A Likely Expansionary Budget 2020, Mainly From Higher DE

Budget 2020 likely to include measures to sustain private consumption

The 2020 Malaysian Budget will be presented on 11 October 2019, with the theme “Shared Prosperity: Sustainable and Inclusive Growth Towards High Income Economy.” The upcoming 2020 Budget is crucial as it will be the final budget under the Eleven Malaysia Plan (11MP) for the 2016-2020 period. Similarly, the strategies on the Budget proposals should be seen in the context of ensuring a transition to the development plan of the Twelve Malaysia Plan (12MP) for the 2021-2025 period, as well as setting out the directions and right strategies for Malaysia to become a high-income economy.

Despite widely expected to be an expansionary budget to stimulate domestic demand amid the global economic uncertainty in 2020, we believe the Federal Government will remain focused on fiscal discipline, incurring a slightly lower budget deficit of 3.2% of GDP in 2020, compared with a deficit of 3.4% of GDP in 2019E, slightly higher than the initial official target of 3.0% of GDP (see Fig 1).

The increase in the budgetary allocation for operating expenditure will be gradual, but allocation for development expenditure (DE) will likely be increased in Budget 2020. Based on our estimate, we believe the Government’s operating expenditure will be slightly higher by 2.6% to RM235.9bn in 2020 (RM222.9bn in 2019E). We believe development expenditure plays an important role to sustain the country’s economic growth, where the expansionary impact will help to preserve the Government's revenue source (i.e., direct taxation) generated by economic activities.

Our estimate forecasts development expenditure to be higher at RM55.7bn in 2020 as compared to RM54.7bn in 2019E. This move is intentional as development expenditure on construction-related projects generally has a higher multiplier impact on the economy relative to operating expenditure, see Fig 2.

We expect the Government revenue to still outpace that of operating expenditure to register a substantial operating surplus of RM2.8bn in 2020 (RM2.0bn in 2019E), remaining in surplus for 33 years in a row since 1987. Similarly, based on historical trends, it is evident that allocation of development expenditure will be higher in the last year of the five-year plan. The Government had proposed and revised development expenditure under the mid-term review of the Eleven Malaysia Plan (11MP) to RM220bn. Based on our estimate, development expenditure is expected to be substantial at around RM55.7bn in 2020, as compared to RM54.7bn estimated for 2019. In the first four years (2016-2019) of the 11MP, the Federal Government has disbursed about 89.9% or RM198bn of the total RM220bn.

2020 budget may be based on oil assumption of US$70 per barrel

We believe the crude oil price assumption in preparing and tabling for the Malaysia’s Budget 2020 has been revised higher from an initial figure of US$60- 65 per barrel to US$70 per barrel, following the Saudi Arabia oil attacks.

Saudi Arabia oil attacks a turning point leading to higher global oil prices

The drone attack over the past weekend on Saudi Arabia's Abqaiq refinery and oil processing facility and Khurais oil field has impacted production by around 5.7mmbpd, lowering current production from 9.8mmbpd to 4.1mmbpd, as reported. This represents a significant 58% of its own production and 19% of OPEC’s total production as of August 2019, which made up 5% of world supply. Since the attack on 15 September 2019, the price of Brent crude oil has risen sharply by around 15% from US$60 per barrel to US$68 per barrel currently.

While Saudi Arabia had initially guided for full production resumption early this week, Saudi turned less optimistic about a full recovery and currently only expects to restore one-third of the lost production in the near term. It is uncertain at this juncture how long the global outrage will last.

However, we believe the US strategic petroleum reserve may be used to mitigate the shortfall. President Trump has earlier guided that it will tap into US oil reserves to ensure that there is no sharp increase in global oil prices. Higher oil prices will likely be bad for the US economy, especially prior to his upcoming presidential election. We currently maintain our 2H19 Brent oil price assumption at US$65-70/bbl, but there could be upward bias to our current assumption in the short term depending on the timeline of production resumption. Our view reflects the current uncertainty on global crude oil supplies.

Federal Government’s revenue to benefit from oil price gain

From a macro perspective, based on an earlier estimate, for every US$10 per barrel increase in the price of global crude oil, the Federal Government’s revenue will likely translate into a gain of about RM3.0bn a year. While the expected additional revenue can help cover for the Government’s subsidy bill from rising domestic petrol prices, we believe the upcoming proposed implementation of the targeted fuel subsidy scheme will also lower the subsidy amount allocated by the Government for petrol (RON95) and diesel. There will be some windfall from subsidy savings to provide for possible contingency measures (such as additional allocation for development expenditure or cash assistance through BSH), to cushion the negative impact from the global trade war tensions.

Lower subsidy bill from the upcoming targeted fuel subsidy scheme

As guided, with the proposed targeted fuel subsidy scheme, the price cap on RON95 petrol (currently at RM2.08 per litre) may soon be gradually removed. Based on an earlier calculation from last year’s Budget, the targeted subsidy is expected to cost the Government only RM2bn for 2019, with the oil price assumption of US$70 per barrel. While the Government may still be subsidizing RM0.30 sen for every litre of RON95 petrol as well as every litre of diesel, the authority will likely provide a timeframe for phasing out the current system and introduce a targeted fuel subsidy scheme for 2020, which may include proposals such as cash assistance directly given to lower-income households.

