Some of the detailed assumptions in Malaysia’s 2016 federal budget look optimistic, posing some downside risk to the projections, Fitch Ratings says. Fitch expects Malaysia’s fiscal and broader economic outlook to remain under pressure from weaker commodity prices into2016.Malaysia’s 2016 federal budget projects a reduction in the deficit to 3.1% from 3.2% expected for 2015. The budget also estimates the share of revenues in GDP to drop by 1.1pp relative to 2015, dominated by a 0.9pp decline in the dividend expected from the state oil firm Petronas (to MYR16bn from MYR26bn in 2015). The authorities expect 2016 revenues to be buoyed by a 44% rise in receipts from the new Goods and Services Tax (GST) introduced in April 2015, or by 12.5%, consolidating the taxes it replaced. This is considerably faster than Fitch’s expectation for nominal GDP growth of about 7% or nominal consumption growth of about 8%, despite a longer list of zero-rated items from next year. Slower growth in GST receipts in line with consumption would add about 0.1% of GDP onto the deficit, in Fitch’s estimate.Overall, GST appears to have been much more significantly revenue-positive than the government originally expected. This could be partly because more businesses have signed up for the scheme than originally expected. The government estimates the deficit would be 4.8% in 2016 under the previous system of sales taxes.The government also projects spending to form a smaller share of GDP. The burden of adjustment falls on current expenditures (which the government terms “operating expenditures”). Government wages are expected to grow by just 2%, below Fitch’s expectation for annual average inflation (2.5%). Recent experience gives grounds for caution that this tight settlement can be achieved. The government originally aimed to shave wages by 1.9% in 2015, but the revised budget expects wages will rise by 3.2%. Spending on supplies and services is also expected to contract. Delivering on these projections could be challenging, particularly as they would affect the livelihoods of some of the government’s core supporters.Set against these issues, the budget’s conservative oil price estimate of USD48/barrel is below Fitch’s projection of USD60. This could point to some upside for oil-based revenues. This would partly be offset by higher subsidy payments, although the 2015 budget reduced fuel subsidies substantially. Fitch thinks the net effect of higher oil prices than the budget expects in 2016 is unlikely to be larger than 0.1% of GDP.Development expenditure (that is, capital spending) is projected at 4% of GDP in 2016, not much changed from 2015 (4.1%). However the government has typically found it difficult to execute the full development budget. Capital spending could provide a buffer in the event that there is slippage elsewhere in the budget, whether through “normal” under-execution or deliberate restraint. However, this would in turn weigh on broader GDP growth both in 2016 and in the future. It would also be difficult to square with the authorities’ broader emphasis on infrastructure development.Fitch cited the authorities’ success in insulating economic policy from intensifying political pressures when the agency revised the Outlook on Malaysia’s ‘A-‘ rating to Stable in June 2015. The proposed further reduction in the deficit is in line with this conclusion, although the budget also acknowledges political realities. The introduction of two new tax brackets for higher earners is redistributive, although the intention may have been more political than fiscal – the government estimates just 17,000 taxpayers will be affected, generating minimal expected additional revenue of MYR0.4bn. This does not quite cover a budgeted MYR0.7bn rise in transfers to lower-income households. The government also announced rises in minimum wages by between 11% and 15% in different parts of the country.Although Fitch thinks the federal budget deficit could exceed the 3.1% projection, the agency currently believes it is unlikely that the slippage would be enough to put Malaysia’s debt ratio on an upward trajectory. Fitch expects Malaysia’s federal debt to stay at about 52% of GDP until 2017. The evolution of non-budget contingent liabilities, including government guarantees, will bear monitoring. More broadly, the economy and sovereign credit continue to face challenges associated with shifting investor risk appetite, reflected in pressure on the currency and foreign reserves.
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