We estimate the fiscal deficit target for 2020 to be higher at 3.2% of GDP from 3.0% previously. Budget 2020 is anticipated to be moderately expansionary, with the likelihood of higher development spending and continued support for the vulnerable group to ensure growth remains sustainable and inclusive. Although the government is unlikely to introduce new tax measures for Budget 2020, contingency plans may be included to cushion Malaysia’s growth from potential adverse impacts arising from prolonged trade tensions and global economic slowdown. This may lift the fiscal deficit target to 3.5% of GDP.

We expect the fiscal deficit target for 2020 to be higher at 3.2% of GDP with an overall balance of RM52.5bn (2019: 3.4% of GDP; RM52.1bn). Budget 2020 will be released on 11th October 2019.

Revenue: Following the receipt of RM30bn one-off special dividend from Petronas last year, it is likely that federal revenue for Budget 2020 will be lower. Nevertheless, revenues are still higher for 2020 if the special dividend is excluded (2020: RM238.3bn; 2019: RM231.8bn ex. special PETRONAS dividend). Total revenue is anticipated to be supported by slower but continued economic activity and refinement of new revenue policies that were introduced in Budget 2019 (digital tax, sugar tax and departure levy). Within total revenue, corporate income tax collection is expected to grow at a moderate pace (+2.0% YoY; 2019: +5.6% YoY) to RM71.6bn, aided by the Special Voluntary Disclosure Programme (SVDP) which is anticipated to capture a wider pool of tax payers which were previously under-reported or undeclared. As of June 2019, it was reported that some 486,360 taxpayers had participated in the SVDP programme. Similarly, individual income tax should see modest growth to RM35.7bn (+2.0% YoY; 2019: +7.2% YoY). Meanwhile, SST collection is anticipated to grow in 2020 by +5.3% YoY to RM23.2bn (2019: RM22.0bn), driven by continued growth in the consumption sector and implementation of digital tax. To assess the potential digital tax revenue from foreign service providers in Malaysia, we have extrapolated the estimates for South Korea and adjusted for differences in Malaysia’s population, internet penetration and tax rate. Consequently, the digital tax could potentially generate RM449m in annual tax revenue, within the range shared by MoF of RM300- 500m during our previous meeting with them. Apart from digital tax which will come into force in 2020, the government has indicated that there are no plans for new tax measures in the upcoming budget. As we anticipate average Brent oil price to be stable in 2020 (HLIB average 2020 forecast: USD65/pb), oil-related revenue is expected to contribute 21.3% of total revenue, lower than 2019 and 2018 oil dependency ratio (30.9% and 22.0% respectively).

Expenditure: While total government expenditure is estimated to be lower in 2020, it is still higher after excluding the one-off RM37bn tax refunds allocated in 2019 (RM291.3bn; 2019: RM277.6bn excluding tax refund).

Development expenditure: On development expenditure, we expect allocations to increase (RM56.0bn; 2019: RM54.7bn), based on the Medium-Term Fiscal Framework 2019-2021 which provides for RM110bn remaining development expenditure for the 2020-2021 periods. We anticipate government to front-load the spending in 2020 and remain focused on agriculture and rural development, transport, public utilities in the economic sector and education, health and housing in the social sector. In the face of palm oil price volatility, the government may provide incentives for palm oil planters to diversify into food crops with enhanced technology levers to lower farmers’ dependency on palm oil. We also anticipate the government to allocate funds for rehabilitation of old buildings, restoration of roads, and implementation of projects that were previously delayed due to review (e.g. LRT3 and Pan Borneo portion in Sabah). In the social sector, education, health and housing subsectors will most likely be allocated higher funds as the government works towards bridging the urban-rural development gap through improved access and quality of basic services.

Operating expenditure: On operating expenditure, spending is anticipated to be driven mostly by higher payments for emoluments, pensions & gratuities, debt service and subsidies & social assistance. Emoluments, pensions & gratuities remain a financial burden to the government, with emoluments and public pension scheme amounting to RM108.6bn (34.5% of total government expenditure). Over time, emoluments could see a more modest pace of growth, as the government switches to a contractual scheme for civil servants, with the aim of achieving targeted savings of RM5bn a year. As such, the proposed contractual scheme for new recruits in the civil service will see the civil sector on shorter-term basis employment with limited pension payouts. Nevertheless, until the proposal is finalised, the emoluments, pensions & gratuities component is expected to grow further. As we foresee a moderately expansionary budget, subsidies & social assistance could likely increase in 2020, partly reversing its previous decline (+11.0% YoY; 2019: -19.1% YoY). In an environment of weaker growth, government is expected to provide more targeted assistance to vulnerable groups (e.g. expanded social welfare programs, early childhood and education assistance, nutrition programmes). Targeted petrol subsidy scheme is also expected to be implemented in 2020. Meanwhile, we expect the allocation for supplies & services to decline further in 2020 (-5.0% YoY; 2019: -17.6% YoY) to RM27.6bn as the government continues its cost rationalisation efforts through the practice of open tender system and zero-based budgeting. Similarly, grants and transfers are also expected to see lower allocation.

Other key areas of focus for Budget 2020 would include Visit Malaysia Year 2020 (VMY2020). The Tourism Ministry is targeting 30m tourist arrivals, generating RM100bn in tourist receipts. According to Finance Minister Lim Guan Eng, the government is proposing an additional allocation for VMY2020 from RM100m provided in 2019 for marketing and promotional activities. In line with this, visa on arrival requirements for tourists from China and India may be relaxed. We also expect to see an extension of grants and incentives for SMEs in the push towards IR4.0. In August 2019, Cabinet approved the implementation of RM21bn National Fiberisation and Connectivity Plan over five-year period from 2019-2023. A special task force will be set up to coordinate the construction of digital infrastructure in schools, police station, hospital and libraries. This is in line with the government's goal of encouraging the development of the digital economy in Malaysia in the era of IR4.0. Measures to improve the business environment through simplifying and accelerating the investment approval process should also be expected. In World Bank’s report, it was reported that as a result of increased reform activity, Malaysia ranked 3rd global performer in dealing with construction permits indicator and 4th for getting electricity indicator. Nevertheless, Malaysia still faces obstacles. In the area of starting a business, it is still relatively cumbersome for local entrepreneurs while it takes an average 188 hours per year for businesses to prepare, file and pay taxes, significantly longer than other regional countries. Hence, as Malaysia gears towards a high-income economy, improving the ease of doing business may help enhance the dynamics of Malaysia’s economic development and attract more foreign direct investment.

Contingency plan: With heightened risks to growth emanating from prolonged US China trade tensions and slowing global growth, we opine that Budget 2020 will include a contingency plan to cushion Malaysia’s growth from the potential adverse impacts. During the Global Financial Crisis, an initial RM7bn stimulus package was rolled out in November 2008, while the second stimulus package worth RM60bn was introduced in March 2009. As growth is anticipated to be slower, we think a contingency plan amounting to RM4bn could be in the offing. It will likely be in the form of additional development expenditure and tax benefits which could lift the overall balance to RM56.5bn and fiscal deficit to 3.5% of GDP. The additional allocation will be used to fund projects with high multiplier effect on the rest of the economy, including construction of infrastructure projects like low and medium-cost homes, public transport (MRT3), extension of housing loan repayment, possible tax cuts to support the economic activity.

Source: Hong Leong Investment Bank Research - 25 Sept 2019