• Prudent budget and fiscal discipline in the face of financial constraints

• Falling tax revenue may restrict public spending in 2019

• Maintain GDP growth forecast at 4.8% in 2018, with a more moderate 4.5% growth in 2019

Executive summary

In our opinion, Budget 2019 which is to be tabled on 2 Nov, will likely be a more contractionary budget with lower public spending and a focus on fiscal consolidation.

For this budget, the government is also expected to set the direction for the future growth of the Malaysian economy, as it further fine-tunes the fiscal reform measures that have been promised in its election manifesto.

In 1H18, the Malaysian economy grew at a slower pace of 5.0% compared to 5.7% in the corresponding period of 2017, due to a moderation in the manufacturing sector coupled with a slowdown in public investments.

The Bantuan Sara Hidup (BSH), previously known as Bantuan Rakyat 1Malaysia (BR1M), will likely be maintained at levels similar to the previous year, but will most probably be pared down in the coming years. However, the government may narrow down its targeted scope to reduce the total allocation to only benefit those in need.

To create new potential revenue streams, the government may consider to introduce new tax structures such as digital tax, inheritance tax, soda tax and capital gains tax.

On the fiscal side, the government will continue to exercise prudence in spending and diversify its sources of revenue. In the coming years, oil-related revenue (2018e: 15.7% of total revenue) will likely be higher as Brent crude oil prices are currently trending up, while corporate income tax (2018e: 30.2% of total revenue) will remain one of the main contributors of government revenue.

Overall, we expect the government to remain on track to reduce the country’s fiscal deficit to 2.8% of GDP this year. However, Malaysia’s fiscal deficit is likely to rise back to 3.0% of GDP in 2019, as the government is now grappling with a number of financial constraints that need to be addressed next year.

Inflation-wise, consumer prices in Malaysia will likely come in higher in the fourth quarter of 2018, given the transition from zero-rated GST to the implementation of SST (YTD-Aug CPI: +1.3%). Full year 2018, we expect CPI to moderate lower at 2.0% (2017: +3.7%).

The Overnight Policy Rate is expected to remain supportive of growth. Therefore, the benchmark interest rate will likely be maintained at 3.25%, but a potential rate cut would be needed if economic conditions were to slow down further.

Finally, we forecast 2019 GDP growth at 4.5% and reiterate our 2018 GDP number of 4.8%, in view of the moderating global growth arising from increasing headwinds such as the US-China trade war, emerging market currency volatility and geopolitical tensions.

Budget 2019 to focus on fiscal consolidation measures

Budget 2019 is highly expected to be a “belt-tightening” budget as the government prioritises on overhauling its fiscal positions to trim the current high debt level. As of 2017, the official total government debt, lease payments for public-private partnership projects and government guarantees amounted to RM686.8bn, RM201.4bn and RM199.1bn respectively. Cumulatively, they add up to form the RM1trn debt that the government is currently saddled with.

For operating expenditure, a 10% pay-cut for all ministers and high-ranking officials, coupled with a reduction in the number of ministry portfolios (25 against 35 previously), has been implemented, given that emoluments make up a large share of operating expenditure. In fact, the share of emoluments to total operating expenditure has risen from 30.5% in 2014 to 35.8% in 2017.

Apart from that, the new government has streamlined the functions of the Prime Minister’s Office (PMO) as one of the measures to save administrative costs. Between 2009 and 2018, the PMO’s budget allocation averaged RM15.0bn (2018: RM17.4bn), almost three times higher as compared to the 2003-2008 average of RM5.2bn.

Furthermore, the introduction of zero-based budgeting method to all its ministries and departments will likely reduce wastages and unnecessary spending.

Nevertheless, the effectiveness of any policy lies with its implementation. Tax collections should continue to be monitored so that leakages can be minimised or eliminated.

Through all these streamlining and cost-cutting measures, around RM10bn in operating expenditure could be saved annually. Nevertheless, the government is confident of meeting the 2018 targeted fiscal deficit of 2.8% of total GDP.

Given that Malaysia’s budget has been in deficit since 1998, it is imperative for the government to spend prudently and wisely in order to meet its target of attaining a balanced budget by 2023, the year that the World Bank forecasts Malaysia to achieve high-income nation status.

