Confidence test for Malaysia’s topsy-turvy finances
Finance Minister Lim Guan Eng told investors to expect 'pain and sacrifice' in the 2019 budget but a lack of actual belt-tightening will put pressure on the ringgit
Saddled with debt and liabilities exceeding 1 trillion ringgit (US$240.3 billion) and the risk of a credit rating downgrade, Malaysian Finance Minister Lim Guan Eng had forewarned investors to expect “pain and sacrifice” upon the release of the new Pakatan Harapan government’s inaugural budget.
Amid expectations of new taxes and austerity spending cuts, Lim quipped that he could end up as the most unpopular finance minister in the nation’s history. But when Malaysia’s six-month-old government announced its 2019 budget on November 2, there were no substantial spending cuts to be found.
Observers of Southeast Asia’s third-largest economy, who for months have waited for signs of fiscal clarity from Prime Minister Mahathir Mohamad’s freshly installed government, now have a clearer picture after the unveiling of an expansionary budget that prioritizes institutional reform and will raise the national deficit to its highest level in five years.
All eyes were on Lim, a trained accountant and former chief minister of the state of Penang, as he stood to table the high-stakes budget in a closely-watched parliamentary address, a make or break opportunity for the newly minted finance minister to prove his mettle as detractors and naysayers have already started to question his management.
Chief among his critics is scandal-plagued former premier Najib Razak, who has regularly questioned Lim’s fitness for the job in lengthy and scathing Facebook posts. Lim sparked a brief sell-off of the ringgit shortly after being appointed in May when he revealed the country’s public debt level was substantially higher than what the previous administration stated.
Lim maintains that Malaysia’s public debt amounts to 80.3% of gross domestic product (GDP) after counting for off-budget debt liabilities that commit the state to shoulder debts of cash-strapped state entities, not least the 1Malaysia Development Berhad (1MDB) fund now at the center of domestic and international corruption probes.
Najib’s government reported the national debt at 50.8% of GDP, significantly below his administration’s self-imposed debt ceiling of 55%.
Though the new government’s higher debt revelation initially shook international confidence in the country’s finances, Lim has pointed to strong economic fundamentals and a commitment to greater transparency to mitigate those concerns.
Lim has since stuck to his guns and remained unapologetic for his forthright style, describing the previous government as “kleptocratic” and vowing in his budget address to restore Malaysia’s fiscal health within three years through “clean, people-centric policies” and institutional reforms that would revive Malaysia’s previous reputation as an “Asian tiger” economy.
The 2019 federal budget, the first in six decades to be tabled by a government other than the long-ruling Barisan Nasional (BN) coalition, boosts government spending to 314.6 billion ringgit (US$75.6 billion), a 10% increase over 2018’s pre-election spending plan touted by Najib at the time as “the mother of all budgets.”
Expectations of belt-tightening were upended with operational and development expenditures rising by 10.9% and 18.9% respectively, moves that finance ministry officials said are part of a “smart spending” strategy to lay a firmer foundation for long-term growth, despite higher short-term deficit spending.
The country’s deficit is expected to hit 3.7%, up from the Najib government’s target of 2.8%, a figure Lim said was unrealistic considering the previous administration’s hefty off-balance sheet expenses. Over the next three years, Harapan aims to lower the fiscal deficit to 3.4% in 2019, 3% in 2020, and 2.8% by 2021, he said.
The top three ministries to benefit from the operating expenditure will be health (26.5 billion ringgit or US$6.3 billion), finance (23 billion ringgit or US$5.5 billion), and education (60.2 billion ringgit or US$14.5 billion), with the latter accounting for close to 20% of the budget. Defense spending, by contrast, was slashed by 10.2%.
Lim also unveiled plans for a new Debt Management Office tasked with reviewing and managing government debts, as well as monitoring debts issued by the government, statutory bodies and special purpose vehicles. He also announced new legislation regulating fiscal responsibility and government procurements.
