• Pessimistic growth outlook. No change to 2015 growth forecast range of 4.5% - 5.5% but growth expected to moderate further in 2016 to between 4.0% - 5.0% on weakening domestic demand and a broad-based slowdown in emerging markets.
• Trade slump in 2015, weak recovery next year. Total trade is expected to shrink 0.9% this year alongside a 0.7% contraction in gross exports (revised down from +1.5% growth). Exports will recover in 2016 but growth will be weak at just 1.4%.
• Mildly expansionary and fiscally prudent. Total budgetary expenditure will increase by 1.7% in 2016 with most of it coming from a development spending allocation of RM50.0b, the second highest on record. Weak revenue growth means only a small decrease in the fiscal deficit to 3.1% of GDP.
• Oil & gas revenue evaporates, GST plugs the gap. With crude oil prices expected to remain under US$60 a barrel until 2018, oil & gas revenue will shrink to just 14.1% of total revenue in 2016, the smallest share in 13 years. Some of the shortfall will be made up for by much higher-than-expected GST collections, which in 2016 is expected to grow to 17.3% of total revenue.
• Medium term fiscal targets. The 2016 Budget establishes a framework with a medium-term target (2016-2018) of real GDP growth of 4.5%-5.5% and a crude oil price of US$48-60 a barrel. Going by these assumptions, it expects government revenue to account for 18.2% of GDP and for oil & gas revenue to make up only 13.2% of total revenue (versus five-year average of more than 30%).
• More progressive income tax system. Higher taxes for the very wealthy with the introduction of new tax brackets for annual incomes above RM600,000 with higher marginal rates of 26% and 28% as well as targeted personal tax relief for dependents.
• More for development spending. More money people-centric projects such as affordable housing and improvements to public transport as well as the road and rail network
• Targeted help for companies. No corporate tax cut as initially expected but instead targeted tax incentives to certain industries.
• Voter handouts. Social welfare and cash assistance schemes are here to stay with a further increase in BR1M allocation. Various proposed aid focused on the B40 group, rural poor and Bumiputera.
• More goodies for East Malaysia. A total of RM28.9b allocation for construction of highways in Sabah and Sarawak, a proposed BRT in Kota Kinabalu, a new airport in Mukah, Sarawak, and more.

Overview

Pessimistic growth and revenue forecast. The 2016 Budget was announced with a pessimistic view on near-term growth and federal government revenue, despite the promise of higher-than-expected collections from the Goods and Services Tax (GST) helping to make up for a sharp fall in oil & gas (O&G) revenue this year and next. Economic forecasts for 2016 tell of challenges ahead, with a further moderation in GDP growth to 4.0% - 5.0% from weakening domestic demand and a prolonged slowdown in emerging markets.

Striking a fine balance. Further fiscal consolidation is planned for 2016 but at a slower pace than 2015 and previous years in order to allow for a mildly expansionary budget in view of a moderate growth outlook. To boost the economy, the government is projected to increase total budgetary expenditure by 1.7% in 2016 with most of it coming from a development spending allocation of RM50.0b, the second highest on record. Government revenue growth will remain weak in 2016 on an expected big cut to Petronas dividends paid to the government of about RM10.0b (estimated 2015 dividend payout is RM26.0b), allowing for only a 0.1 percentage point decrease in the fiscal deficit to 3.1% of GDP. In spite of the Government’s commitment to pursue fiscal consolidation, the latest budget remains supportive of economic growth.

Growth Outlook

Risk to growth in 2015. Worsening external conditions and weak business and investor sentiment will drag on growth this year, leaving domestic demand to pick up the slack. The latest forecasts from the Ministry of Finance expect exports to shrink 0.7% this year (revised down from 1.5% growth). Imports are expected to fall by a larger 1.2% making for negative growth in total trade but a slightly larger trade surplus. Despite the trade slump, the official GDP growth forecast is maintained at 4.5% - 5.5% with the midpoint at 5.0% after domestic demand growth was bumped up slightly, probably to reflect the more subdued negative impact of GST implementation on consumer spending. Given 1H15 growth of 5.3%, GDP growth in 2H15 would need to at least top 4.7%, which at this stage is achievable due to a low-base effect and the resilience of the Malaysian economy to external shocks.

Slowdown to stretch into 2016. The contraction in exports in 2015 will be followed by a weak recovery next year. Export growth in 2016 is expected to rebound albeit marginally at 1.4% as the slowdown in global trade looks increasingly likely to be prolonged. For the Malaysian economy this means the current moderating growth trend that has persisted since 3Q14 is likely to stretch out for longer as external demand remains too weak to spur domestic growth. We initially thought that growth in developed economies would accelerate toward the end of the year and generate the necessary demand to lift domestic growth but now this is unlikely to happen.

Depending on domestic demand. The main driver of the Malaysian economy in 2015 and 2016 will be domestic demand, in particular private expenditure. In 2015 private expenditure is expected to grow by 6.9% and in the following year by 6.4%, faster than GDP and overall domestic demand growth. As a result, the share of private expenditure to GDP will increase to 69.7% this year (2014: 68.5%). Private consumption was affected by the negative effect of GST implementation in 2Q15 but should recover in 2H15. In view of the government’s role in supporting the weak economy, public expenditure is expected to expand from 0.4% in 2014 to 2.8% in 2015 and 2.7% in 2016.

Broad-based growth. Though weak external demand is expected to spill over into 2016 on the back of China’s weak growth outlook and slowing growth trend in other emerging economies, growth on the supply side is expected to be broad-based with all economic sectors recording positive growth. However, the official forecast indicate that there will be a slight moderation in the growth trend across the board. Nonetheless, the main driver would be the services sector which is projected to grow by 5.4% in 2016 (2015: 5.7%) underpinned by resilient private consumption. Though seemingly resilient it would be a tough year for value-added manufacturing as its growth would continue to taper to a projected 4.3% in 2016 from 4.5% and 6.2% in 2015 and 2014 respectively. While agriculture and mining remained resilient, the construction sector growth is also tapering reflecting the gestation of the major infrastructure projects.

Ringgit depreciation. Allowing the ringgit to fall according to market forces has worked to take most of the pressure off the decline in exports, particularly that of commodities such as crude oil, natural gas and palm oil. A generally deflationary global environment means that imported inflation has been minimal. The Malaysian economy is now better structured to handle sharp currency depreciation. Borrowings are mostly ringgit-denominated and the current account has been consistently in surplus for 17 years and counting. Still, several domestic factors present a risk to future growth; high leverage in the household and corporate sectors, lack of follow through with structural reforms, and investor concern over the current political environment. 

Source: Kenanga Research - 26 Oct 2015