Tuesday, September 23, 2014

Budget 2015 – five things Najib needs to focus on

PRIME Minister and Finance Minister Datuk Seri Najib Tun Razak will be presenting Budget 2015 on Oct 10.

As the year 2015 will coincide with the final year of the Tenth Malaysia Plan (10MP), 2011-15, the budget would serve as a platform for the policymakers to take stock and outline short to medium-term economic initiatives and strategies for a final push of the 10MP and going into the 11th Malaysia Plan (11MP). Besides this, 2015 is also a big focus year, as it marks the implementation of the goods and services tax (GST) on April 1. The Government is expected to set Budget 2015’s deficit target at 3.0% of gross domestic product (GDP) (estimated 3.5% of GDP in 2014).

The budget is a matter of meeting competing priorities. Carefully crafted fiscal discipline carries the day. Clearly, the Government needs to increase spending allocation where they are critically needed and re-prioritise spending to ensure a sustainable economy. The daunting task and delicate balancing act is for Najib to draw up a radical and responsible budget and execute it well in the year ahead. Broadly, the budget should focus on five thrusts: fiscal consolidation, continued improvement in the management of public funds, sustaining investment momentum, productivity and innovation, controlling inflation and the rising cost of living as well as ensuring affordable housing.

Thrust One

There should be no compromise on fiscal consolidation to avoid the sovereign de-rating risk. Budget 2015 must get the balance right between supporting economic growth, primarily through productivity gains rather than imposing additional taxes, which will hinder investment performance, and generating operating surplus, primarily through productive spending and cost savings. The long-awaited multi-tier fuel price scheme based on income will be unveiled in the budget. Fuel subsidies are likely to come down, but the saving of this has been eaten away by higher cash handouts to low and middle-income households.

In Budget 2015, expectations are that the quantum of the 1Malaysia People’s Aid (BR1M) scheme will be increased by between RM150 and RM200 for eligible households. The quantum of increase could be higher to offset the impact of the GST implementation on the net disposable income of targeted households. We reckon that the guiding principle for prudent fiscal management is based on a targeted subsidy programme, aimed at reaching out to the needy groups, but some have questioned the sustainability of cash transfers, going forward. The worry is that conditional cash transfers can cause unintended consequences, including fiscal costs and perverse incentives to work harder for more income or to seek rent.

A fiscal consolidation strategy should be accompanied by better fiscal and financial control over public-private partnerships and state-owned enterprises, aimed at putting the gross public debt-to-GDP ratio, as well as contingent liabilities (loans guaranteed by the federal government), on a firm downward trajectory in the medium term. It is timely to revamp the public sector pension scheme to ensure fiscal sustainability whilst providing adequate retirement security and maintaining public sector workforce productivity. A migration to a collective defined-contribution plan from a defined-benefit pension system is best suited to meet the overarching goal of balancing the competing interests of public employees and taxpayers.

The Government may revisit the restructuring of its housing loan division (estimated outstanding loans of RM42bil), as part of efforts to consolidate the fiscal deficit and ease the Government’s financial burden. This initiative was mooted in Budget 2013, whereby the Government would appoint panels from commercial banks to manage new housing loans, effective January 2013. However, nothing has been implemented.

Thrust Two

There should be continued improvement in the management of public funds, with a view to increasing transparency and accountability in the management of public expenditure. The fiscal transformation programme entails radical and sustainable reform, not only in curtailing operating expenditure via subsidy rationalisation, but also in undertaking more cost-saving initiatives, including the implementation of a critical review and reform of the procurement system to combat wastages and leakages. The problem of overlapping spending schemes has to be avoided. A fundamental review is also required to weed out the country’s non-developmental, low-priority and unproductive expenditure, while focusing on growth-oriented spending. The “supplies and services” component made up 16% of total operating expenditure and 15.9% of total revenue in 2013. The authorities need to put in place tougher and more deterrent rules to stop rampant cases of financial mismanagement and leakages, as well as cost overruns of development projects exposed in the Auditor-General’s Report. Senior management of implementing agencies will have to assume greater accountability for the mismanagement of funds, poor judgement as well as carelessness in the monitoring of projects.

Thrust Three

Private investment has regained strong momentum to expand by 15.8% per annum in 2010-2013 (12.8% of GDP in 2010 and 16.7% of GDP in 2013) and 13.1% pa in the first half of 2014 (H1’14) (19.1% of GDP in H1’14). The challenge going forward is how to sustain investment momentum when the Economic Transformation Programme (ETP) hits its maturing phase in the years ahead. Additional measures and initiatives will be needed to ensure that stable, balanced private investment growth can continue in Malaysia.

The vitality of private investment needs to be given focus, as it is now ready to take over the driver’s seat as the Government continues to consolidate its fiscal balance sheet. It is vital, therefore, that Budget 2015 provides a clear outline and direction on how the Government intends to deal with the fuel subsidy rationalisation, tariff rebalancing structure, minimum wage and foreign labour policies. Be prepared and ready to reap the opportunities out of the Asean Economic Community (AEC) by 2015.

The Government needs to reaffirm Malaysia’s stable and transparent corporate tax regime, with a view of lowering the tax rate (currently at 25%) to a more competitive level regionally. In Budget 2014, the Government had pre-announced that the corporate income tax would be reduced by 1% pt from 25% to 24%, while the income tax rate for small and medium enterprises (SMEs) will be reduced from 20% to 19% from the 2016 year of assessment.

