Transformation mandate. Although a two-third majority win would be ideal Barisan Nasional’s victory is still considered a mandate for PM Datuk Seri Najib Abdul Razak to continue his economic and government transformation policies (ETP and GTP). It also means that BN has to fulfil a long list of economic and social welfare promises outlined in its election manifesto (please refer table). One thing for sure, the continuity of BN’s leadership remains intact to ensure the ETP projects and policy reforms are implemented without delay or disruption. As BN’s status quo is within our expectation, we maintain our 2013 GDP growth forecast at 5.3%.

Stepping up reforms. However, given the criticism and pressure to wipe out corruption and review the archaic affirmative action policy, the onus is on BN to make the necessary changes and ensure key infrastructure projects to be dished out fairly and completed on time with minimal cost overruns. It also needs to put extra commitment to spruce up the efficiency of the public service, reduce crime rate and reform the national education system. Tough decisions. While Pakatan Keadilan Rakyat (PKR) promised to lower the price of fuel, electricity and water, BN could face a big challenge to stick to its original plan to do the opposite. Already the cost of petrol and gas subsidies are expected to exceed RM30.0b this year from an estimated RM25.2b in 2012, which is more than half of the total subsidy of RM42.4b. With the global economy expected to be better in 2H13, we believe BN would resume its subsidy rationalisation plan the soonest by 4Q13. The scheme was suspended for more than two years since it was introduced in 2010 when inflation hit a 27-year high of 3.5% in June 2011. Based on the original plan, we may see the Government raise petrol and diesel prices by about RM0.10/litre every six months and LPG by +20% annually. The impact on fiscal savings would only be felt in 2014 as the price hike would be staggered and gradual.

Promises come with a price. Apart from the concern of rising subsidy, Government’s promises in the form of annual cash handout to poor households and individuals under Bantuan Rakyat 1 Malaysia scheme, gradual reduction in car prices of between 20% to 30%, and subsidising the construction of 1 million affordable homes nationwide would further raise the fiscal operating expenditure (opex) in the near and medium term. The fiscal opex reached a record high of RM205.5b in 2012, up 11.5% or 21.9% of GDP. At the rate the Government is spending and dishing out funds, we will not be surprised to see the opex probably increasing by another 5%-10% this year as opposed to the official target of a reduction of 0.3%. To mitigate the rise in opex it all depends on how soon the Government would resume its planned fiscal consolidation, mainly by reducing subsidies.

Declining oil revenue. On top of that, the contribution of oil and gas sector is expected to dwindle as global prices are expected to remain subdued leading to lower revenue and profits of O&G companies or this year. Declining demand from recession-hit eurozone, lower margins due to higher exploration cost, and high inventory levels of major oil consuming nations are major factors that could weigh on crude prices. The International Monetary Fund forecast oil price to fall by almost 3% in 2013 on mainly strong growth in non-OPEC supply, particularly in North America. The IMF said the oil price – which it calculates as a simple average of Brent, Dubai and WTI – is expected to average US$102.60/barrel from US$105.01/barrel in 2012. Given that O&G’s contribution is more than a third of total fiscal revenue, there is a compelling need to reduce subsidies by raising fuel prices. Depending on timing and quantum of subsidy cuts, we project fiscal deficit to narrow to 4.2% of GDP from 4.5 % last year but slightly higher than the official target of 4.0% of GDP.

Managing 2014 fiscal expectation. The challenge for the newly-elect is to bring forth a more dynamic long-term plan in the Federal Budget for 2014 which is scheduled to be tabled in October. Fulfilling the election promises would likely require more spending or higher opex, which could pose a challenge amidst potential reduction of traditionally large O&G revenue or possible decrease in car tax revenue in 2014. Along with the need to step up its fiscal consolidation mode, the Government is expected to turn to an alternative revenue generator in the form of the much-awaited goods and services tax (GST).

Need for broader income base. The broader tax base under the proposed GST is expected to increase the Government’s tax revenue and would likely more than compensate the shortfall in O&G as well as corporate and individual tax collection. In fact, the Government has earlier assured that goods and services considered as basic needs would either be zero-rated or exempted from GST so as not to burden the low-income group. Small businesses would also be exempted from this tax. Given the success of the implementation of GST in countries like Singapore and Australia in the past and the fact that they are less susceptible to declining income during an economic downturn compared with countries with conventional tax regime, it is timely for Malaysia to rekindle its GST plans in 2014. We expect the Government to set an initial GST rate between 5% and 7%, which would allow a gradual reduction in corporate and personal income taxes. This in turn encourages more foreign direct investment that eventually leads to overall economic growth.

Unavoidable side effects. As in other countries, the initial implementation of the GST would likely be a bane to Malaysia’s growth potential at least in the first year of its implementation. Australia suffered its first GDP growth contraction in more than a decade in 1Q of 2001 following the implementation of GST six months prior. Our preliminary forecast suggest that domestic demand largely private consumption growth would slow following the impact of GST starting in 2Q14 but may gradually pick up in the 4Q14. This would put a cap on the GDP growth upside in 2014 which is projected to grow between 5.0% and 5.5%. Meanwhile, as the Government is expected to be more prudent in its spending, the impact of broadening its tax base would likely be positive on its fiscal balance. This would have a cushioning effect on the fiscal deficit which is projected to remain between 4.0% and 4.5% of GDP in 2014.

Fiscal sustainability to remain intact. Ample liquidity and relatively large domestic resource surplus should continue to provide the capability and flexibility to the Government to fulfil its election promises while implementing expansionary measures to support growth without crowding out private sector lending. Public sector debt remains manageable, estimated at about 53% of GDP as of the end of 1Q13, which is still below the legal debt-ceiling threshold of 55% and globally acceptable benchmark of 60%. Furthermore, a chunk of it is funded domestically with only about 2.1% of GDP were raised abroad to date, making it less prone to the whims of foreign investors. In addition, domestic liquidity remains ample as reflected in the rise in foreign external reserves which currently stand at a record high of US$139.9b as at mid-April.

Hidden fiscal risk. Though it may appear that Malaysia could weather both external and domestic shocks there are a few hidden fiscal risks that could jeopardise the country’s fiscal capacity and long-term growth prospects. It has been reported and made fully aware by the IMF in its recent Country Report that “the Malaysian government’s contingent liabilities are not fully known but are growing.” This includes government guarantees on debt and off balance sheet borrowings largely from government entities that fund massive transportation and infrastructure projects which have more than doubled since 2009. If push comes to shove it is not implausible that these liabilities may eventually find their way onto the federal balance sheet.

Source: Kenanga