GST after 100 days and beyond

JULY 9 marked 100 days since the introduction of the Goods and Services Tax (GST) in Malaysia.

The regressive consumption tax has been highly controversial among the public and business sector since it has increased costs.

The negative effects of GST are a palpable issue of the moment, but the bigger scheme into which GST fits – to bring Malaysia’s government budgeting in line with the vision of the International Monetary Fund (IMF) – may also raise challenges by 2020.

Inflation in April 2015 was comparatively low at 0.9%, up from the previous month. While the Government claimed that the prices of eight out of 12 categories of goods in the Consumer Price Index (CPI) would decrease after GST, in fact the prices of all categories increased. However, the overall impact was offset by the sharp drop in oil prices since the fourth quarter of 2014.

Thus, while low oil prices have battered the Government’s revenue and the value of the ringgit, they have effectively spared consumers from a more severe impact after the introduction of GST.

Underlining the regressive nature of GST and the failure of the Government’s complicated system of exemptions and zero-rating to cushion low-income consumers from it, official data from the Department of Statistics also show that for those consumers earning below RM3,000 per month, inflation was marginally higher than overall national inflation at 1%.

Inflation patterns in May continued to follow pre-GST patterns for most goods, suggesting that price hikes were “one off ”. However, given that an undisclosed number of businesses have chosen to temporarily absorb GST for their customers, we can expect a further inflationary bump in the third and fourth quarter of 2015 when they relax their policy.

Despite GST’s price impact being “one off ”, the gloom that has descended on consumer sentiment may be prolonged by choppy global economic conditions such as the falling ringgit, China’s growing market turmoil and its impacts on our exports. Research analysts have forecast lower growth in domestic demand over the next six months than the first six months of 2015.

With the Government now expecting to more than double its GST takings in 2015 to RM50bil, up from an initial estimate of RM23.2bil, the greater financial outflow from the private sector may further dampen domestic demand.

Some of this negative sentiment can be explained by the fact that consumers won’t be receiving wage increases that could compensate for GST for a while yet.

Businesses are also grousing that Customs and the Domestic Trade, Cooperatives and Consumerism Ministry have been overzealous in fining them for tax and price infringements since April 2, rather than allowing a grace period for implementation hiccups.

While unpopular at home, GST has received accolades from financial entities such as the World Bank, IMF, and most recently the Fitch Ratings Agency. These entities have been concerned about the Government’s revenue base and ability to service its loans, namely Malaysia’s dependence on oil revenues and a small income tax base.

Since 2009, the administration of Prime Minister Datuk Seri Najib Tun Razak has committed itself to a fiscal policy approach broadly in line with that prescribed by the IMF. This involves slashing subsidies for key consumer goods, raising government revenue via GST, and bringing the budget deficit towards zero by 2020, to achieve a so-called “balanced budget” that would reduce government debt commitments.

This effectively commits Malaysia to a more moderate form of austerity than that inflicted upon Greece by the IMF and its partners. This policy stance has been driven in part by a fear that excessive public debt will hurt economic growth. However, the IMF has recently admitted that high debt doesn’t hurt economic growth.

Nonetheless, the IMF recommends placing the bulk of the burden of financing Najib’s austerity programme upon the GST, which means that Malaysian consumers will ultimately foot most of the bill while subsidies evaporate.

Subsidies on various essential goods such as foodstuffs and fuel have helped Malaysia offset decades of wage repression to make its exports more competitive.

Rolling back subsidies in the absence of counterbalancing wage gains helps keep exports competitive but squeezes consumer incomes.

It also means that those consumers who aren’t receiving direct assistance from the Government – the middle class – will feel greater financial pressure, especially if the Government follows the IMF’s suggestion to raise GST above its initial rate of 6%.

The Government’s budget is divided into operating and development expenditure. The latter should be investment that improves Malaysia’s productive capacities. The Government is limited by law to only borrow to finance development expenditure. Reducing government debt and the related budget deficit means using GST revenue to finance development expenditure instead.

Development expenditure has a strategic role to play in stimulating the economy and boosting economic productivity. However, the 11th Malaysia Plan projects a contraction in development expenditure by 2020 of -0.4% below 2015 levels to RM47.6bil, while indirect tax revenue (which includes GST) will rise to RM65.6bil.

Less Government development spending combined with more GST drain on private incomes could deflate growth by weakening domestic demand. Demand could be boosted by increasing private debt but this, if allowed to climb too high, could make economic growth dependent on growth in private debt and vulnerable to any contractions in the latter.

A major factor in the 2008 financial crisis was the growth in US private debt for speculation on asset prices. A loss of confidence led to deleveraging, a contraction in the growth of private debt, and a drop in growth dependent on private debt, resulting in a financial crisis.

The implementation of GST in the pursuit of a zero deficit, combined with reduced development expenditure, could fuel economic dependence on private debt.

Household debt in Malaysia is already one of the highest among developing economies at 87.9% of GDP in 2014, and exceeds US household leverage levels, according to the McKinsey Global Institute.

GST entered the Malaysian economy under the guise of fiscal prudence, but vigilance is required to ensure that it does not leave us in financial ruin.