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KUALA LUMPUR (BLOOMBERG) – Malaysia will enter 2021 with its biggest spending plan yet to stimulate its virus-hit economy, but concerns center on how to pay the bill after a sovereign rating downgrade earlier this month. .
The government expects revenues to rise 4.2 percent next year, counting on higher tax collections, without raising taxes or introducing new ones, along with a measure to reduce its dependence on oil. The plan is based on a key assumption: that tax revenues will increase as economic activity returns to normal.
“If the economy doesn’t recover as strongly as the 6.5% -7.5% the government expects, any revenue shortfall is likely to manifest itself” in lower tax revenues, said Wellian Wiranto, an economist at Oversea- Chinese Banking Corp in Singapore.
It’s a great gamble. Finance Minister Tengku Zafrul Abdul Aziz said last month that this year’s economic performance will be “closer to -5.5 percent” than the 4.5 percent contraction previously expected.
That was after taking into account renewed movement restrictions, which are expected to cost the economy RM 300 million (S $ 98.49 million) per day, amid a new wave of Covid-19 infections that emerged from end of September.
Even with the pandemic still raging, the government relaxed restrictions this month to give the economy a breather. Daily virus cases hit a record 2,234 on Dec. 10, and several major glove manufacturers, including Top Glove Corp, the world’s largest, halted production lines as infections spread among staff.
“There are obstacles on the road to recovery,” Maybank analysts wrote in a mid-December research note.
The latest wave of viruses is more severe and there may be a “scar effect” on the economy that has been masked or delayed by relief measures that have been extended into next year, they wrote. The bank expects Malaysia’s gross domestic product to grow 5.1 percent in 2021.
Oil revenue drop
The problem is compounded by the fact that Malaysia has few sources of income to draw from. Since the abolition of an unpopular goods and services tax in 2018, the country has relied on oil and gas revenues and dividends, largely from state-owned energy company Petroliam Nasional Bhd, to fill its coffers. That backfired when crude prices plunged this year, contributing to a 14 percent decline in government revenue for 2020.
Given low oil prices, coupled with the gradual shift of major economies towards green energy, the contribution of oil to government revenues will decline, said economist Firdaos Rosli of Malaysia Rating Corp, a national credit rating firm.
“The government urgently needs to expand its revenue base as spending is projected to increase to finance economic recovery efforts,” he said. “The government could not increase its coffers if it does not capitalize on taxing consumption.”
Malaysia is studying various models of excise taxes to measure their effects on the economy and costs of living, Finance Minister Zafrul said in a written response to Parliament on December 15. The government will not make any such decision during the pandemic and will wait until the economy recovers, he added.
The government’s difficult budget situation is sounding alarms after Fitch Ratings downgraded the sovereign earlier this month. Even with a stronger recovery in real GDP, any revenue growth next year is likely to be “moderate in nature,” said Andrew Wood, an analyst at S&P Global Ratings in Singapore.
“A smaller revenue footprint relative to the size of the economy could put pressure on Malaysia’s fiscal setup, either by limiting public spending or leading to a larger budget deficit,” he said. S & P’s long-term rating for Malaysia has a negative outlook and could face “downward pressure” if the agency sees a weaker commitment to fiscal consolidation, Wood said.
Moody’s, in an outlook report released Dec. 1, said the narrow revenue base limits the government’s flexibility to respond to shocks like the pandemic and leaves the country prone to volatile capital flows.
For now, investors are looking beyond Fitch’s downgrade and the surge in Covid cases after lawmakers approved Prime Minister Muhyiddin Yassin’s annual spending plan, eliminating some political risks.
The ringgit is trading near its strongest level in more than two years, and the major stock index is up 4% on the year, after posting annual declines in 2018 and 2019.
“In the medium term, the government will probably realize the importance of bringing back even a politically complicated revenue stream like GST,” said OCBC’s Wiranto. “Even if the plan might have to wait for a better economic and political environment to be adopted, it may be a matter of time before it is reintroduced in some form.”
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