The impact from last week’s subsidy cuts affecting petrol, diesel, liquefied petroleum gas (LPG) and sugar would be manageable, and will likely have a mild effect on inflation, said analysts.
They generally agreed there would be further subsidy cuts, adding that the government had made clear its intention and it had reached a point of no return.
Last week, the government announced the increase of RON95 petrol prices by five sen per litre to RM1.85 per litre, while RON97 petrol prices would no longer be subsidised. Diesel prices rose by five sen per litre to RM1.75 while LPG price was raised 10 sen per kg to RM1.85. Sugar price was raised 25 sen per kg to RM1.90.
“Should the government renege on its pronouncement, it will diminish global investors’ confidence in the ability of the public sector to undertake fiscal reforms,” said MIDF Research head Zulkifli Hamzah.
He said there could be a further 10 sen hike in fuel price, as Pemandu had proposed to increase petrol and diesel prices by 15 sen in 2H10.
“The government has yet to finalise the mechanism through which the burden of the low income segment of the population will be eased. This is the critical area and until this has been finalised, we do not expect the pace of the subsidy removal to be in high gear,” he said.
Zulkifli said companies that had a significant fuel cost component would inevitably feel some pressure on profit margin.
“However, it all depends on how strong their pricing power is and whether they are able to pass on the incremental cost to their customers.
“Food producers, for example, operate on relatively thin margin and depend more on volume for earnings. They are strongly expected to pass on additional costs to customers. The same applies to logistics companies,” he said.
Zulkifli said overall, the subsidy removal would have a mild impact on inflation, but the worry was on the “second-round” effect of the price hike, which had more to do with inflation psychology than the actual cost numbers.
“In this regard, the government should step up enforcement to ensure that there is no unwarranted escalation in prices,” he said.
CIMB Investment Bank head of economic research Lee Heng Guie said ending subsidies gradually was the best option, as consumers and businesses would have time to digest the small hikes.
The overall impact on inflation, domestic demand as well as businesses would be manageable, he said.
“Also, compensatory measures must be ready for targeted or vulnerable groups to ease their financial burden arising from the removal of subsidies.
“The estimated small reduction of subsidies amounting to RM2.6 billion in 10MP reflects that subsidies and price controls will be gradually rationalised to remove market distortions,” he said in a note last Friday.
Lee said though there would likely be some opposition to the subsidy cuts, Malaysians would generally accept the subsidy rationalisation, especially if the government showed accountability and earn public trust that it would use the subsidy savings wisely.
“Tackling subsidies alone is unlikely to solve the fiscal deficit problem. What is required is that fiscal reform be part of a wider programme of macroeconomic reform and political reform.
“There should be greater openness in government expenditure programmes, including significant acceleration in enforcement and prosecution for misappropriation and mismanagement of resources within the government,” he said.
Expenditure leakage as well as wastage was a pervasive problem and had an impact on overall economy, said Lee.
“Based on our calculations, the price hikes will result in 0.3 percentage point rise in the headline inflation. As such, we maintain our headline inflation forecast at an average 2% for 2010 and 2.5% in 2011.
“We are keeping our year-end Bank Negara Malaysia’s policy target rate of 2.75% given the anticipated moderate inflation pressure,” he said.
He also said while the price hikes would have a small impact on inflation in the short-term, it was likely to be a one-off price shock, and it did not mean that it would lead to persistent price increases.
OSK Investment Research’s Chris Eng said as there were no cuts on gas subsidy, toll rates and cooking oil, the impact on the broad market would be limited.
The cuts on sugar subsidy will likely see food and beverages companies passing on the cost to consumers as the quantum should be small.
Eng said as petrol prices were to be raised only by some 2.8% for now, he expected the impact on the auto, toll road and retail sectors to be limited.
The sugar price increase of 15% should see some costs being passed on to consumers but again, the impact on disposable income should be mild, he said in a note last Friday.
“We see more cuts in these and other goods possibly in 2011. We also identify three potential beneficiaries, namely Tenaga Nasional Bhd, which may secure its tariff hike, Gamuda Bhd and MMC Corporation Bhd, which may lobby for subsidy savings to be used to fund the KL MRT project, which may then kick off earlier.
“Overall, the cuts are a signal that economic reform is pushing ahead and we remain bullish on the FBM KLCI, particularly for 4Q, with an unchanged target of 1,465 points at year-end,” he said.
Meanwhile, Supermax Corporation Bhd group managing director Datuk Seri Stanley Thai said while it was a bold move by the federal government, there was no indication from the government on how to help the poor to cope with the increasing cost of living.
The federal government must walk the talk, and the corporate sector wanted to see the effectiveness in carrying out the reduction of subsidies in an orderly manner and consistency in carrying its policies, he said.
“Immediate focus and action to abolish the subsidies should be on those subsidies which benefit the rich and those who are politically well connected.
“We would like to see the government take immediate action to abolish the subsidies on natural gas to all IPP plants who have been enjoying the lowest tariffs and thus probably enjoying the highest subsidies, and that more natural gas is channeled to manufacturing industries, in particular to the glove manufacturing industry and other sectors of the economy where it could contribute multiplier effect to the economy,” he said in a statement.
Written by Surin Murugiah
This article appeared in The Edge Financial Daily, July 19, 2010.
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