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Economists play down concerns over Malaysia's fiscal health despite government’s populist measures

SINGAPORE — While moves by the new Malaysian government to roll back a consumption tax and reinstate fuel subsidies have heightened concerns about its fiscal position, analysts say that the country's strong fundamentals and efforts to cut wasteful spending will cushion any shocks.

Economists play down concerns over Malaysia's fiscal health despite government’s populist measures

While moves by the new Malaysian government to roll back a consumption tax and reinstate fuel subsidies have heightened concerns about its fiscal position, analysts say that the country's strong fundamentals and efforts to cut wasteful spending will cushion any shocks.

SINGAPORE — While moves by the new Malaysian government to roll back a consumption tax and reinstate fuel subsidies have heightened concerns about its fiscal position, analysts say that the country's strong fundamentals and efforts to cut wasteful spending will cushion any shocks.

They add that reducing the Goods and Services Tax (GST) from six per cent to zero from June 1 and replacing it with the Sales and Services Tax (SST) — at a rate that has yet to be determined — will likely result in a revenue shortfall of up to RM25 billion (S$8.41 billion).

But this amount can be offset by the expected increase in revenue due to higher oil prices and savings in government spending from reduced waste and leakages, they note, adding that the new Pakatan Harapan (PH) government would streamline the civil service and review big-ticket projects.

"GST rollback does not constitute a fiscal tragedy; especially viewed through wider lenses of more holistic and comprehensive fiscal reforms," said Mr Vishnu Varathan, head of economics and strategy at Mizuho Bank in Singapore.

The PH coalition — led by Dr Mahathir Mohamad — won the May 9 general election on the back of a promise to scrap the highly unpopular GST, which disgruntled voters blamed for their rising living costs.

A week after its stunning electoral victory, the new government announced that it would scrap the GST and reintroduce a sales tax as well as fuel subsidies as part of its promise to tamp down rising living costs.

Malaysia abolished fuel subsidies in 2014 and instead fixed the price of petrol and diesel in accordance to market rates under a managed float system, a move which the then government said would save taxpayers RM10 billion to RM20 billion annually.

At the same time, the Mahathir administration has also pledged to do away with toll collections, although it has not announced details of how this would be done.

Some analysts have said that government may have to opt for privatisation of listed toll operators, and the amount may come up to RM55 billion which includes taking over the operators' debt obligations.

The amount however does not include compensation for the operators for breaking the toll concession agreement.

Some credit ratings companies like Moody's Investors Service have warned that PH's populist measures such as the removal of the GST could have negative implications for the country's credit rating.

The GST differs from the SST in that it is levied at all stages of the supply chain, meaning manufacturers and suppliers also pay tax on the goods produced, not just the consumer.

The GST is also charged at a flat rate compared to variable rates for a sales tax.

The more modest SST was introduced in the 1970s, but ousted prime minister Najib Razak did away with it and introduced the GST in 2015 amid low oil prices and a need to beef up the government's coffers.

The previous government collected RM43.8 billion in GST last year. At 18.3 per cent of tax income, GST was the largest contributor to government revenue after only corporate tax receipts.

The collection helped the Najib administration to narrow the fiscal deficit from 6.4 per cent of GDP in 2009 to 3 per cent in 2017.

Malaysia's fiscal deficit target of 2.8 per cent of GDP for this year is under review pending clarity on the impact of new tax measures and policy initiatives.

Mr Lee Heng Guie, executive director of independent research house Socio-Economic Research Centre (SERC), believes the government's expected revenue shortfall and high debt will not affect the country's ratings.

This is because global rating agencies would have reassessed Malaysia's fiscal stability framework and debt dynamics, taking into account the impact of the new tax and policy changes as well as the planned review of several mega projects.

"Likewise, the government is able to service debt obligations as long as it keeps prudent expenditure programmes within the revenue collection," he said, pointing out that the country has never defaulted on its debt obligations, even during the 1997/1998 Asian financial crisis.

Malaysia's debt stood at RM1 trillion, or 80.3 per cent of the GDP, as at December 31 last year.

On Monday, Dr Mahathir Mohamad confirmed that Malaysia would scrap the Kuala Lumpur-Singapore High Speed Rail project - which he said would cost Malaysia RM110 billion - as part of drastic cuts to government spending and investment that are required for the country to "avoid being declared bankrupt".

He added that Malaysia would also talk to the Chinese government about renegotiating "unequal treaties", including the Chinese-backed RM55 billion East Coast Rail Link.

Professor Yeah Kim Leng, an expert in economics from Sunway University, noted that Malaysia's debt as a ratio of its GDP is just above the 60-80 per cent range considered to be prudent for developing economies.

"This increases the country's financial risk but remains well within its debt service capacity as its current debt services charges is estimated at 13.2 per cent of total expenditure in 2018 which is high but manageable," he said.

Mr Lee's views were supported by Mizuho's Mr Vishnu who pointed out with global oil prices on an upsurge in the last 12 months, Malaysia's oil-related revenues may be bumped up by some RM12 to RM18 billion.

Moreover, rising oil prices are positively correlated to state oil company Petronas' profitability, translating into higher corporate taxes.

Brent crude oil, which was at US$75 per barrel on May 28, was well above the price assumption of US$52 per barrel in the government's 2018 budget.

This could provide an additional revenue cushion of RM18 billion to RM28 billion for the net oil producer, compensating for about half of the GST, while another RM18 billion to RM20 billion may be recouped from the SST, said Mr Vishnu.

"While market fixation is now driven by fears about fiscal deterioration, insofar that 1MDB probe turns up assets that Malaysia is able to recover, this will be positive for Malaysia's balance sheet and public finances," he added, referring to the billions of dollars said to be missing from state investment fund 1Malaysia Development Berhad which the government has pledged to recover.

At the same time, analysts added that scrapping the GST could also boost consumer spending to support the 5.5 to 6 per cent economic growth forecasted by the central bank.

"By eliminating this (GST), they will gain political capital that they can use elsewhere," said Dr Francis Hutchinson, who coordinates the Iseas-Yusof Ishak Institute's Malaysia Studies Programme.

"We also can expect the new government to be very transparent about the country's finances so that the public is aware of the factors influencing decisions to implement certain reforms or to modify initial pledges."

One downside with the scrapping of the GST is that the government's reliance on petroleum-related revenue will rise again, making the budget more vulnerable to swings in oil prices.

"The country needs a replacement for oil and gas revenues which will decline over time even with new discoveries," said Dr Lim Teck Ghee, the director of Centre for Policy Initiatives, a policy think tank.

"We have lost two decades in building a less oil dependent economy. This failing needs to be a priority concern for the new government."

There is also a need to keep operating expenditure on a tight leash, especially since there are estimates that the previous government's spending was over-bloated by 30 per cent due to overpricing, corrupt practices as well as overrun on time and costs.

"Above all, getting rid of the worst of brazen corruption will instill confidence in processes and raise governance through accountability. These will go a long way to boost business, investor and consumer confidence," said Mizuho Bank's Mr Vishnu.

"In economic speak, this will reduce Malaysia's risk premium and yield better returns."

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