As such, we believe the increase in the price of global oil will improve Malaysia’s revenue from the contribution of oil-related revenue including PITA, Petronas dividends, petroleum royalties and other oil-related income (such as export duties on petroleum/crude oil and income from exploration of O&G), which is expected to support Malaysia’s fiscal position.

Government to continue with measures to support private consumption

To address the socio-economic conditions from a higher cost of living, we believe the Budget 2020 to continue with its targeted incentives for households under the B40 category. The Government has been assisting the B40 group through cash assistance, such as Bantuan Sara Hidup (BSH), and this will likely be continued in 2020 to support their well-being. Apart from BSH, the budget allocation for the tourism sector will also be another focus in the budget for the 2020 Visit Malaysia Year campaign. In tandem with the event, Tourism Malaysia is targeting 30 million tourist arrivals in 2020 and tourist receipts of RM100bn (28.1 million tourists in 2019E and RM92.2bn in 2019E, respectively). We believe the Government will likely provide additional allocation for the Visit Malaysia 2020 Year campaign, possibly a higher allocation than 2019, to grants for international marketing and promotional programmes.

Cut in corporate income tax on hold to preserve revenue streams

The Finance Minister already guided that the 2020 Budget is not expected to introduce new tax measures targeting the corporate sector and investment community (which may be referring to capital gains tax on shares and inheritance tax). Nevertheless, while we believe the positive upside surprise to the Budget measures will be from an across-the-board 1%-point cut in taxes on corporate income earned, the Government will likely leave its corporate tax rate unchanged in 2020 to preserve revenue streams from direct taxation.

Corporate income tax accounts for 51.1% of direct tax and 38.2% of total Government revenue. We believe any cut in the corporate tax rate will only be implemented from 2021 onwards, after Government revenue starts to increase more steadily. Recently, Indonesia has proposed a reduction in the corporate income tax (CIT) rate to 20% in 2022, from 25% currently, starting in 2021.

Need measures to support economy from uncertain global economy

Going into 2020, the global economy still faces substantial downside risks emanating from the global trade war. The International Monetary Fund (IMF), in its latest issue of the World Economic Outlook (WEO), downgraded its growth forecast on the world economy by 0.1 percentage point to 3.5% for 2020 (3.2% in 2019).

The global manufacturing PMI remained in contraction for the fourth consecutive month at 49.5 in August from 49.3 July. Global semiconductor sales contracted for the seventh consecutive month in July by 15.5% yoy, albeit at a slower pace compared to 16.8% in June. With recent weak external data, as reflected in the global PMI, this may suggest that manufacturers will remain cautious on new orders and international trade going forward.

According to the IMF’s latest assessment of the impact of the trade war, based on a simulation, the recently announced tariffs by the US and China will lead to a 0.3 percentage point reduction in global GDP growth in 2020, where more than half of the impact will be due to lower business confidence and negative financial market sentiment. Assuming that further tariffs are implemented, this may lower global growth by 0.8 percentage points in 2020, with the IMF’s global GDP growth possibly falling below the 3% level next year.

Growth in Malaysia’s private investment is highly correlated with external conditions, where slower growth is likely from some postponement and delay in the actual implementation of investment in the manufacturing and services sectors, due to the global slowdown. Nevertheless, we believe the country's domestic demand, especially private consumption, will sustain its growth momentum, possibly benefitting from Budget 2020 measures.

The Government is likely to project the country’s real GDP growth to average around 4.5-5.0% for 2020, against our expectation of 4.5% (4.7% estimated for 2019). However, in the event that the external environment deteriorates sharply and if there is a need to introduce additional fiscal stimulus, we believe the Government will allow its fiscal deficit target to be flexible to shore up economic growth, whereby the fiscal deficit may be slightly higher than the deficit target set and revert to the fiscal consolidation path once the global economic environment stabilises

Likely sectoral budget strategies and measures

On a sectoral basis, for the construction sector, we expect the Government to likely revive some of the large-scale infrastructure projects (at reduced cost and longer implementation timeline) such as the MRT3 and Pan Borneo Highway Sabah (PBH) projects. We believe the MRT3 will enhance the public transportation system in Klang Valley, while PBH will improve road connectivity in Sabah and Sarawak.

According to our construction analyst, other projects such as the Penang Transport Master Plan (PTMP) and HSR could be implemented based on a public-private partnership concept. However, the decision on whether the HSR will be revived is unlikely to be announced during the Budget 2020 announcement since the deadline agreed between the Malaysia and Singapore governments is May 2020.

