The Beginning of Subsidy Rationalisation

• On 21 May 2024, Prime Minister Datuk Seri Anwar Ibrahim announced that the Cabinet has approved the subsidy rationalisation programme for fuel. It will start with diesel fuel and will first be rationalised in Peninsular Malaysia. For now, it will not involve Sabah and Sarawak as it may lead to a drastic increase in the cost of living over there due to the high usage of diesel consumption.

• The decision is already within our expectations as the government has frequently hinted on such plans. The aim is to ensure a better fiscal position and reducing the financial burden on the country. To recap, the goal for the Fiscal Responsibility Act (FRA) was to reduce the debt level to not exceed 60% of the GDP and a fiscal deficit of between -3.5% and -3.0% by 2025, as stipulated by the 12MP Mid-Term Review. By rationalising subsidies and raising service taxes, the government should be able to meet its fiscal deficit goal of 4.3% of GDP in 2024 (TA forecast: - 4.2% of GDP), improving from -5% recorded in 2023.

• The implementation of a targeted diesel subsidy for consumers in Peninsular Malaysia, is expected to save RM4bn annually, equivalent to 0.2% of GDP. In Budget 2024, the government has allocated RM52.8bn to fund various initiatives including subsidies, incentives and assistance, with almost 50% of the allocation for controlling prices of goods and services.

• Nevertheless, there was no announcement of the implementation date, or the quantum. We believe this is to buy time for the relevant ministries in providing details as well as to recognise the eligible recipients who will still enjoy the subsidised price.

• To curb strong rises in prices of goods and services in the Peninsula, the government has announced several measures (a mixed of new and old measures), which include:
  
  - Continuous subsidies for traders using diesel-powered commercial vehicles and for public transportation. Ten types of public transportation vehicles, including buses and taxis, as well as 23 goods transport vehicles will come under the Subsidised Diesel Control System (SKDS). According to the Ministry of Domestic Trade and Cost of Living, the SKDS 2.0 application process for companies operating 9 types of goods transports vehicles commenced on 7 March 2024 and has since expended to an additional 14 types as of 13 May 2024.
  
  - This means that bus, taxi operators and also fishermen will continue to be protected through subsidies or assistance that will help them. Cash aid would also be given for eligible individuals who own private diesel-powered vehicles such as small traders and farmers, among others.
  
  - The government will improve the Sumbangan Asas Rahmah (SARA) programme by increasing allocations to RM700mn, a five-fold increase from RM130mn last year that will benefit 700,000 recipients with added assistance of RM1,200 compared to the previous RM600.
  
  - This is on top of the allocation of the Rahmah Cash Assistance (STR) which has been raised by RM2bn or by 25% to RM10bn this year (as announced during Budget 2024) from RM8bn last year, which will benefit 9mn recipients or roughly 60% of Malaysia’s adult population.
  
  - Besides this, the Rubber Production Incentive was raised twice, first from RM2.50 a kilogramme (kg) in 2022 to RM2.70 a kg in 2023 and then to RM3 a kg this year, while the rate of the Rice Price Subsidy was raised from RM360 in 2022 to RM500 per metric ton in 2023.

• At this stage, details remain unclear whether the eligible individuals owning diesel-powered vehicles will need to apply for cash aids or if the government will utilise information from the PADU database, which is now in the second phase

What’s Next?

• While details of this diesel subsidy rationalisation plan are still vague, all eyes are on the targeted RON95 subsidy programme, which is the most widely used and constituted the majority of the RM81bn subsidies spent last year. We anticipate the rollout to commence soon.

• RON95 is currently sold at RM2.05 per litre and diesel at RM2.15 per litre. Gauging from the non-subsidised petrol station, the RON95 is currently sold at a market price of RM3.35 per litre while Diesel Euro 5 price is priced at RM3.33 per litre. That indicates roughly about RM1.18 being subsidies for each litre of diesel sold. The diesel fuel price was last changed on 6 February 2021, up by 4 cents from RM2.11 per liter to RM2.15 per liter. It remains at this level until now.

• At the point of writing, it is hard to quantify the impact of the diesel subsidy rationalisation plan. Until we get a clearer picture on this, we maintain our inflation forecast at 2.9% with risks remain to the upside, and our real GDP forecast for 2024 is 4.7%.

• We foresee the direct impact on inflation may be small and negligible as the CPI weightage of fuel has been reduced from 8.5% in 2018 to 5.9% in 2024. The Transport CPI Index now contributes 11.3% to the overall inflation, lesser than more than 14% six years ago.

• Nevertheless, there could be negative ripple impacts on the economy, including sudden price increases of goods and services and shrinking confidence from consumers and businesses, which could slow down growth.

The Past Hikes

• The previous significant one-time increase in domestic fuel prices in response to crude oil prices exceeding USD 100 per barrel, occurred on June 5, 2008. At that time, RON92 (which was phased out in September 2009 and replaced by RON95) and diesel prices were raised by RM0.74/litre (or 39.4%) and RM1.00/litre (or 63.3%), respectively, to RM2.62/litre and RM2.58/litre, up from RM1.88/litre and RM1.58/litre, respectively. The price of RON97 was also increased to RM2.70/litre, 78 sen higher than the previous price of RM1.92/litre. The government stated that this move saved RM13.7bn on fuel subsidies when global crude oil prices ranged from USD100 to USD144 per barrel between late February 2008 and July 2008. Consequently, headline inflation surged from 2.2% YoY at the beginning of 2008 to as high as 7.9% YoY in July 2008. It remained above 7.0% until October 2008 before dropping sharply thereafter. As a result, the annual inflation rate rose to 5.4% in 2008, compared to 2.0% in 2007.

• Between February 2011 and August 2014, crude oil prices hovered above USD100 per barrel, leading to two increases in subsidised fuel prices during this period. The first hike occurred in September 2013, raising RON95 and diesel prices by 20 sen to RM2.10/litre and RM2.00/litre, respectively. The second increase was in October 2014, with RON95 and diesel prices rising by another 20 sen to RM2.30/litre and RM2.20/litre, respectively. Despite these adjustments, the impact was more manageable due to the smaller increments. Consequently, there was no significant spike in the inflation rate or any notable anomalies in statistics. The average CPI rate was 2.5% during 2011-2014, with the highest reading of 3.5% in the first quarter of 2014.

Our Forecast

• We anticipate the simple average fuel price (including RON95, RON97, and diesel) will rise by 20 sen to RM2.73/litre compared to the 2023 average of RM2.53/litre. This serves as the base case scenario for an average inflation rate of 2.9% YoY in 2024. However, if the government decides to increase the ceiling price for diesel higher than our expectations or even float the prices, the inflation rate could surge even higher. We need more specific details to accurately calculate these potential scenarios.

• The inflation rate will definitely increase in the second half of the year if all the government’s plans materialise. April’s CPI is due this Friday (TA forecast: 1.9% YoY). Naturally, other segments beyond transportation costs, such as food, housing, water, electricity, gas, and other fuels, as well as restaurants and hotels, will also be affected.

• For now, we stick to our base case scenario, projecting that inflation will average 2.9% YoY in 2024, with risks to the upside. We also believe that the current inflation situation appears to be well-managed, and there seems to be no immediate pressure for Bank Negara to hike our OPR.

Source: TA Research - 23 May 2024