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Malaysia’s Budget Woes

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Pacific Money

Malaysia’s Budget Woes

Prime Minister Najib Razak is under pressure to raise taxes to address Malaysia’s persistent budget deficits.

An Asian government facing persistent budget deficits is under pressure from financial markets to introduce a consumption tax, despite popular and internal party opposition. Sound familiar? This time though, it is Malaysia and not Japan whose leader is in the firing line ahead of its 2014 budget announcement on Friday.

ANZ economist Weiwen Ng did not mince words when describing the challenge facing the Malaysian government in an October 22 research note, which was headlined “Bitting the fiscal consolidation bullet.”

“Given international capital’s aversion to ‘deficits’ and Malaysia’s multi-year structural fiscal deficit, we would prefer to see Malaysia err on the side of fiscal prudence rather than growth…Malaysia’s fiscal deficit is still woeful – multi-year structural deficit (for 15 consecutive years) and not enough has been done to narrow the structural deficit,” Ng said.

“Tax reforms such as the introduction of GST [goods and services tax] is never popular but is a necessary evil that has been long overdue for Malaysia,” he added.

According to Bloomberg News, the Malaysian ringgit has shown the biggest gains this month among 24 emerging market currencies on speculation that Malaysian Prime Minister Najib Razak will honor promises to curb the budget gap by enacting politically unpopular tax hikes.

Fitch Ratings cut Malaysia’s credit outlook to negative in July, citing increasing debt levels and a lack of fiscal reform. After responding with a cut to fuel subsidies, Najib, who also serves as finance minister, faces the threat of further downgrades and potential spikes in government bond yields should his budget disappoint.

“Going into the budget, there is an expectation from the market that Malaysian authorities will take the right steps,” Nomura strategist Vivek Rajpal told Bloomberg. “We believe authorities will take the right steps. But in case they don’t, it should impact the bond markets negatively.”

ANZ’s Ng expects Kuala Lumpur to introduce a goods and services tax at a rate of around 4 to 5 percent in 2014 or 2015, which could raise as much as 14 percent of total tax revenue. Citing the need to broaden the tax base, the economist noted that “only 16 percent of the working population currently pay taxes” and petroleum-related revenue, accounting for 40 percent of total revenue, has been in decline.

However, this would give consumption spending a “double whammy” due to expected cuts to subsidies for essential food items along with energy costs. Other measures forecast include slower spending on infrastructure projects, higher property tax and hikes in “sin” taxes for the brewery and gaming sectors.

Yet after staving off challenges from rival factions for the leadership in recent party elections, Najib is in a stronger position to implement the budgetary reforms. According to ANZ, the result would be an estimated narrowing of the forecast deficit from 4 percent this year to 3.5 percent in 2014 and 3 percent in 2015, assuming the goods and services tax is implemented.

While aiming for a balanced budget by 2020, the growing budget deficits have increased national debt to 53.5 percent of GDP from 43 percent in 2008, approaching a self-imposed ceiling of 55 percent.

Malaysia’s central bank has cut the nation’s GDP growth forecast to 4.5 to 5 percent in 2013, down from the previously expected 5 to 6 percent, with further fiscal tightening likely to hit both consumers and the ruling National Front’s popularity.

According to Bank of America Corp., government expenditure is the highest among the five biggest Southeast Asian economies, accounting for nearly 27 percent of GDP, while Malaysia also has the highest civil servant to population ratio in the region.

Can Najib deliver? Ng said there was a risk of a sell-off should the prime minister underwhelm investors, “though not to the extent of a repeat of the 1997/98 crisis.”

“Nonetheless, lower-than-expected GDP growth, as well as higher-than-expected subsidy and developmental expenditure could result in slippage, translating to upside risks in our fiscal deficit forecast,” he said.

Datuk Seri Nazir Razak, group chief executive of Malaysia-based CIMB Group, warned Tuesday that Malaysians should not expect any handouts given the “challenging” conditions.

“We have gone through a long period of incentives and we have a collective interest to make sure that we put the public finances as priority. If the government gets that wrong, then it would have a negative impact on the ratings outlook,” he was quoted saying by Malaysia’s The Star.

Najib has a potential role model in Japanese Prime Minister Shinzo Abe, who is planning his own consumption tax hikes to improve government finances. Yet with a debt burden considerably lower, the Malaysian leader likely will not be seeking advice from Tokyo anytime soon.