Fitch Solutions forecast a fiscal deficit amounting to 6.3% of GDP in 2022, which is slightly wider than the government’s projection of 6.0% of GDP in its Budget for 2022 presented to Parliament on October 29.
“We believe that the government is likely to underperform its revenue projection, while the risk of overshooting budgeted expenditure remains high as the pandemic remains in play.
“While the government’s decision to pursue a highly expansionary budget (with a deficit above 6% of GDP for the third year in a row) will help support the economic recovery over the short-term, the continued accumulation of government debt as a result will diminish the prospects for development expenditure as more revenue goes towards interest payments overtime.”
Third Expansionary Budget
To be sure, the government has underperformed its budget projections over the past two years since the beginning of the pandemic.
In 2020, revenue underperformed while expenditure increased as a result of the measures taken to combat the pandemic leading to the actual deficit coming in at MYR87.6bn (6.2% of GDP), compared to a projected MYR34.5bn (2.5% of GDP).
Government estimates for 2021 indicate that there will also be a slight degree of overshooting in 2021. In 2022, we expect pandemic related risks to present a high likelihood of an increase in spending over the MYR23.0bn allocated for Covid-19 related spending.
Deficit Exceed Projection
In 2022, we expect revenue to come in largely in line with the government’s projection of MYR234bn (14.8% of 2022 forecast GDP). That said, the alignment of our projections does not indicate a complete agreement with the government’s arguments.
For starters, our 5.5% real GDP growth forecast in 2022 is on the lower end of the government’s forecast range of 5.5% to 6.5%, which indicates that the government is counting on average, on a higher level of economic activity than we are.
Moreover, pandemic related risks could affect economic activity, although this is more likely to be localised and transient compared to the long national lockdown that was in effect in Q220 and much of 2021. On the upside, however, the government has posited a lower average crude oil price of USD67.00/bbl compared to our Oil & Gas team’s projection of USD73.00/bbl in 2022.
Oil Prices To Provide Some Support
Budget 2022 includes a raft of revenue expansion measures, including a one-time prosperity tax levied on corporate income in excess of MYR100mn, at a rate of 33%, compared to the 24% in previous years. Individuals will also be taxed on their foreign-sourced income, while the service tax will now apply to delivery services, including food.
The increasing reliance on one-time measures to boost revenue could have negative consequences for Malaysia’s attractiveness as an investment destination in our view, as it introduces uncertainty about the tax bill businesses should expect when operating in Malaysia. This tendency is likely to remain in place over the coming years, especially if high deficits persist.
Covid-19 Remains A Big Part Of Spending
Meanwhile, we see a high likelihood of expenditure exceeding the projected amount of MYR331.5bn (21.0% of GDP), of which MYR23.0bn has been set aside for Covid-19 funds.
Accordingly, our forecast for expenditure is slightly higher at MYR334.1bn (21.1% of 2022 forecast GDP) to reflect this risk. Specifically, we expect pandemic related spending to exceed initial allocations. While Malaysia has made significant progress both in terms of lowering the daily caseloads and in terms of vaccinating the population, the experience of other highly vaccinated economies including Singapore, suggests that a re-opened economy still presents the risk of the healthcare sector being overwhelmed, especially in the initial weeks.
This could lead to localised restrictions to ensure the healthcare sector is not overwhelmed and may form the basis for more stimulus spending. The risk of this happening is heightened by the looming elections, which are due by July 2023, and indeed, the generous economic sweeteners that are included in the budget are likely meant to shore up the support of the government ahead of the polls.
Of the MYR23bn set aside for Covid-19 spending in 2022, MYR8bn has been set aside for cash handouts for eligible families, compared to MYR16.8bn in 2021. Another MYR3bn will go towards wage subsidies, compared to MYR9.7bn in 2021, with the rest being spent on retraining subsidies and social assistance programmes for vulnerable groups, among other initiatives.
Debt Limit Already Binding
Given a large deficit of 6.0% of GDP or above in 2022, the third such deficit in a row after 2020 (6.2%) and 2021 (6.8%), government debt is likely to continue climbing at a fast pace over the course of 2022. To be sure government debt has increased rapidly as a proportion of GDP, from 52.5% of GDP in Q419, to 64.3% of GDP in Q221.
“Unsurprisingly, our view that the government would once again raise the debt limit played out in October, when the debt limit was raised to 65% and will remain there provisionally until the end of 2022. However, this puts the government in a similar position as it was near the end of 2020 when it was already over the debt limit. Therefore, we believe that there will likely be another hike to the debt limit before the next legislative elections in July 2023 to 70% of GDP.”
The large government debt load presents two possible scenarios for the Malaysian economy over the medium-to-long term. The first is if the government embarks on fiscal consolidation, gradually improving the fiscal balance and even paying down debt once pandemic risks recede more completely. This would mean reduced spending for a number of years depending on how much rationalization the government is prepared to undertake and would pose a direct headwind to growth. However, the longer-term fiscal health of the country would be improved as a smaller proportion of revenue will have to go towards interest charges.
The other scenario is if the government continues to run consistent deficits after the pandemic is over. If these are kept to around 3% of GDP, then the public debt load can be kept somewhat steady. However, given the reduced long-term growth prospects (we expect growth to average around 3.7% between 2023 and 2030) in Malaysia, any sustained fiscal deficits significantly above 3% of GDP would lead to a rise in the government debt load.
“Investor concern about the sustainability of government debt would mount and could lead to an increase in borrowing costs. Given the more competitive political landscape, we believe that fiscal consolidation is the less likely scenario over the coming years, which would weigh on long-term fiscal health.”
