just 3.4 per cent, while Malaysia’s consumer price index rose just 0.3 per cent year on year in September, despite the reintroduction of the SST that month. The central bank can probably stand pat on benchmark interest rates. 

The government expects inflation of between 1.5 and 2.5 per cent in 2018 and 2.5 to 3.5 per cent in 2019 as the SST kicks in. However, the relatively limited scope of the tax means there is unlikely to be a repeat of the sharp deceleration in consumption that followed the introduction of the GST in 2015. 

Fiscal risk

Populist measures, such as the removal of the GST and the reinstatement of fuel subsidies, fulfil campaign promises but leave the government pinning its hopes on private consumption to drive economic growth. Doing so threatens to erode its fiscal position. 

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Although the government has been able to collect a RM30bn special dividend this year from state-owned oil company Petronas, it cannot rely on what could be a one-off windfall, given oil price volatility. Despite efforts in the most recent budget to develop new sources of tax revenues — including expanding the scope of the capital gains tax and higher stamp duty — revenue forecasts are too ambitious given the dimming economic environment. In the case of higher stamp duty, buyers may be deterred as the country’s housing market softens. 

The GST may have been resented but at least it was a reliable source of tax revenue, contributing RM44bn, or 20 per cent, of the federal government’s revenue in 2017. In contrast, the SST is expected to bring in less than half that amount next year. The government hopes the oil sector will increase its contribution to revenues to 30.9 per cent in 2019 from 21.7 per cent this year, though that means relying on volatile commodity markets. 

Meanwhile, government spending is set to rise 8.3 per cent in the coming year, 82 per cent of which will go towards operational expenditure, while the development spending that is needed to drive economic growth has remained flat for the past three years. 

These fiscal challenges are set against a worsening external economic picture. The government expects export growth to slow to 3.9 per cent next year from 4.4 per cent this year. Malaysia’s economy is officially forecast to grow 4.8 per cent in 2018, below the previous administration’s 5 to 6 per cent target. 

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Mr Mahathir won over the Malaysian electorate with campaign pledges to clamp down on corruption and hand more money back to households. He is making progress in cleaning up the government, taking steps that should provide necessary transparency and stability for doing business in Malaysia. 

But carrying out his promise to give more money back to households is a step towards fiscal irresponsibility that puts an unnecessary cloud over the country’s longer-term economic outlook.

— Siew Mung Tan, Malaysia Researcher, FT Confidential Research

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and south-east Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors


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