Dr Lim Kim-Hwa, Chief Executive Officer and Head of Economics
Tim Niklas Schoepp, Senior Executive Officer
Dr Lim Chee Han, Senior Analyst
Ong Wooi Leng, Senior Analyst
In the last year or so, the Malaysian economy has been affected by two main external headwinds. Firstly, the fall in commodities prices has dented the country’s finances. Secondly, the possibility of US increasing its interest rate has caused some repatriation of foreign investment funds, thus affecting investment climate and ringgit’s value against major currencies.
Therefore, can the Budget 2016 help the country withstand further external economic headwinds given that the US Federal Reserve has hinted that interest rates are projected to rise? A separate press statement will cover the Budget’s impact on households.
Overall projection from the Budget 2016
The budget deficit is expected to be 3.2 percent of GDP in 2015 and will reduce marginally to 3.1 percent of GDP in 2016. Economic growth is expected to be 4-5 percent in 2016. In 2016, the expected revenue is RM 225.7 billion whilst the expected expenditure is RM 267.2 billion; thus the expected shortfall is RM41.5 billion.
Impact factor 1: Exposure to commodity prices
Crude oil contributes to the government coffers predominantly from petroleum income tax, export duty from petroleum, petroleum royalty and Petronas dividends. Perhaps to alleviate concerns by foreign investors and rating agencies that Malaysia’s government revenue is dependent on crude oil, the Budget 2016 has projected significantly lower contribution from petroleum based revenue.
Crude oil based revenue is expected to fall from RM 64 billion in 2014 to RM 29.4 billion in 2016. This is equivalent to 29 percent of total government revenue in 2014 and 13 percent of total government revenue in 2016. As the figures in petroleum income tax and export duty for 2016 are largely similar to 2015, the Budget 2016 is implying that crude oil prices in 2016 are largely similar to 2015.
However, Petronas dividends are expected to fall RM10 billion to RM16 billion in 2016. This might be due to the reallocation of resources towards the RM18 billion investment in Refinery and Petrochemical Integrated Development Project in Pengerang, Johor.
Table 1:
| RM (m) | 2014 | 2015 (revised estimate) | 2016 (estimate) |
| Petroleum income tax | 26,956 | 9,529 | 9,331 |
| Export duty petroleum | 1,577 | 904 | 900 |
| Petroleum royalty | 6,532 | 4,415 | 3,169 |
| Petronas dividend | 29,000 | 26,000 | 16,000 |
| Total (RM m) | 64,065 | 40,848 | 29,400 |
| Total (% of revenue) | 29% | 18% | 13% |
Petroleum-based revenue estimates are largely conservative since they are based on 2015 crude oil prices. Nevertheless, should crude oil price rebounds strongly and/or ringgit depreciates further in 2016 and Petronas dividends increase, then the projected deficit might be lower.
To buffer the RM11.4 billion fall in petroleum based revenue and the RM4.8 billion and RM2.6 billion loss in Sales and Service Taxes respectively, RM6 billion more revenue will come from Company Income tax and RM12 billion more revenue will come from the Goods and Services Tax (GST). Therefore, GST has firmly become an important tax generator for the federal government.
Nevertheless, the increase in Company Income Tax of 8.9 percent looks optimistic given the economy in 2015 and 2016 is expected to grow by 4-5 percent only. The higher contribution from GST is also optimistic since the 11th Malaysia Plan projects private consumption to grow at 6.4 percent only. Therefore, the 8.9 percent growth in GST revenue (taking into account Sales and Service Tax in 2015) could be due to stricter tax collection.
Table 2:
| RM (m) | |
| Loss in Sales tax | -4,784 |
| Loss in Service tax | -2,851 |
| Lower petroleum related revenue | -11,448 |
| Higher GST | 12,000 |
| Higher Company income tax | 6,061 |
| Net effect | -1,022 |
Impact factor 2: Vulnerability to financing cost due to reliance on foreign debt financing
Over the years, Federal government debt has grown from RM502 billion (51.6 pecent of GDP) in 2012 to RM627 billion (55.6 percent of GDP) in Quarter 2 2015 according Bank Negara. If one includes the debt guaranteed by the federal government, debt would have increased from RM625 billion (64.4 percent of GDP) in 2012 to RM803 billion (71.2 percent of GDP) in Quarter 2 2015.
With the projected deficit of RM41.5 billion in 2016, federal government debt is expected to grow to RM669 billion (56.5 percent of GDP assuming 5 percent GDP growth) by next year.
Table 3:
| 2012 | 2013 | 2014 | 2015 Q2 | 2016 (based on Budget 2016 projected shortfall) | |
| Federal government debt (RM m) | 501,617 | 539,858 | 582,828 | 627,499 | 668,999 |
| Federal government debt (% of GDP) | 51.6% | 53.0% | 52.7% | 55.6% | 56.5% |
| Federal government debt plus guaranteed debt (RM m) | 625,088 | 696,666 | 754,847 | 803,313 | 844,813 |
| Federal government debt plus guaranteed debt (% of GDP) | 64.4% | 68.4% | 68.2% | 71.2% | 71.3% |
| Debt financing cost (RM m) | 20,776 | 22,588 | 24,379 | 26,639 | |
| Debt financing cost/Federal government debt (%) | 3.8% | 3.9% | 3.9% | 4.0% | |
| Debt financing cost/Revenue (%) | 10.8% | 10.9% | 11.0% | 11.8% | |
Source: Bank Negara, Ministry of Finance and authors’ calculation
The interest rate that Malaysia pays on its debt in the past three years has been manageable. However, it has been rising from a financing cost to debt ratio of 3.8 percent in 2013 to 4.0 percent in 2016.
Whilst this is low, it is probably influenced by the low interest rate environment in the developed world as well as no change in Malaysia’s sovereign credit rating. Besides, foreigners have been investing significantly in Malaysian debt. Out of RM627 billion of federal government debt (excluding guaranteed debt) in the second quarter in 2015, RM198 billion of debt is owned by foreigners.
On an international basis, this 31.6 percent foreign ownership is a high proportion.
So, Malaysia is vulnerable to foreign capital repatriation as a result of actual or expected increase in US interest rates or changes in credit rating. Should any of these change, Malaysia might be forced to paying higher interest rates to borrow. This has happened recently in August and September 2015 when the yield on government debt increased.
Moreover, it is unlikely that the guaranteed debts amount from Bank Negara would have included debt from 1MDB. Should the 1MDB debt be included as part of Malaysia’s debt, then the total debt burden and financing cost would be higher plus investors’ confidence would be affected negatively.
Impact factor 3 on Malaysia: Lower foreign exchange reserves pressure
Bank Negara foreign exchange reserves has fallen significantly to US$94.1 billion as of Oct 15, 2015. Therefore, Bank Negara’s provision of ringgit-renminbi credit swap facility for local banks is positive. This will reduce the country’s reliance on US$ denominated trade since China is a major trading partner.
However, given that investors’ confidence in ringgit is driven mainly by political risk as well as the uncertainty surrounding 1MDB, it is unclear whether the use of ringgit-renminbi swap will have big impact in restoring confidence.
Conclusion
The Budget 2016 has tried to allay investors’ and credit agencies’ concern on Malaysia fiscal balances. There is a significant move away from petroleum related revenue towards company income tax and GST. Nevertheless, the growth assumption in these two taxes looks optimistic. Overall debt amount and interest payments remain areas of concern.