Budget 2019, which will be tabled in Parliament on November 2, will be important for a number of reasons. For a start, it will be the first budget presented by the new Pakatan Harapan (PH) government. Next, this budget will be a challenging one as the new PH government will need to fix huge fiscal finances and at the same time address the well-being of the rakyat.

We believe this budget is unlikely to contain short-term populist measures such as providing subsidies, grants and easy government-led financing, but should provide strong and clear policies that will help the economy ride out the current challenging time in the near future. With lower GDP growth envisaged in 2019, projected at 4.5% from 5.0% estimated for 2018, added with higher fiscal deficit/GDP after taking into account of the RM35bil refund for GST and income tax plus slower revenue growth and 5% - 10% cut in expenditure, the fiscal deficit/GDP could jump between -3.7% and -4.6% in 2019. We view this as a “one-off” scenario.

Looking at the local KLCI sentiments, we adopt a fairly cautious outlook as compared to the fixed income market. Underpinned by slower GDP growth, the 2019 corporate earnings are projected to grow by 5.7% from 2.4% in 2018. Besides, the rising fiscal deficit/GSP may open the door for foreign rating agencies to revisit our current ratings. Thus, we have lowered our 2018 and 2019 KLCI target to 1,790 (previously 1,900) and 1,890 (previously 2,020) based on 18.5x PE multiples.

Meanwhile, we foresee higher issuances of papers in 2019. Factoring the “one-off” refund of RM35bil for GST and income tax added with lower revenue growth following slower GDP outlook for 2019 and a reduction of total spending by 5% to 10%, we expect the supply of papers to hover between RM126.1bil and RM144.6bil next year based on a fiscal deficit/GDP between -3.7% and -4.9 in 2019. Thus, the fixed income market is poised to stay exciting.

Hence, we maintain our OPR outlook at 3.25% until 1H2019, with room for a 25bps hike in 2H2019 as potential inflationary pressure is expected to emerge in 2H2019 driven by rising underlying inflation added with higher cost partly due to the weaker ringgit. Besides, the rate hike is also to address the narrowing interest rates differential with the US Fed fund rate which should reach zero in 2019 based on three rate hikes by the Fed in 2019 and another hike in 2020 bringing the normalised rate at 3.50%.

A. Slower GDP outlook

• Budget 2019, which is the first under the Pakatan Harapan (PH) government, is scheduled for tabling in Parliament on November 2. This budget is expected to be a challenging one for the PH government who needs to fix the fiscal finances and at the same time addresses the well-being of the rakyat.

• After seeing the Barisan Nasional (BN) government lowering the fiscal deficit/GDP from its peak in 2009 at -6.7% to - 3.1% in 2017 and projected to drop to -2.8% in 2018, it now remains unclear if the 2018 fiscal deficit/GDP will be able to meet the target. The PH government is saddled with: (1) a huge public debt of RM1.087tril or 80.4% of GDP under the “balance sheet”; and (2) the need to refund RM35bil GST and income tax which will appear under the “income statement” besides experiencing the shortfall of revenue by replacing the GST with the SST.

• We have lowered our 2018 GDP growth projection to 5.0% on the back of lower public expenditure, weak mining and agriculture and slower construction/infrastructure activities following the postponement of some of the mega projects. Growth will be supported by private consumption and private investment, compounded with exports. On the supply side, we foresee growth from services and manufacturing.

• Looking into 2019, underpinned by tighter fiscal spending, the focus of growth will come from private expenditure. Private consumption will be the main growth driver supported by favourable labour market conditions, continued growth in income levels and moderate inflation. Besides, private investment will be another growth catalyst riding on the government’s plan to further strengthen the ecosystem, attracting quality investments that create more high-paying skilled jobs, particularly in the manufacturing and services sectors. With moderate exports growth and softer public expenditure, we foresee growth to be around 4.5%.

B. A ‘one-off’ spike in fiscal deficit/GDP

• The PH government is slapped with two major issues – addressing the balance sheet and income statement owing to the huge debts it needs to shoulder. However, our focus will be on the size of the fiscal deficit/GDP for both 2018 and 2019.

• For 2018, we are not ruling out on the possibility of the fiscal deficit/GDP rising higher than the projected -2.8%. After taking into account of the revenue loss following the replacement of the GST with the SST, much depends on the expenditure cut. Assuming expenditure is slashed by 3%–5% with the oil price at US$66 to US$71 per barrel, we project the 2018 fiscal deficit/GDP to be around -2.8% to -3.3% of GDP.

• In our view, the fiscal deficit/GDP is expected to jump in 2019, largely due to the RM35bil refund for GST and income tax. With the GDP projected at 4.5% that results in a 3%–5% drop in revenue plus a 5%–10% cut in total expenditure, we expect the fiscal deficit/GDP to jump to between -3.7% and -4.9%. We believe this jump is more likely a “one-off” spike. We expect the fiscal deficit/GDP to ease in 2020 on the back of better growth of 5.1% supported with prudent management, greater levels of transparency and governance. The fiscal deficit/GDP should hover between -2.9% and - 3.1% of GDP.

C. Capital market

• Looking at the local KLCI sentiments, we adopt a fairly cautious outlook as compared to the fixed income market. Underpinned by slower GDP growth, the 2019 corporate earnings are projected to grow by 5.7% from 2.4% in 2018. Besides, the rising fiscal deficit/GSP may open the doors for foreign rating agencies to revisit our current ratings. Thus, we have lowered our 2018 and 2019 KLCI target to 1,790 (previously 1,900) and 1,890 (previously 2,020) based on 18.5x PE multiples.