Possible upside in oil-related revenue collection

On the other hand, the reintroduction of SST in place of GST will result in lost revenue of approximately RM19.0bn. According to Bank Negara Malaysia, the reported revenue collection amount stood at around RM106.8bn (1H17: RM97.1bn) for 1H18, slightly over 44.5% of total expected annual revenue collection.

Particularly, GST collections totalled RM18.8bn in 1H18 (1H17: RM19.3bn), around 42.9% of the projected full-year GST collection of RM43.8bn.

Therefore, the total collection of GST including SST is only likely to be around RM24.8bn due to the implementation of zerorated GST from Jun-Aug 2018 – we estimate SST collections to come in at around RM6bn in the remaining 4 months of 2018 after the tax holiday period.

Fortunately, higher oil-related revenue collection could mitigate the impact of the loss in GST revenue collections from the abolition of GST this year. This is in view of rising crude oil prices globally, which is averaging at a YTD price of USD73.1 per barrel.

In the previous budget, the government had estimated total revenue collection to come in at approximately RM239.9bn in 2018, based on a Brent crude oil price assumption of USD52 per barrel. Of that, 15.7% of total revenue is expected to be contributed by oil-related revenue at around RM37.7bn.

Based on our estimates, an increase of USD1 per barrel in Brent crude oil price will result in additional oil revenue of RM300m. Therefore, the government is likely to collect higher oil-related revenue of around RM6.3bn.

Apart from that, the government is also likely to garner higher dividend payments of RM5bn from Petronas, Bank Negara Malaysia and other government-linked companies (GLCs).

Meanwhile, the government has recently guided that it will most probably save up to around RM10bn in administrative costs due to its expenditure rationalisation exercise. Based on the recent developments, we can now expect a higher amount that is in the range of RM15-20bn.

Overall, given the higher corporate income tax collections, oilrelated revenue and the government’s expenditure rationalisation exercise totalling up to RM21.3bn or more, we are confident that the government will meet its guidance of 2.8% targeted fiscal deficit this year (2017: 3.0% of total GDP).

However, we expect the government’s revenue and total expenditure in 2019 to amount to RM228bn (-5.1% y-o-y) and RM273bn (-4.9% y-o-y) respectively. This will result in 2019 fiscal deficit to increase to 3.0% of total GDP, in the view of its commitment to repay the shortfall in GST refunds (RM19.3bn) and unpaid refunds in personal income tax and corporate tax (RM16bn).

Commitment to fiscal consolidation

With the revelation of RM1trn public debt (approx. 80.3% of total GDP), the government is now giving serious attention to this issue by proactively seeking ways to reduce this to healthier levels of around 50%-55% of total GDP as previously guided.

In its effort to pare down public debt levels, the government has postponed or cancelled some mega projects, including the KL-Singapore High Speed Rail (HSR), MRT Line 3 (MRT3) and East Coast Rail Link (ECRL).

On top of that, the government has also reduced the cost of certain mega projects such as Light Rail Transit 3 (LRT3) from RM31.65bn to RM16.63bn (savings of RM15.02bn) and MRT Line 2 (MRT2) above-ground works from RM22.6bn to RM17.4bn (savings of RM5.2bn).

Furthermore, the government is also in the midst of reviewing projects undertaken by the previous government that involve government guarantees and public-private partnership schemes (PPP).

Moreover, the government is committed to lower public debt further through introducing new taxes, recovering funds from the 1MDB financial scandal, and monetising non-critical and non-strategic assets in the upcoming budget.

Existing tax incentives will also be reviewed to ensure that there are no redundancies. Recently, the Minister of Finance Lim Guan Eng had announced that the upcoming Budget 2019 will likely be a “budget of sacrifice”.

On the financial market side, the government may consider lowering its significant equity ownership in GLCs via Khazanah Nasional Berhad. The value of Khazanah’s equity holding in GLCs amount to RM77.4bn. Of that, the top equity holdings are in Tenaga Nasional Bhd (RM22.78bn), IHH Healthcare Bhd (RM16.61bn), CIMB Group Holdings Bhd (RM14.44bn), Axiata Group Bhd (RM13.47bn) and others (RM10.08bn).

We reckon through proper guidance and evaluation, the government could gradually divest the equity holdings of Khazanah in GLCs by 20%-30% (RM16bn-RM24bn) to other government linked investment companies such as EPF.

Another option is for the government to divest Khazanah’s stakes to private/strategic investors. This is because the reduction in government holdings to the private sector would also mitigate the crowding-out effect by the government and also encourage private participation in the local equity market, allowing the private sector to potentially drive the market forward with lesser intervention and control.

