Malaysia's Fiscal Policy Shift Faces a Tough Road Ahead

Malaysia's measures, announced Tuesday, to lower fiscal subsidies and limit import-intensive investment are a strong statement of the government's intention to stem pressure on the sovereign credit profile from deteriorating public finances (as reflected in the Negative Outlook assigned to the 'A-' rating in July 2013).


The measures are consistent with Fitch Ratings' fiscal projections, and are credit-neutral over the near term. Further steps to improve fiscal sustainability and long-term macroeconomic stability could see the ratings revert to Stable Outlook.


The fuel subsidy reduction is a first, small, step ahead of possible additional measures to shore up public finances. Projected near-term fiscal savings from the 20 sen/litre hike in the price of subsidised fuel products are MYR1bn in 2013 (0.1% of GDP) and MYR3bn (0.3% of GDP) in 2014.


Fitch was already factoring in a net 1ppt of GDP reduction in government expenditure in its fiscal projections for the period to 2015, so these measures in themselves do not significantly alter the agency's analysis.


Fitch says the timing of Tuesday's announcement seems responsive to heightened global market volatility brought on by impending Fed tapering and greater investor scrutiny of vulnerabilities in emerging markets.


"A more calibrated pace of public investment prioritising non-import-intensive projects should limit the risk of near-term fiscal overruns as well as lower the likelihood of the current account slipping into a deficit. We estimate that Malaysia's current account surplus will fall - sharply - to 3% of GDP this year after averaging 11% over 2009-2012," says Fitch.


However, the fundamental driver of the narrowing current account surplus has been the widening public sector deficit, drawing attention to the health of medium-term public finances.


Effective fiscal consolidation in the next 12 months will by no means be easy. This is for two reasons.


First, the Malaysian economy is undergoing a terms-of-trade shock, with the prices of key commodity exports falling sharply. In this environment, expenditure restraint could raise downside risks to our GDP growth forecasts of around 5%, year-on-year, in 2013-2014. If this were to materialise, slowing growth could also lower tax receipts, making it that much more difficult to achieve the medium-term government deficit target of 3% of GDP by 2015.


The second reason is that the political position of the ruling coalition has weakened following the May election. This means the government is likely to continue to encounter difficulties in implementing far-reaching, and much delayed, revenue-enhancing reforms such as the Goods & Services Tax (GST).


"The upshot is that the corrective fiscal measures announced are too small to alter the Negative Outlook on Malaysia's 'A-' sovereign rating. Sustained reform implementation, if accompanied by structural measures to broaden the revenue base, could make a difference to the sovereign's credit profile. But such an intensification of reforms that can also withstand potential growth headwinds, is not on the cards at present," says Fitch.


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