• Historically, Malaysia's inflation peaked three months post-GST, then normalized
• Modest June inflation, noticeable diesel SRI impact expected from July
• Limited CPI impact expected due to targeted measures
•  Our forecast for 2024 inflation remains at 2.7%, with a potential for upward revision

The Goods and Services Tax (GST) in Malaysia, implemented on 1st April 2015, was applied at every stage of production and distribution. In contrast, the Sales and Services Tax (SST), which replaced GST on 1st September 2018, is applied only once, either during manufacturing or when goods and services are consumed. The switch from GST to SST was intended to lower the tax burden on consumers and make it simpler for businesses to comply with tax regulations. Looking at historical data, inflation in Malaysia peaked at 3.3% in July 2015, just three months after GST was introduced, but then normalized. After this initial peak, inflation jumped to 4.2% in February 2016 due to an El Niño-driven shortage of fresh vegetables, and then spiked again to 4.9% in March 2017 because of high fuel prices, a weaker ringgit, and the low base effect from the previous year.

The impact of GST implementation on inflation was initially significant but proved to be temporary, as inflationary pressures peaked a few months after the GST was introduced and then gradually normalized. Similarly, we anticipate that the effects of diesel subsidy rationalization will follow a comparable pattern: initially causing noticeable inflationary pressures, which will eventually stabilize and normalize after reaching their peak.

FUEL SUBSIDY RATIONALIZATION – POSSIBLE IMPACT

When fuel prices rise, the spill over effect raises the cost of goods and services that depend on fuel. For example, higher fuel prices lead to increased transportation costs, making items like groceries and manufactured goods more expensive. This chain reaction pushes up overall prices and adds to inflationary pressures. The extent of price increases depends on how essential these items are to consumers and how competitive the market is. Historically, fuel price increases have led to higher transportation, food, and housing costs. However, government price controls or subsidies can mitigate these impacts, helping to prevent a rapid spike in overall inflation and stabilize the economy.

In June 2024, Transport inflation rose to 1.2% (May: 0.9%), driven by a 1.7% increase in personal transport equipment costs and a 0.9% rise in Fuels & lubricants. This coincided with higher average prices for Unleaded Petrol RON97, and Diesel compared to the previous year. Food inflation increased to 2.0% in June (May: 1.8%). The Food at Home subgroup rose by 0.9% (May:0.5%), while Food Away from Home grew by 3.3%, slightly slowing from 3.4% in May. Meanwhile, inflation for the Housing, Water, Electricity, Gas & Other Fuels group remained at 3.2% in June, consistent with May 2024. This was driven by a 32.1% increase in the Water supply & miscellaneous services subgroup, with Water supply costs rising 32.0%, maintaining the same rate as in May.

Despite expectations that removing the diesel subsidy in June would raise Malaysia's CPI above 2%, June’s inflation held steady at 2% due to rising costs in restaurants, accommodation, utilities, and food. The impact of the diesel subsidy rationalization, which began on June 10, 2024, was modest in June's inflation but is expected to become more noticeable from July onward. However, the effect will be limited since the rationalization only applies to Peninsular Malaysia and diesel makes up just 0.2% of the CPI basket. Additionally, targeted measures like the diesel fleet card system and cash transfers are likely to offset the inflationary effects.

Outside of the direct impact on price pressures, the fuel subsidy rationalisation would also have an indirect impact on the purchasing power of households. In recent months, people on the ground have been very vocal of the increasing costs of living. The prices of goods and services has been on the rise, especially for those in urban centres, but wages are relatively stagnant. A proxy that can be used to monitor the financial capacities of households is their savings. Based on a report by the Malaysia Deposit Insurance Corporation (PIDM), the majority of Malaysians, consistently across the board, would only save when they can – signalling situations only when they have excess cash to spare for their savings. As such, in the aftermath of the Covid-19 where most households had tapped into their emergency funds, their financial conditions are tighter now. A survey by RinggitPlus shows that approximately 70% of Malaysians save less than RM500 per month.

So how does this tie into the policy reforms? Households are already burdened by the higher costs of living crisis as well as their tighter financial conditions. Adding the fuel subsidy

rationalisation, especially the Ron 95, to the mix will only cinch household spending further. Malaysians would have to restructure their spending patterns to prioritize the essentials and reduce recreational and entertainment spending. This would lead to lower retail sales as shown by historical data. Following the implementation of GST, retail sales had slipped to 8.4% in April 2015, down from 12.7% in March 2015. The downtrend persisted for a while, where retail sales expanded slower than the previous average of double-digit growth. Consequently, the private consumption and services sector growth would be weighed down by the dampened domestic demand.

MOVING FORWARD

The removal of fuel subsidies affects households differently by income. Poorer households (B40) spend more on food, making them more vulnerable to fuel price changes, but targeted financial transfers should help mitigate this. High-income earners (T20) are less impacted, while middle-income households (M40) may face significant challenges without government support. Malaysia's Finance Minister II said recently that it's not a good time to bring back a broad-based goods and services tax because many people are struggling with rising costs. Instead, he explained that the government will work on improving the current tax system and introduce new taxes that would not hurt vulnerable groups before deciding if a new consumption tax is necessary.

Furthermore, May's labour participation rate held at 70.3%, boosting household spending through better labour market conditions, tourism recovery, and increased trade. Targeted cash assistance is expected to mitigate inflation despite potential subsidy rationalization impacts. Prime Minister Anwar Ibrahim confirmed no current plans to rationalize the RON95 subsidy, prioritizing the diesel issue first. With the likely delay of RON95 subsidy rationalization until next year, our current inflation forecast of 2.7% for this year may be revised downward. We still expect inflation to remain within Bank Negara Malaysia’s (BNM) 2.0% to 3.5% range, considering the reduced CPI weight of fuel and lubricants to 5.9% from 8.5% last year. BNM is likely to keep the overnight policy rate at 3.00% for the rest of 2024, closely monitoring subsidy policies.

Looking ahead, inflation trends will be shaped by policy decisions and global commodity prices. Overall, we are optimistic about Malaysia's economic outlook for 2024, driven by strong domestic spending, improved external demand, a robust labour market, and a strengthening Ringgit in the latter half of the year.

Source: BIMB Securities Research - 6 Aug 2024