by Budget analyst
A careful analysis of the 2014 Budget Speech by the Prime Minister-cum-Finance Minister, Datuk Seri Najib Razak is most revealing and disappointing as there is little by way of an exposition of the challenges the economy faces.
The customary presentation of data on the performance, in the current year and prospects in the year ahead, are matters that are dismissed in a few perfunctory sentences.
The speech gives little information on basic macro-economic assumptions used in basing the revenue and expenditure forecasts that make up the Budget.
The speech gives no hint of how the Government proposes to deal with the less than robust external environment in which the key Malaysian export markets – China, US, the EURO zone – will continue to record sluggish demand.
The price for Malaysian oil and gas are likely to be weaker because of increasing supply from US shale oil and the re-entry of Iranian oil into global markets. With greater supply and lower demand, prices are likely to be lower. Malaysian oil and gas exports will undoubtedly feel the impact.
The speech provides no insights into policy changes and measures to counter the impact of the US “tapering” on interest rates and its effects on Malaysian borrowings and debt management.
Higher interest rates in global markets will have several implications for the domestic scene. Bank Negara will need to set higher rates which in turn will burden the Government by way of higher interest charges on its huge debt obligations; households with a debt burden of over 80% of GDP will inevitably face a larger burden and or face insolvency.
The recently announced reduction of the subsidy on petroleum products and the removal of the subsidy on sugar, announced in the Budget, appear to be driven by the pressure from markets and the Rating Agencies.
The net contribution of these adjustments is not likely to significantly contribute to reducing the deficit but will in all probability contribute to inflationary pressures. The latter are likely to be heightened in any event by a weaker Ringgit that will push up the cost of imports in general.
Various Ministers and officials have made claims that the GST would be revenue neutral as it would replace the existing sales services taxes.
In a seminar, reported in the News Straits Times on Oct 28th, some light was thrown by the Secretary General of The Treasury on the incidences of the GST and the change in income tax rates.
The government is expected to collect RM23.1 billion in goods and services tax (GST) from April to December in 2015 and RM32 billion for the whole of 2016. Were the sales and services tax remain in place it would yield RM 14.8 billion.
Thus the GST turns out to be far from revenue neutral but would represent an almost doubling of tax on consumption.
However, no information has been released as to how much of a reduction would result as a consequence of the lowered income taxes on individuals and corporations. The benefits these reductions will largely accrue to high income tax payers and large GLCs and crony corporations.
These are a few but glaring examples of the pathetically weak framework on which the 2014 Budget is constructed.
Parliament and the electorate are being kept in the dark about the true state of affairs. It would appear that the Prime Minister has departed decidedly from any respect for the concepts of Accountability and Transparency.
In overall terms the budget as tabled boils down to imposing new burdens on the low and middle income groups given that they will bear the greater part of the clearly regressive GST and the removal of subsidies.
The upper middle and higher income earners will however benefit from a lowering of the marginal rates of income tax.
The corporate sector stands to benefit from a lower of income taxes and the various new rebates and exemptions offered ostensibly to encourage investment. The tax changes will lead to a further widening of income disparities.
Taken as a whole, the Speech does little beyond giving in great detail the multiplicity of programs and projects and the outlays that will be made.
A cynical view would be that the Prime Minister was indulging in a characteristic manner – spreading funds to placate his shrunken electoral constituency, factions in his divided party while keeping at bay those in the market that demand responsible and credible leadership in the management of the economy.
It is appropriate to delve a little more into certain parts of the Speech to further illustrate the befuddled state of mind that the Prime Minister displays. Even a cursory review leads to the conclusion that the Prime Minister has many illusions and appears to be out of his depth in addressing the challenges that confront the nation.
In his opening remarks he makes the claim that the National Transformation Policy is the bedrock and catalyst for achieving Vision 2020. It is indeed strange that this amorphous set of policies now occupies center stage.
The New Economic Model, developed with inputs from the World Bank, and announced with great fanfare has now been apparently cast aside. It is also interesting that the recently proclaimed BEE policy hardly merited a mention in the Budget.
The latter policy has neither been discussed nor approved by Parliament. This was an incomplete policy framework as it did not touch on the macro-economic issues, the broader policies, but had a narrow focus on the Malay and Bumiputra agenda.
The Prime Minister’s speech then goes off on a tangent about the demographics of Malaysia with focus on the Malay and Bumiputra agenda. This discussion appears to suggest that the concept of 1Malaysia launched at the cost of millions is no longer a part of the political rhetoric of the Prime Minister.
