Redefining fiscal deficit

New target for 2020 and narrower budget shortfall expected for 2018

PETALING JAYA: The Government is expected to redefine its fiscal ambition for 2020 as it has become increasingly clear that its earlier target to achieve a near-balanced budget position by the end of the next three years has been challenged by the changing economic circumstances.

An economist told StarBiz that the Government would likely set a new target for 2020, the year in which Malaysia is expected to achieve developed nation status when it unveils Budget 2018 this Friday.

“Some officials have conceded to the fact that the goal of a near-balanced budget by 2020 is too ambitious, and it has to be relooked at,” the economist with a local bank said.

Noting the slow pace of fiscal deficit reduction in recent years, the economist said: “The challenges to achieve the goal within a short period of time are immense – an almost unlikely feat.

“The last two years had put a dampener on the goal of the Government, which had to recalibrate its Budget 2015 and 2016 due to the significant weakness in global oil prices.”

“So, now it will be extremely difficult due to the ‘lost time’ and even if global and local economic conditions continue to improve in a significant manner as the government expenditure will definitely increase along with its revenue growth,” he explained.

In 2015, Malaysia changed its 2020 fiscal target to “a near-balanced budget” of 0.6% of the country’s gross domestic product (GDP) after it became clear that the country would unlikely meet its target of a balanced budget five years down the road. Malaysia’s fiscal deficit-to-GDP ratio then stood at 3.4%, down from 6.7% in 2009.

According to another economist with a local brokerage, even lowering the fiscal deficit-to-GDP ratio to less than 2% by 2020 would be a difficult task.

“It is ‘impractical’ for the government to cut its deficit by a large

quantum within a short span as it may not be healthy for the economy,” he said.

Standard & Poor’s Global Ratings had in June also raised scepticism over Malaysia’s ability to achieve a near-balanced budget by 2020, deeming the target as “ambitious”.

“This is particularly given that, even in the case of a significant and sustained recovery in oil prices, spending would likely rise in tandem with revenue,” the international rating agency said.

While Malaysia’s fiscal consolidation would broadly remain on track, economists said they would expect the slow pace of fiscal deficit reduction to continue through next year.

According to consensus expectations, the government would likely set the 2018 fiscal deficit target at around 2.8% to 2.9% of GDP.

That’s only a marginal decrease from the projected fiscal deficit of 3% of GDP for 2017.

In 2016, Malaysia’s fiscal deficitto-GDP ratio stood at 3.1%, compared with 3.2% in 2015 and 3.4% in 2014.

In its preview of Budget 2018, RHB Research said it expected the Government to increase its expenditure in 2018 by 4.3% to RM269.3bil from an estimated RM258.2bil in 2017, on expectations of higher revenue from stronger oil prices and tax collection.

“Despite an increase in expenditure, we believe the fiscal consolidation drive remains on track and we project a budget deficit of RM41.6bil, or 2.9% of GDP, for 2018, improving marginally from 3% of GDP in 2017. This would likely be achieved on the back of higher revenue,” the brokerage said.

In total, RHB Research said it expected government revenue to improve by 4.5% to RM226.9bil in 2018 from the estimated RM217.2bil in 2017.

Similarly, CIMB Research expects the Government would target a narrower budget deficit of 2.9% of GDP under Budget 2018.

“Increased operating expenditure is sufficiently funded by improved fiscal revenue, driven by a higher GDP growth target, a more constructive oil price outlook, a higher Goods and Services Tax (GST) contribution, and enhanced efficiency of tax collection,” CIMB Research said in its Budget 2018 preview.

Economists in general expect Budget 2018, themed “Shaping the Future”, to be “rakyat-friendly”, with lots of goodies, especially for the lower-income households, ahead of the 14th general election (GE), which needs to be held on or before Aug 24 next year. This would mean increased expenditure amid the absence of new taxes or tax hikes.

“Despite the generous budget proposals to stimulate domestic demand, based on our estimate, the Government will still focus on fiscal discipline and likely incur a smaller budget deficit of 2.8% of GDP in 2018, compared with a deficit of 3% of GDP in 2017,” Affin Hwang Capital Research said.

“While the tax and expenditure programme in Budget 2018 involves striking a challenging balance between fiscal consolidation and supporting the economy, we believe the improvement to the budget deficit position in 2018 is premised on the following factors: 1) a synchronised improvement across both advanced and emerging-market economies; 2) manageable capital flows; 3) steady commodity prices, especially global crude oil prices; 4) steadier economic growth in Asia; and 5) strong domestic demand with a stable ringgit,” it explained.

Meanwhile, TA Research said despite Budget 2018 being an expansionary budget, with increased spending, deficit reduction would remain on track, falling to 2.8% of GDP in 2018 from 3% in 2017.

“Considering that operating expenditure has averaged about 83% of total budget allocation in the last five years and given that we are looking at a pre-election budget, the balancing act is not going to be easy. Thankfully, higher collections from the GST, a rebound in crude oil prices, efficient tax collection and new sources of tax can provide some breathing space to still pursue a friendly budget,” the brokerage said.

“Naturally, with a GE around the corner, this budget is widely expected to empathise with and appeal to a wider group of the population. While goodies and incentives, especially for civil servants, households and businesses, could be on the cards, it should remain as a pragmatic budget that balances fiscal discipline and future growth aspiration with the well-being of Malaysians,” it added.

Despite the gradual pace, the expected improvement in Malaysia’s fiscal position would be positive on the country’s sovereign rating, which, in turn, would be supportive of the ringgit.

“A favourable rating for Malaysia would somewhat lower the country’s vulnerability to capital outflow vis-a-vis other countries in the region that have weaker sovereign ratings,” an economist explained.