Friday 5 October 2012

Malaysia’s Fiscal Account - The need for high crude oil prices or a new tax system


In the event that the world economy goes into a tailspin and global demand for crude oil plummets, Malaysia may face the risk of a wider fiscal deficit. Though to some extent it may bring cheer to consumers due to lower fuel prices and it may ease the financial burden of the Government due to subsidy reduction, it might also have a debilitating effect on the fiscal account.

Crude oil is Malaysia’s biggest mineral export accounting for about 5.0% (RM32.0b) of total exports in 2011. In terms of commodity exports, it is second to palm oil - which accounts for about 10% of total exports. However, movement in crude oil prices has wider impact on the Malaysian economy as it has to the world.

Petroleum related income is the largest single contributor to the Government coffers. It accounted for about 33.9% or RM62.9b of Government’s total revenue in 2011. In 2009, it reached its highest level at almost 40%. This is largely derived from Petroleum Income Tax (RM32.0b), Petronas’ dividend payment (RM30.0b), royalty (RM5.1b) and export duties (RM1.7b).

Based on our sensitivity analysis of different levels of crude oil prices and its effects on Malaysia’s fiscal account balance, the latter would benefit from a slightly higher crude oil price. The optimal yearly average level would be at around US$100/barrel (WTI), which help to narrow the budget deficit to around 3.3% of GDP for 2013 (Please refer to table). The equivalent Tapis crude price is around US$126/barrel. It would also help to lower the fuel subsidy to around RM20.7b from an estimated RM25.2b in 2012.

There is a higher probability that the Ministry of Finance’s fiscal deficit forecast for 2012 is achievable as its target average Tapis price is US$105/barrel for the whole year, which is rather conservative as the year-to-date average is currently at around US$120/barrel. Tapis crude is currently traded at around US$113/barrel. The MoF’s budget deficit forecast for this year is 4.5% of GDP better than its initial target of 4.7% of GDP, suggesting that fiscal consolidation is well-paced along with pro-growth policies to strengthen domestic economic activity in spite of weakening global economy.

If average crude prices manage to remain below US$90/barrel, there is the likelihood that Malaysia’s budget deficit would remain above 4.5% of GDP for 2013. Based on our worse case scenario of US$60/barrel, this would result in the budget deficit to possibly hit 5.6% of GDP. However, this would be relatively better than the 22-year-high 6.7% deficit that Malaysia registered in 2009 when the average crude price was around US$61/barrel. Even if Malaysia hit a budget deficit of 6.0%, we still think that it is still manageable and may escape a sovereign credit rating downgrade. But this is premised on whether its debt to GDP could still be maintained at below 60% of GDP.

The dependency of crude oil by the Government is a strong case for efforts to broaden Malaysia’s tax base. We believe that the Government is already committed towards fiscal discipline and it takes more than fiscal restraint to achieve a budget deficit target of 3.0% to GDP or lower by 2015. One of the major and most awaited policies is the implementation of the Goods and Services Tax (GST) which we believe is likely to be introduced in 2014. The broader tax base under the proposed GST would boost the Government’s coffer as proven by countries that have done so. Though the GST may bring short-term adjustment pain to the people and the economy in general, a further delay of the implementation of GST may disrupt Malaysia’s long-term goal of becoming a developed nation by 2020.

Source: Kenanga 

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