• Meanwhile, we foresee higher issuances of papers in 2019. Factoring the “one-off” refund of RM35bil for GST and income tax added with lower revenue growth following slower GDP outlook for 2019 and a reduction of total spending by 5% to 10%, we expect the supply of papers to hover between RM126.1bil and RM144.6bil next year based on a fiscal deficit/GDP between -3.7% and -4.9 in 2019. Thus, the fixed income market is poised to stay exciting.

• Hence, we maintain our OPR outlook at 3.25% until 1H2019, with room for a 25bps hike in 2H2019 as potential inflationary pressure is expected to emerge in 2H2019 driven by rising underlying inflation added with higher cost partly due to the weaker ringgit. Besides, the rate hike is also to address the narrowing interest rates differential with the US Fed fund rate which should reach zero in 2019 based on three rate hikes by the Fed in 2019 and another hike in 2020 bringing the normalised rate at 3.50%.

D. Our area of focus

• A key growth driver will be private investment which has suffered a drop. However, we found private investment growth eased from 21.4% in 2012 to 9.3% in 2017 due to challenges like cost competitiveness and competition for foreign direct investment. Hence, we hope the budget will continue to nurture a flexible and open business environment alongside simplifying and streamlining the systems, processes and regulations to set up businesses. Also, we hope the budget will revisit all the tax exemptions, credits and allowances and streamline them based on their effectiveness. If possible Budget 2019 should look at ways to dismantle some of these tax exemptions, credits and allowances and in turn translate them into a lower corporate tax. And to support automation and technology upgrading, we hope the government will look at ways and means to plough back a portion of foreign workers’ levies collected around RM2.8bil per year probably by establishing a “special investment fund”.

• Small and Medium Enterprises (SMEs) play an important role in driving economic growth. Its contribution to GDP is projected around close to 40%. We wish to see the government laying out very clear direction on manpower that has curtailed the expansion capacity and taking new orders of some of the SMEs as well as clearer classification of those under manufacturing or service providers for the purpose of the SST. Besides, we hope there will be measures/incentives for the SMEs to strengthen and promote the development of the tech industry with the aim of embarking on new technologies and invest in value-added equipment, a move that will also help reduce foreign workers.

• With the increasing focus on driving the contribution of digital economy to GDP from 18.2% in 2016 to 20% of GDP by 2020, we hope the budget would present a holistic strategy. The strategy is expected to benefit everyone and at the same time help contribute to the development of the economy. Hence, we hope Budget 2019 will include initiatives that will accelerate the fourth industrial revolution by developing and regulating the tech industry and promote digital technology. By regulating the tech industry, the authorities can look forward to a new stream of revenue while tech companies will increase their reported earnings. With the digital tax expected to be introduced in Budget 2019, we will be the second country in Southeast Asia after Singapore to introduce such a tax. Alongside that, we hope there is also focus on e-commerce besides emphasising that companies list their products online with the aim of becoming a hub for tech companies in the future.

• Budget 2019 should focus on exports which are important given that we are a trading nation. The budget could look at increasing the market development grant from RM200,000 to RM500,000 for export promotion programmes (branding, packaging and international marketing) and further enhancement of exports through cost-efficient transportation, logistics and ports; trade facilitation and custom clearance (simplifying documents, streamlining procedures; market intelligence). Besides, the budget could increase the R&D funding to incentivise original equipment manufacturers (OEM), own design manufacturers (ODM) and original brand manufacturers (OBM).

• To support the consumption-related services — the retail trade, accommodation, food and beverage — which benefit from tourism through greater tourist spending, we hope the budget would provide incentives for tourism vehicles, website development and upgrades, information communication technology (ICT) and automations.

• In a move to spur private consumption which plays a key role in driving the economic activity, the budget should look into tax relief measures for retail chains planning to invest in expansion by renovating new and existing outlets. The tax relief could be based on the number of stores or amount spent on expansion.

• On healthcare, many Malaysians still cannot afford to buy the health insurance they require. We hope the government would look into a mechanism that provides enable the B40 group to seek basic treatment from registered private clinics. Also, we hope the budget would look into some form of an annual family insurance scheme to pay hospital bills.

• To address the rising urban living cost, we hope the budget will look at urban housing i.e. “social housing” below RM100,000 which the urban poor are currently renting from third parties. Measures should be designed to assist and motivate them to buy and own. Also, there should be measures for them to use both bus and rail services based on a transport card on a fixed nominal monthly fee for unlimited rides.

• We would like to see the budget provide more tax breaks for children’s education expenses which are increasingly costly. Also, the need to continue to prioritise education by investing more and reduce cutbacks to improve the education system like the training of teachers, school facilities and sports education. We hope the budget will continue emphasizing the importance of information technology (IT), introduce coding in the curriculum and go digital.

• The budget may incentivise investments in new building technologies (such as the industrialised building system or IBS and aluminium formwork system) and new construction machineries. This will help to reduce the reliance on foreign labour, wastage and downtime.

• The budget may revisit the “Home Ownership Campaign” that was introduced in 1998 and 1999 to stimulate demand and resolve property oversupply in the aftermath of the Asian financial crisis. Financing incentives include the exemption of stamp duties and lower financing costs for houses purchased during this period. Legal fees were lowered for the sale and purchase and loan agreements as well as other charge documents. A total of 19,281 and 17,956 units of residential and commercial properties were sold during the first and second campaign.

Source: AmInvest Research - 24 Oct 2018