Financing a 21 billion ringgit (US$5 billion) shortfall in the national budget has been a key challenge facing Harapan after it abolished a Najib-era goods and services tax (GST) to meet a core election promise. Mahathir’s government has replaced it with newly implemented sales and services tax (SST) that analysts see as less efficient than the previous sweeping consumption tax.
Lim plans to make up the difference with revenue from new sources of income such as new taxes on sugary drinks, online services, the gaming industry, travel and property gains. Non-tax revenue will make up 27.2% – up from 17.2% in 2018 – with an increased dependence on dividends from state oil company Petronas amid a windfall from higher global oil prices.
There were no changes to the corporate tax rate of 24%, though measures have been introduced to make the tax system more business-friendly, including a 1% reduction on earnings below a 500,000 ringgit (US$120,000) threshold designed to benefit small and medium enterprises (SMEs) that reportedly make up 98.5% of Malaysia’s corporate sector.
Estimates project growth to slow to 4.8% this year, down from 5.9% in 2017, against the backdrop of trade tensions between the US and China, supply disruptions and lackluster performance of liquefied natural gas (LNG) and crude palm oil. Malaysia’s export-driven economy is expected to grow by 4.9% next year driven by private demand and investment.
The budget included a number of initiatives to assist lower and middle-income groups, including a targeted petrol subsidy initiative and a cash assistance scheme known as Bantuan Sara Hidup (BSH), essentially a rebranded version of the BN government’s Bantuan Rakyat 1Malaysia (BR1M) scheme that provided cash handouts to low-income earners.
Other highlights included an affordable home ownership scheme and a National Health Protection Fund for low and middle-income earners. A new minimum wage, another measure being introduced by Harapan to reduce income inequality, will come into effect next year at 1,100 ringgit (US$263) per month, a figure analysts expect to gradually rise.
“This isn’t a reform budget, but a budget to bring confidence back to the financial system,” said James Chin, political analyst and director of the Asia Institute at the University of Tasmania. “The higher deficit is not important as Lim is looking at a 3-year cycle. Harapan wants to send a signal that they are different from Najib and more careful with money.”
“The international community will like this budget,” said Chin. “The only thing they may not like is the continued cash handouts under the new BSH scheme. But the political reality is that the poor really need and rely on financial assistance.”
Malaysia plans to deploy funds raised through yen-dominated “Samurai bonds” worth 200 billion yen (US$1.77 billion) to repay foreign debts with higher interest rates, like those associated with 1MDB. The ten-year bonds were secured with an interest rate of just 0.65%. Chin said the bonds were an “unexpected bonus” signaling closer Japan-Malaysia ties.
Andrew Wood, an analyst with S&P Global Ratings, pointed to a heavier reliance on commodity-based revenues in a statement saying that risks to Malaysia’s fiscal accounts and debt profiles remained in the absence of “more structural revenue-raising measures.” The government’s commitment to gradual fiscal consolidation, he noted, appears credible.
Lim ended his address by highlighting recent charges brought by the US Department of Justice against fugitive Malaysian financier Low Taek Jho, also known as Jho Low, and two former Goldman Sachs bankers accused of money laundering and bribery in connection with the 1MDB scheme, regarded as one of the biggest heists in financial history.
The finance minister said Malaysia would take all measures necessary to reclaim missing or stolen funds from the sovereign fund. He also said the government would claim fraud to relieve itself from obligations to pay back billions of dollars owed by 1MDB to the Abu Dhabi sovereign fund International Petroleum Investment Co (IPIC) and its subsidiary Aabar Investments PJS.
Instead, it will demand the return of US$1.46 billion already paid by 1MDB as part of a dispute over 1MDB bonds that IPIC had guaranteed during the Najib premiership. In any case, Lim’s maiden budget appears to have gone down well with Malaysians who long for a clean and competent steward to plug leakage, restore confidence and stoke new growth.