Budget 2010 seen offering few deficit cuts

Written by Royce Cheah
Wednesday, 14 October 2009 11:14

KUALA LUMPUR: Budget 2010 will see little fiscal consolidation to rein in its deficit, which the government forecasts at 7.6% of gross domestic product (GDP) this year, the biggest in over 20 years.

According to a Reuters poll of 11 economists and International Monetary Fund forecasts, the deficit in 2010 will be 7.3% of GDP.

Malaysia’s budget consolidation reversed in 2008 following extra spending to counter the global economic downturn and that spending is expected to remain in place until sustained economic recovery is secured.

Prime Minister Datuk Seri Najib Razak, who is also finance minister, is also constrained by a tough domestic political environment with the MCA embroiled in a damaging leadership battle. And Najib’s popularity has fallen since an initial surge.

Following are possible scenarios for next year’s blueprint.


Big budget consolidation
Najib is unlikely to take his foot off the gas any time soon on RM67 billion of spending, loan guarantees and other funding without clear signs of a return to sustained economic growth. The government is set to cut its 2009 growth contraction forecast for this year from the current minus 4%-5% when it announces the budget.

Budget consolidation could be helped by the introduction of a Goods and Services Tax (GST) which has been mooted for a long time, but there is still no timetable for its launch. The government could also take further steps to phase out oil and gas subsidies, which accounted for 2.5% of GDP at their peak in 2008. The move to price the premium RON97 grade of petrol at RM2.05 a litre earlier this year was part of that move.
Likelihood: Very small.
Market reaction: Positive for the ringgit. The foreign exchange market has priced in another big deficit and very little consolidation this year. With Malaysia’s huge foreign exchange reserves and deep liquid financial markets backed by huge state funds, it can finance the deficit.

“If the budget deficit manages to hit 5.5% to 6.5%, we are looking at the ringgit staying below 3.40 and heading towards 3.35,” said Suresh Ramanathan, rates and currency strategist at CIMB. “A gradual scaling down of the deficit will be seen positively by the market.”


Slight decline in 2010 deficit
Malaysia can afford another sizeable fiscal gap without risking its credit rating, thanks to its reserves. It does not need to borrow abroad. S&P rates Malaysia’s local debt “A-minus” and Fitch cut its rating in June to “A” from “A-plus”, while Moody’s rates Malaysia “A3”. All have a stable outlook.

Morgan Stanley says, however, Malaysia needs to show a “clear commitment” to bring the deficit below 4% of GDP in the next two years and Najib will have to signal a clear exit strategy from his pump-priming measures to retain market confidence.

Malaysia depends on state oil giant Petronas for almost 50% of revenues and the country desperately needs to diversify its tax base. The IMF estimates the non-oil budget deficit will hit 15.1% of GDP in 2009 and 13.8% of GDP in 2010.

Tax-raising efforts are however constrained by tax competition in Asia as countries bid for a share of smaller foreign direct investment inflows.
Likelihood: Central market assumption
Market impact: Limited


Overshoot, lack of credibility
Malaysia scores poorly on budget transparency. According to the Open Budget Initiative it scores 35 out of 100. Figures under 50 means “minimal” information to taxpayers.

Given the lack of budget transparency as well as graft, an overshoot this year and subsequent wider than anticipated deficit next year are a possibility. Three economists in the Reuters poll put the 2009 deficit at or above 8.5%.

Another risk is that the global economic upturn will prove less vigorous than thought, casting doubt over the strength of recovery in the country’s exports, which are equivalent to 100% of GDP.
Likelihood: Small
Market impact: Malaysia’s credit rating, the ringgit and foreign investment could suffer.


This article appeared in The Edge Financial Daily, October 14, 2009.