He appears to be moving towards an ethno-centric agenda espoused by PERKASA and its Patron. It is somewhat puzzling that Datuk Najib took to providing the ethnic breakdown of the population but chosen to overlook the existence of some 8.2 % the population who are non-citizens!
The use of statistics selectively appears to be a special feature used in the speech. Reference is made to the FBMKLCI index and the level is described as: “….. underscores the increasing local and foreign investors’ confidence in the economy”.
He failed to point out that the buoyancy of the market reflected inflows of speculative funds seeking a refuge. He has chosen to ignore the massive outflows of illicit capital or the weak performance of the Ringgit or the recent pressures in the bond markets.
The claims about FDI flows cannot be substantiated as they are based on nebulous statistics about “approvals” rather than “actual” flows. The statement concerning International reserves is equally slanted.
The truth of the matter is that reserves are customarily expressed in US Dollars whereas Najib has chosen to use the amount in depreciated Malaysian Ringgit. Furthermore, it is wholly disingenuous to provide a single point estimate given that over the past year the Reserves in US Dollar terms have dipped somewhat.
The Prime Minister makes the claim that the economy is expected to expand by between 4.5% and 5%. and that it would be supported in part by private and public consumption which are expected to grow at 7.4% and 7.3%, respectively mainly supported by strong domestic economic activity.
What he fails to indicate is that private consumption over the period under review was fueled by cash transfers (BRIM and other handouts), salary increases to 1.4 million public servants, the rapid increase in private household debt to finance over-priced homes, education loans, and over-priced transport equipment. These transfer are not sustainable and should not be counted in projecting private consumption.
The International Monetary Fund (IMF) Report following the annual consultations pointed with some concern to the rapid increase in loans extended to households by the banking sector.
The Report noted that total household debt exceeded 80 % of GDP. Thus, sustained growth in private household consumption is unlikely with slower growth in global trade that will impact incomes of commodity producers.
These developments will have a negative overall impact on incomes and consumption. Given, the limited head room, it will be virtually impossible to take counter-cyclical measures.
The Prime Minister continues to play fast and loose with the per capita GNI figures. He has chosen to use GNI in domestic current prices to calculate a period growth rate. This is wholly erroneous as growth rates are never calculated based on current price series.
He has then plucked a figure of US$ 15,000 as the bench mark for “developed country status.
There are several flaws in the approach. In the first place the World Bank does not have a “developed country status”. It does have a cut-off for determining “High Income Countries”.
Secondly, the methodology for calculating this level is done annually using a unique methodology that takes account of inflation rates, and incorporates moving average exchange rates etc. The methodology has no provision for projecting the cut-off points. Thus the entire presentation in the speech on this theme is spurious and misleading and builds false expectations.
In any event, the figure of RM 46,500 as the Ringgit level for reaching the “High Income Country” status by 2018 let alone 2020 is out of reach given the current and projected growth rates for Malaysia.
The Prime Minister indicated that in 2014, the Federal Government revenue collection will amount to RM224.1 billion, an increase of RM4 billion over the 2013 level.
It is a cryptic figure as no details are provided about how this level will be achieved. It also highly puzzling why the increase in revenue will only amount to RM4 billion, an increase of 1.8 percent, a rate well below the growth of GDP. This would imply that either the tax “give-ways” by way of rebates and exemptions are large or that there are other leakages in the system.
The Prime Minister made a number of points about reducing the size of the fiscal deficit. The most critical comment was that the Government is committed to achieving a balanced budget by 2020.
This indeed is a remarkable admission that deficits will continue to be a feature of fiscal policy until the end of the decade.
This addiction for spending beyond its means on the basis of borrowed money is a mind-boggling statement. Markets will undoubtedly take note and react in predictable ways and mete out punishments.
It is also most audacious on the part of the Prime Minister to state that the Government will ensure that the Federal debt level will remain low and not exceed 55 per cent. He fails to take account of the Contingent Liabilities which are estimated to amount to 15% of GDP.
The latter cannot be dismissed – they certainly will not be ignored by the markets and Rating Agencies. Fitch Rating has served notice that it will take note of Contingent Liabilities.
The KLCI performance on Monday October 28th was sobering and indicative of the market’s initial reactions.The benchmark FTSE Bursa Malaysia Kuala Lumpur Composite Index gained 0.82 points, or 0.05 per cent, to settle at 1,818.39.
What was more telling were the reactions of the two principal Rating Agencies. Fitch Ratings, in a carefully worded statement, noted the introduction of the GST as a potential constructive step but indicated that it was keeping the sovereign credit rating on Negative Outlook, pending “a track record of budget management.”
It pointedly reminded that the down grade in July was due to the deterioration in public finances and a perceived weakening of prospects for fiscal consolidation and budgetary reform.