Budget 2019 expectations

In contrast to the previous budget that was perceived as a wishlist, Budget 2019 will likely be more focused on cost-saving measures to grapple with the financial constraints arising from the RM1trn debt that the government is currently saddled with.

Reducing Bantuan Sara Hidup (BSH) allocations

BSH, previously known as Bantuan Rakyat 1Malaysia (BR1M), will likely be maintained, while the targeted scope could be narrowed down to benefit those in real need (the previous eligibility for entry-level financial aid was households earning less than RM3,000 per month).

Furthermore, the government should also focus on ways to help the rakyat (mainly the Bottom-40 or B40 income group) to increase its productivity levels and move up the income ladder, so that BSH could be pared down in the future.

We estimate that the government could save up to RM3bn in handouts, if it could successfully narrow down the scope of recipients and reduce the number of recipients in the process. This may be achieved by cross-referencing information with the relevant government agencies and NGOs that keep track of the needy, instead of just referring to the income level alone.

Potential new revenue streams

We also expect the government to announce potentially new revenue streams in the form of new tax structures, such as digital tax, inheritance tax, soda tax and capital gains tax.

With the ongoing Industry 4.0 creating disruptive waves in many sectors globally, the rise of the digital economy in Malaysia is somewhat unavoidable and a natural progression.

Therefore, the government could ride the wave by introducing a digital tax on the provision of digital services to Malaysian consumers. In Europe, there is a proposal to levy a 3% tax on a company’s digital revenue turnover, targeting tech giants such as Google, Facebook and Netflix. The new taxation structure is estimated to contribute around EUR5bn annually.

However, instead of a tax based on a company’s revenue, the new government could consider the new mechanism of levying taxes based on profit that exceeds a certain threshold to avoid burdening digital start-ups that are still in the initial phase, as well as not to hinder the pace of innovation within the country.

Unfortunately, the scope of targeted companies is only limited to those that are based in Malaysia for now, unless the government formulates a mechanism to track transactions of digital services provided by foreign tech companies.

Besides that, the new government may look into reintroducing the inheritance tax for a short period of three years, using rates that are similar to the previous ones before the tax was repealed in 1991. Previously, a 5% tax rate was imposed for estates worth between RM2m and RM4m, while a 10% tax rate is imposed on estates worth RM4m and above.

In order to promote a healthy lifestyle, the government may also consider introducing a soda tax that is imposed on the manufacturing level in units of kilograms per litre, which is similar to the recent implementations by Mexico, Brunei, France and the UK.

We reckon that the government could impose a 5%-10% tax rate on sugary drinks that exceed the minimal healthy sugar level of 6g per 100ml.

Lastly, another revenue stream that the new government may likely consider is the capital gains tax. A tax mechanism with a 5% rate may be imposed on capital gains from the trading of shares, as compared to a 15%-20% tax rate in the US for longterm capital gains.

However, the tax mechanism may be further fine-tuned to allow shares capital losses to be offset up to a certain amount per annum for investors’ personal income tax, to provide a safety net for investors.

Increment of personal income tax on top brackets

Income inequality in Malaysia has been on a decreasing trend since 2004 (2004: Gini Co-efficient of 46.2 vs 2016: 39.9). Nevertheless, to further reduce the income inequality among Malaysians, the government could consider increasing personal income taxes for the Top-20 (T20) household income group.

In 2016, the median income for the T20 was at RM13,148 (2014: RM11,610), as compared to the B40 median income of only RM3,000 (22.8% of T20 income). In fact, the T20 category makes up 46.2% of Malaysia’s total income.

Meanwhile, the total number of households earning more than RM13k per month forms 10.3% of the total households in Malaysia (approx. 716k out of 6,949k total households).

As of 2018, the tax rates for individuals earning above RM12.5k per month (T20 category) are 24.5%, 25%, 26% and 28%. In short, the government may likely collect an average of RM1,000 additional tax payments per annum, for each individual that falls within or above the RM150k-RM250k per year bracket.

If the government were to consider increasing the tax rates for the T20 household group by 0.5% for each T20 category, the government is likely to gain marginal additional income tax revenue of RM0.7bn. We assume that the breadwinner of a T20 household commands a minimum monthly salary of RM12.5k.

Source: Alliance Research - 15 Oct 2018