Fiscal prudence has been the key focus, reflected by the drop in budget deficit from 6.7% of GDP in 2009 to 3.0% in 2017 and we expect it to reduce further to -2.8% of GDP in 2018. The unprecedented victory by Pakatan Harapan (PH) in the recent GE14 has put the focus on the fiscal deficit based on its manifesto to switch the GST to SST and introduce electricity and fuel subsidies.

In our analysis, if we assume an environment where there is weaker transparency, financial prudence, reduction in wastages and corruption, and better public service, the deficit is expected to swell up to RM51bil, which translates into a fiscal deficit of -3.5% of GDP. However, based on the success stories of Penang and Selangor under PH, if we factor in a 5% reduction in operating expenditure, the deficit will be around RM39bil to RM40bil, translating into a fiscal deficit of -2.7% or -2.8% of GDP.

Overview

• Between 2009 and 2017, the government has successfully reduced the fiscal deficit from 6.7% of GDP to 3.0% of GDP. The fiscal policy continues to prioritise fiscal consolidation while at the same time ensures a sound macroeconomic environment.

• The unprecedented victory by Pakatan Harapan (PH) in the recent GE14 has put the focus on the fiscal deficit. It comes about following PH’s manifesto that among others, promises to: (1) abolish GST and reintroduce SST; (2) reintroduce electricity subsidy; and (3) reintroduce petrol subsidy. The Ministry of Finance has announced that GST will be set at zero beginning June 1, 2018.

• Will these measures add strain to the fiscal balance that we have projected at -2.8% of GDP, in line with the forecast of 2018 Budget? We aim examine this in this paper.

A. Replacing GST with SST

• We projected the revenue for 2018 at RM240bil. Contribution from tax revenue is expected to be around RM192bil where the direct tax accounts for RM128bil while indirect tax makes up RM64bil. The projected contribution from the goods and services tax (GST) in 2018 is RM44bil or 18.3% of total revenue.

• By replacing GST with sales and services tax (SST) and assuming the sales tax is 10% while the services tax is 6%, we can expect some shortfall in the revenue collection. GST covers everyone, retailers and traders while sales tax only covers manufacturers and services tax covers certain prescribed services such as professional services (see Table 1).

• If the economy had continued to operate under the SST environment (GST was introduced on April 1, 2015), our extrapolation shows that the estimated revenue collected from SST will be around RM28bil in 2018, resulting in a RM16bil shortfall against the RM44bil GST forecasted for 2018. (See Chart 1)

B. Electricity and fuel subsidies

• The 2018 Budget estimates that the total subsidies will be RM26.5bil, which make up 11.3% of the RM234bil total operating expenditure.

• Given that PH has planned to reintroduce the electricity and fuel subsidies, this has raised concerns on the impact to the operating expenditure as well as the overall fiscal balance.

Electricity subsidy

• By introducing electricity subsidy, it could result in TNB absorbing part of the higher fuel costs. At present, it is being passed on to consumers though the Imbalance Cost Pass-Through (ICPT) mechanism.

• A move to subsidise electricity is expected to add RM2.0bil per annum into the projected RM26.5bil of subsidies allocated under the 2018 Budget.

• Hence, the new amount of subsidies will increase to RM28.5bil, translating to 12.2% of the RM234bil operating expenditure from 11.3% previously.

Fuel subsidy

• PH plans to introduce fuel subsidy and stabilise oil prices. The consumption of petrol and diesel for 2018 is projected at 23bil litres based on a 2% vehicle growth to 588,168 units. Sales of EEV vehicles will be around 52% of total sales or around 305,847 units (see Chart 2).

• Should there be a 10sen/litre fuel subsidy, it will raise the subsidy bill to RM2.3bil based on 23bil litres of petrol and diesel expected to be consumed in 2018.

• However, the current retail pump price for petrol and diesel is subsidized at about 20sen/litre. If the subsidy level remains at 20 sen/litre, based on our projected 23bil litres of petrol and diesel consumed in 2018, it will amount to RM4.6bil.

C. Oil revenue

• The total increase in subsidies will be approximately RM30.8bil – RM33.1bil, taking into account of the electricity and fuel subsidies. Additional subsidy of RM4.3bil – RM6.5bil could be compensated with the firming of global crude oil prices.

• For the 2018 Budget, the projected crude oil price was US$52 per barrel, which translates to a total oil revenue of RM11.4bil. However, oil prices have climbed steadily since then. The YTD prices for WTI and Brent are US$64 and US$69 per barrel, respectively.

• In the meantime, we have revised upwards our 2018 outlook for WTI and Brent to average at US$64 and US$68 per barrel from previously US$56 and US$58 per barrel.

• Our estimates suggest that for every US$1.00 gain in crude oil prices, the additional revenue collected from oil will be around RM300mil. Following our upwards revision on oil prices by US$9 – US$11 per barrel, the additional income will be between RM3.6bil to RM4.8bil. It will help to reduce the burden of higher subsidy which is estimated around RM RM4.3bil – RM6.5bil.

D. Fiscal deficit

• In our base case prior to the introduction of SST and additional subsidies coming from electricity and fuel, our projected net deficit amounts to RM40bil which translates to a fiscal deficit of 2.8% of GDP.

• If we take into consideration of the switching from GST to SST with a shortfall of RM16bil, additional revenue from oil around RM9bil – RM11bil and subsidies for electricity amounting to RM2.0bil and fuel subsidy of 10sen/litre or 20sen/litre which translates to RM2.3bil to RM4.6bil, our forecasted net deficit will hover around RM51bil and RM52bil. It translates into a fiscal deficit of -3.5% to -3.6% of GDP in 2018 (see Table 3).

• However in a more realistic scenario, we do not expect the fiscal deficit to swell up. With PH’s strong track record in managing the states of Penang and Selangor, we expect a similar model will be applied at the national level. It would mean greater level of transparency, financial prudence, reduction in wastages, reduce corruption and better public service. These will help improve cost savings in the operating expenditure.

• If we assume the new administration is able to save 5% of its operating expenditure which is estimated at RM239bil – RM242bil after incorporating the subsidies and assuming there are no additional taxes which means the revenue will be around RM233bil – RM235bi), the deficit will be around RM39bil -RM40bil for 2018. And with no change to our GDP growth of 5.5% for 2018, the budget deficit is expected to be between -2.7% and -2.8% (see Table 3).

Source: AmInvest Research - 17 May 2018