The budget needs to reflect on the vital importance of increasing productivity, creativity and innovation, the SME sector and seizing investment in domestic enterprises. The following measures could be considered in the budget:

1) qualifying capital allowance be given for companies involved in productivity and innovation enhancement in high value-added and knowledge-based industries, including services and trading companies,

2) accelerating the utilisation of ICT-supporting solutions by SMEs via tax deductions or tax credits,

3) enhancing the micro-loan programme and seed capital funding to encourage youth entrepreneurship. The Government should design a risk sharing scheme with participating financial institutions for loans to young SMEs, and

4) supporting entrepreneurs through intensive mentoring via public-private partnerships’ incubator programme. The funding will be used by participating organisations to provide entrepreneurs with intensive mentoring and other resources to develop their business.

Where enhancing skills is concerned, the Government must continue to critically review as well as strengthen policies that align skills training and capacity building with labour market needs. Providing graduates with the right skills is essential to further Malaysia’s economic prospects. Looking to harness the demographic dividend, the budget should re-allocate spending on a national multi-skill programme, including re-skilling and up-skilling to enhance employability and entrepreneur skills. The following initiatives can be considered:

1) providing tax credits to support tangible investments in productive and job-creating initiatives, and

2) setting up a dedicated fund (public-private partnerships) for supporting apprentices, apprenticeship technical training as well as internships for diploma students and graduates in high-demand fields.

Thrust Four

Managing the rising cost of living remains the Government’s priority. Higher inflation expectations will remain for some time, as consumers brace for the second wave of price inflation when the fuel subsidy reform likely resumes in the fourth quarter of 2014 (Q4’14) after the last fuel hike in September 2013 and the rollout of the GST on April1, 2015. Owing to concerns about the bunching impact of price increases on consumers and businesses, careful planning and sequencing on the timing of the subsidy rationalisation is deemed appropriate, allowing households and the business sector to digest the anticipated price pressures.

It is undeniable that consumer inflation will likely rise initially following the GST, but the higher inflation rate will wear off eventually after some months. What worries us is that this may not hold if prices are “sticky downward”, as businesses will continue to maintain profit margins despite enjoying lower input costs, the GST-imputed input tax rebate. It remains challenging for the Government to manage the GST-inflicted impact on domestic inflation during the transition period. The stepping up of the consumer awareness campaign, effective price monitoring and regulatory price check enforcement, especially at the initial implementation stage, as well as real-time price information on GST-imposed items, are vital to help rein in unfair price setting practices or curtail excessive profiteering. The budget is expected to roll out the list of zero-rated and exempt supplies goods and services. A Shoppers’ Guide, which indicates the price changes due to the GST implementation based on selected regions, should be widely disseminated and made available through all channels in Q4’14 or January 2015, so that consumers have more time to digest the information.

The budget is expected to unveil some initiatives to improve the supply chain of production, marketing and distribution channels of agriculture produce and essential food items to help stabilise prices and ensure sustainable supply. If warranted, there should be a fundamental review in terms of procurement, storage and distribution functions to strengthen the effectiveness of these agencies.

On mitigating the rising cost of living, the Government may provide a one-off GST voucher for eligible households and older Malaysians, especially those who are retired or have no income, as they are usually more affected by increases in the cost of living.

Thrust Five

On the issue of ensuring affordable housing accessible to targeted groups, a holistic affordable housing programme needs to be implemented to help close the gap of the demand and supply of affordable housing premised on three broad approaches to affordable housing - rental assistance, homeownership assistance and regulatory policies.

Regulation can be a powerful housing policy tool. However, often overlooked, land use and development regulations such as zoning policies, land use restrictions, development fees, sub-division and design requirements, as well as other regulations, have explicitly or implicitly limited or prevented the development of affordable housing in a jurisdiction. While some of these regulations are necessary, others can be hindered and, when reviewed or removed, should facilitate the supply of more affordable rental and home-ownership.

While there are incipient signs pointing to the easing of the property-buying frenzy, an element of housing froth would still be intact if left unchecked. It is too early for the Government to lift its cooling measures, as the current trend of property prices moderating is manageable, in tandem with the policy intention of keeping Malaysia’s property market stable and sustainable. Going forward, expectations are that property prices would remain firm or rise further, as the developers have factored in GST-related repricing and the re-costing exercise. The impending implementation of the GST from April 2015 onwards is causing a lot of uncertainties in the property market. Although residential properties that are for sale, purchase and rental will be GST-exempt, the higher development and input costs may be passed onto purchasers in terms of higher selling prices.

Excessive speculative property investment financed by over-leveraging would pose a systemic risk to the financial system. Over-investment in the property sector during good times could cause economic malaise when the growth cycle takes a negative turn, resulting in higher non-performing loans, and thus, increasing risks to the banking sector. Besides this, over-concentration in property development projects to support economic growth could lead to the misallocation of resources at the expense of other productive sectors.

Bank Negara is not likely to roll out new macro-prudential measures amid continued vigilance on the household indebtedness, especially for those earning between RM3,000 and RM5,000. Banks’ thorough credit risk assessment on eligible borrowers accompanied by the resumption of interest rate normalisation in July this year are likely to help contain the rise of unsustainable debt-fueled spending. At this juncture, Bank Negara is unlikely to take any policy risk that could trigger an over-adjustment. Growth in household debt has been moderating for six consecutive quarters as a result of Bank Negara’s macro and micro-prudential measures.

Lee Heng Guie is former research head of CIMB Investment Bank.
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