Affordable housing will remain a key area of focus

We expect initiatives on affordable housing to continue in Budget 2020. This will be in line with the recent measures by Bank Negara Malaysia (BNM), where the eligibility criteria for its RM1bn Fund for Affordable Homes which began in January 2019, was raised effective from 1 September 2019. The maximum household income eligible is now RM4,360 from RM2,300, while the maximum property price is now RM300,000 from RM150,000. The Fund will be available for two years from 2 January 2019 or until the RM1bn fund is fully utilised. Benefiting the construction sector, we expect the Government’s development expenditure to emphasise building new hospitals, water and sewerage systems, and rural roads to improve the lives of the people in towns and rural areas under the Government’s concept of shared prosperity.

As for the property sector, we believe the Government will continue or expand on incentives to assist first-time house buyers, as affordability remains an issue for the B40 and low M40 groups, such as stamp-duty exemptions and mortgage guarantees by Cagamas inclusive of down-payment support. There are some reports noting that the minimum property price for foreigners to purchase local residential properties (currently at least RM1m but some states impose a minimum price of RM2m for landed properties) may possibly be reduced to help clear the unsold units.

For the financial sector, potentially additional tax incentives may be given to banks which adopt sustainable financing practices (i.e., green tech, renewable energy) and fund new technology adoption initiated by start-ups (self-driving cars, Prop Tech, Con Tech, Fintech).

As for the gaming sector (i.e., casinos), we believe that there will likely be no increase in gaming taxes or licensing fees after the steep hike in Budget 2019, as company profitability may still be negatively impacted by the hike. Post the hike, Malaysia has one of the highest gaming taxation rates in Asia, which significantly limits casinos’ ability to compete against regional peers for the VIP and Premium-Mass clients. Both gaming volume and margin have are already recorded a significant decline in 2019.

As for the consumer sector, on sin taxes, we believe that the risk of excise-duty hikes on the brewers is less pronounced, with Malaysia’s existing taxation on malt liquor already amongst the highest in the world. The last excise-duty revision in March 2016 constituted a change in the excise-duty structure – from RM7.40/litre plus 15% ad valorem tax, to a flat RM175 per 100% volume per litre of alcohol – rather than a direct hike, and was then preceded by 10 years’ absence of duty hikes.

Moreover, a sales tax of 10% and on-trade service tax of 6% had been already imposed in 2018 following the abolishment of GST. In the event of a duty hike, we expect the brewers’ volumes to be negatively impacted over the short term, should they decide to pass on the cost to consumers – representing a fourth round of price hikes since last year.

For the tobacco players, we do not foresee any excise-duty hikes to materialise in Budget 2020. This is due to the unresolved illicit cigarettes trade situation constituting 60% of the market since the Government’s aggressive spate of duty hikes from 22sen/stick in 2013 to 40sen/stick in 2015, which has been further exacerbated by the rise of cigarettes sold with fake tax stamps, alongside unregulated vape products retailed at relatively more affordable prices than legal cigarettes. We believe any possible revisions to the excise-duty structure would be more likely to occur following the enactment of the MOH’s new Tobacco Act, which is guided to be tabled in Parliament by March 2020 and encompass a broader spectrum of regulations on the usage of tobacco, vape, e-cigarettes and shisha.

For the auto sector, we see several potential initiatives for the sector in the Budget 2020, such as 1) the possible higher allocation or study grants to further strengthen the local workforce (via technical and vocational education training). For instance, the new ‘national car’ definition in the upcoming National Automotive Policy (NAP) 2019 requires the carmakers to use up to 98% local workers in its workforce; 2) higher market development grant/allocation to spur the rate of exports for component manufacturers; 3) possible allocation for the establishment of charging stations, batteries production and management systems for the upcoming ‘next-generation vehicle’, to prepare Malaysia on becoming an energy-efficient carmaker; 4) incentives may be provided in the form of tax breaks/exemptions for carmakers that are keen to expand research and development and higher localisation efforts in Malaysia; and 6) special incentives for first-time national car buyers that may help with affordability among young adults.

As for the healthcare sector, we believe the Government will likely continue with a higher allocation for healthcare, given the Government’s growing emphasis on providing quality healthcare and social welfare protection as well as increasing accessibility to health services. In addition, we believe that the Government might potentially reintroduce the reinvestment allowance for pharmaceutical manufacturers in Budget 2020, which was not renewed in Budget 2019.

As for the insurance sector, we expect continuous tax relief for annual EPF and insurance/Takaful contributions, as well as possible tax incentives for insurance firms, which subsidize insurance coverage for the B40 group / single mothers. As for the plantation sector, we believe that there could be potential allocation by the Government in the Budget for FELDA developments, as well as potential allocation by the Government for development and replanting of palm-oil/ marketing programmes to assist smallholders.

For the telco sector, we expect the Government to highlight the recently launched National Fiberisation and Connectivity Plan (NFCP). Spearheaded by the Communications and Multimedia Ministry, the NFCP is a five-year plan (2019-2023) with an investment cost of about RM21.6bn, to be funded by the Universal Service Provider (USP) fund (RM10bn-11bn) and the private sector. The NFCP is expected to create 20,000 job opportunities. Overall, we expect the potential high investment expenditure to benefit the telco contractors and equipment suppliers.

Source: Affin Hwang Research - 20 Sept 2019