Saturday May 28, 2011

Government needs to urgently address the country's fiscal deficit

By JAGDEV SINGH SIDHU
jagdev@thestar.com.my

There are many ways the Government can tackle the country's deficit position.

IT was in a lecture hall in England when Malaysians got a sense that subsidies that kept electricity and petrol prices low might soon fall under the knife.

“Subsidies as a whole are like opium. Once you take opium it's hard to kick the bad habit; once you provide subsidies it's hard to take them away without some political cost,” Reuters quoted Prime Minister Datuk Seri Najib Tun Razak telling an audience at Oxford University's Centre for Islamic Studies over a week ago.

Over the next week, other politicians echoed the thrust of his message. Subsidies were becoming too big a drag on the economy and without further management of that cost, the budget deficit will soar.

Deputy Prime Minister Tan Sri Muhyddin Yassin, a couple of days before the Cabinet meeting mid week, had also highlighted the need to push ahead with the subsidy rationalisation programme.

The compelling factors were only too evident the country's budget deficit which stands at 5.4% of GDP is under pressure, nudging 6% and subsidy cuts would to some extent be able to address this concern. There was widespread anticipation that fuel and electricity prices would be raised.

But on Wednesday, the day the subsidy cuts were expected to be announced, there was clearly a change of heart. The Government decided to keep the prices of RON95 petrol, diesel and liquefied petroleum gas unchanged for the time being.

“It appeared that the Cabinet was concerned about the impact and financial burden on people, especially the lower income groups, and concluded that further studies need to be done, although no timeframe was given as to how long the “studies” will take,” says Maybank Investment Bank Bhd in a note. Many economists say that the move to avoid doing the necessary at this point was to mitigate the political cost such a move would result in. This was the main factor that led the Government to take its foot off the gas on pushing ahead with the subsidy cut agenda.

The big question now is how long has the Government staved off increasing the prices of these items?

When the price of crude oil rises too high, the cost burden on the Government cranks up.

On the rise

One of the reasons the rationalisation scheme was deferred was that Malaysians are already feeling the pinch from higher costs.

Inflation, as a result of higher price of commodities, is eating its way through just about every economy in the world, and more so in the emerging economies of Asia.

It is a major headache for governments to tackle this dilemma of higher cost as global prices of commodities largely due to bad weather that has hit crops and political turmoil in some parts of the world are pushing up the prices of goods and services all over the world. The existence of subsidies has largely cushioned the impact on this on the general Malaysian population. Subsidies are also viewed as an escape valve from inflationary pressures being transferred directly to the wallets of households.

Malaysia has among the lowest inflation rates in Asia and it's that buffer, along with the strength of the economy, that led Bank Negara to declare that the economy was stronger now than before to withstand the added inflationary pressure should subsidies be rolled back.

“We'll not be immune to price increases but the impact will be less as we've enhanced efficiencies in the economy,” governor Tan Sri Dr Zeti Akhtar Aziz told reporters earlier in the week.

Despite the economy being able to withstand higher inflation, cost pressures have somewhat hit many households.

The headline inflation number for April stood at 3.2%. But for long, many have dismissed such data on the premise that it doesn't quite reflect reality. Several factors have influenced this viewpoint the perception that the inflation data is skewed towards costs in the rural areas, that the basket of goods and services used to calculate inflation is outdated, a large percentage of the basket comprises controlled items while the fact that asset price inflation is not captured in the data. It is for these reasons that not many rely on the inflation data to provide a true reflection of what is actually taking place on the ground. “Subsidy removals will undoubtedly affect consumer spending, especially if such measures lead to widespread increases in the prices of consumer goods,” says Malaysian Rating Corp Bhd (MARC) in a report.

“For a country like Malaysia, where private consumption is a major pillar of the economy, a dent in consumer spending will adversely affect headline growth if such measures were to be implemented aggressively.”

MARC adds the impact on consumption is compounded by the fact a large number of workers have relatively low income levels, with 34% of workers earning a mere RM700 and below per month, according to the National Employment Return (NER) 2009.

“Approximately 70% of the sample surveyed earned less than RM1,500 per month, and even in a big city like Kuala Lumpur, 32% of workers earned less than RM1,500 per month,” it says.

Fortunately, the drop in crude oil prices in recent days has relieved some of the subsidy-related pressures. The price of West Texas Intermediate, in which the Budget uses to calculate fuel subsidy, is trading around US$100 a barrel compared with US$114 at the start of the month.

At the current price, the pressure to scale back the subsidy on petrol is less.

The last gas price revision by the Government was in March 2009, at a discount of 50%. The prices ranged from RM10.70-RM15.35/mmbtu (million British thermal units) with the plan to review every six months but that has not quite taken off.

A report by Bernama says that at a discount of 50%, the gas price ranges from RM10.70-RM15.35/mmbtu. Since the last revision, the price of medium fuel oil, a reference index on which gas is priced, has risen over 100%. As the price of energy continues to rise in global markets, the Government's cost of subsidies are also rising alongside.

Even so, the Government has signalled many times that any price increases in gas would be carried out on a gradual basis to lessen the impact on businesses, particularly the major energy guzzlers.

Despite the argument that subsidies are distortionary, the fact is subsidies are extensively used in the United States and Europe's farming community.

“For instance, agricultural subsidies in the western world, while constantly drawing flak from economists for their distortionary qualities, continue to figure prominently in these economies,” says MARC.

It says that in the United States, farm programmes to subsidise grains, oilseeds, cotton, sugar, and dairy products have cost the government US$20bil per year in the government's budget outlays in recent years.

The report argues that removing any distortion would only yield positive results if, and only if, there is a level playing field within the country.

“That is, if we were to remove a distortion but others do not follow suit, then the overall impact on the economy is rather equivocal. In the same manner, lifting distortions in the goods market and not in the labour market will not bring about optimal results,” says MARC.

“Therefore, although subsidies are commonly being criticised, many countries will not remove subsidies totally because their policies go beyond economic rationale.”

The fiscal deficit

The Public Service Department is now looking into rationalising the civil service as the gripe among many Malaysians is that the size of Government has become unwieldy.

Stories of how the Government has become the employer of last resort, overstaffed departments where too many workers are doing too little has led to the perception of too much wastage and cost within the public sector. Even so, this is not the case across the board as certain departments, such as health, are perceived to be majorly under staffed.

“There is too much wastage and inefficiency on the side of Government. That is what makes people upset,” says an economist.

Should the Government cut the fact, there is concern of job losses. But economist say this can be addresssed by the programmes under the Economic Transformation Programme which create jobs.

“In the long run we have to balance things out,” says Deloitte Malaysia country tax leader Ronnie Lim.

Data shows that since 1995, the Government has spent more than planned even though the majority of the Budgets during that period were expansionary.

“We have done a good job on the way we collect revenue but expenditure is something we need to control,” says Malaysia Rating Corp Bhd (MARC) chief economist Nor Zahidi Alias.

A much talked about change in the government revenue collection has been a goods and services tax (GST) which taxes consumption rather than incomes.Lim says a GST has the potential of increasing revenue and it will be able to tax the large black economy in the country which has so far escaped the clutch of the tax department.

“The Black economy will be hindered rather than stopped,” says Lim,

In order to slash Government expenditure, Lim believes more investment in information technology was needed and outsourcing could also make cost cheaper.

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Saturday May 28, 2011

Government needs to urgently address the country's fiscal deficit

By JAGDEV SINGH SIDHU jagdev@thestar.com.my

By JAGDEV SINGH SIDHU
jagdev@thestar.com.my