Fitch made additional observations that highlighted its reservations. Fitch noted: “One is the restated commitment to the existing objective of a Federal Government deficit of 3.5% of GDP in 2014, and 3% by 2015, signaling a potential intensification of efforts to consolidate government finances.”
It noted that this was despite the Government’s weakened political position following the May 2013 general elections.
A second observation was that it noted a budgeted reduction in subsidy expenditure. However, Fitch noted that the steps to achieving this outcome had not yet been fully identified, and remained subject to external shocks.
Fitch took note of the proposed introduction of the long-mooted GST in April 2015, at an initial rate of 6%. It recognized that this was a key reform that could strengthen the credit profile by broadening the revenue base and lessening the budget’s dependence on petroleum-derived revenues.
The statement however went on to make the following observation: “We will look, however, for a track record of implementation towards the stated goal of deficit reduction (as a percentage of GDP), backed by subsidy rationalisation and GST introduction over 2014-2015. Hence the ratings remain on Negative Outlook.”
According to Fitch, another increasingly important issue was whether Malaysia could avoid the emergence of twin public and external deficits.
“As we have previously highlighted, the rapid erosion of Malaysia’s current account surplus has been driven partly by a drawdown of public-sector savings as well as by increased investment. The slippage of the current account position into deficit could increase Malaysia’s vulnerability to renewed market tensions when Fed tapering becomes more likely.
“Beyond the budget, Fitch has previously highlighted the rapid rise in federally guaranteed debt as a source of pressure on the credit profile. Guarantees rose to 15% of GDP by end-2012 from 8% at end-2008.”
Fitch warned that said this was an area of the public finances that it would be monitoring beyond the budget.
“The upshot of all this is that budget deficit reduction is heavily reliant on expenditure restraint, and a track record of sound budget management and implementation will be integral to our assessment. Moreover, the avoidance of a domestic savings/investment imbalance, which forestalls a weakening of Malaysia’s funding strengths, is also important,” it concluded.
Standard & Poor’s Ratings Services issued a statement stating that the Malaysian government’s proposed 2014 budget would have no impact on the sovereign ratings and outlook on Malaysia.
S&P has Malaysia on foreign currency A-/Stable/A-2; local currency A/Stable/A-1; axAAA/axA-1+.
The ratings agency said the budget’s target deficit of 3.5% of GDP for 2014, from 4% in 2013, was in line with its expectations of a gradual fiscal consolidation over the medium term.
It said the Goods and Services Tax, which will take effect in April 2015 at 6%, would allow the government to diversify its revenue base, but noted that the revenue impact would be neutral in the first few years because of other revenue-reducing measures announced in the budget.
“In our view, Malaysia’s slow fiscal consolidation stemmed from its relatively weak revenue structure and an inability to reduce high subsidies”.
These are no ringing endorsements of the Budget unveiled by Najib. The two Rating Agencies have signified that Malaysia would remain under watch. They have seemingly greater expectations for expenditure restraints and a more prudent fiscal policy.
The Government will inevitably need to make hard choices between adopting more stringent expenditure controls to convince the Rating Agencies and markets that it was truly embarked upon a path of comprehensive reforms to put its house in order.
A credible set of reforms would need to incorporate reining in runaway expenditures, tax reforms for rational distribution of tax expenditures, policies that remove impediments to growth and result in the elimination of policies that contribute to economic distortions.
It is evident from the tone of the statements from the two Rating Agencies that “business as usual” is not a viable option. The Government has to bite the bullet and take on the task of implementing true reforms.
It is starkly clear that the Budget that was unveiled does not address the ailments that afflict Malaysia. The Budget demands belt tightening on the part of households: household incomes will stagnate and household consumer debt will impact on consumption patterns.
The Budget however makes no attempt to introduce an element of austerity as the Operating Expenditure of the Federal Government continues to remain high; Development spending has not been reined in nor have lumpy projects been extended over time. The consequences of these inactions are that despite the extra revenues the Government will reap, the deficits will continue for the rest of the decade. The size of the debt under these circumstances will grow.
The Government and the Minister of Finance have a duty to act responsibly. There are lessons to be learnt from the crisis that the European countries – Portugal, Ireland Greece and Spain (PIGS) –endured.
That crisis was brought about by excessive debt, sluggish growth and fiscal imbalances. Policy remedies adopted were not painless. Austerity measures scaled back public expenditures, taxes were raised, and private consumption took a hit.
There are lessons for Malaysia. The Budget for 2014 and the policies that it incorporates sadly miss the opportunity to avoid the economic cliff.