The Government faces an exceptionally difficult balancing act. Budget 2023 is set against a backdrop of turbulences in global financial markets (equities and bonds) and foreign exchange markets as well as rising risk of global recession in 2023 amid the strengthening of domestic economy.
It sets a course for sustaining economic recovery amid a small effort to resume the fiscal consolidation path for restoring the health of public finances. It will extend short-term fiscal and financial assistance support to the immediate needs of vulnerable households and selected sectors that need time for a full-fledged recovery.
While Budget 2023 contains elements of populist measures (election handouts to create a feel-good factor) with voters’ slant, it lacks bold structural reforms which are critical to ensure sustainable future, inspire investor and public confidence, and improve Malaysia’s high quality growth trajectory.
After three years’ of deficit averaging 6.1% of GDP (gross domestic product) in 2020-2022, the budget deficit is targeted to narrow marginally to 5.5% of GDP (RM99.1 bil) in 2023 from an estimated -5.8% of GDP (RM99.5 bil) in 2022, indicating a baby step in fiscal consolidation due to limited room for maneuvering of spending.
After taking into account Budget 2023’s net revenue loss of RM1.3 bil, the overall deficit still remains at 5.5% of GDP in 2023.
A total allocation of RM372.3 bil or 20.5% of total is allocated for Budget 2023, of which operating expenditure (OE) will be allocated RM272.3 bil (73.1% of total) while RM95.0 bil or 25.5% is set aside for development expenditure (DE). The remaining RM5 bil is for outstanding payments of the COVID-19 Fund commitments made in 2022.
While the Federal revenue and OE is budgeted to decline by 4.4% and 4.3% respectively in 2023, the Finance Ministry (MOF) has budgeted a new record high of RM95.0 bil for DE (25.5% total expenditure and 5.2% of GDP), marking a substantial increase of 32.3% from an estimated RM71.8 bil in 2022.
Higher allocation of DE is for the construction of highways and railways, water and sewerage treatment plants, medical and education facilities as well as a sum of US$3 bil for the redemption of 1MDB’s maturing bond in March 2023. The question is why the redemption of 1MDB bond is not treated as operating expenditure?
Lee Heng Guie
While we reckon that an extraordinary higher allocation of DE is to help cushioning domestic economy against the risk of global recession in 2023, our concern is not only the implementation capacity of the ministries and agencies but also the effectiveness of projects/projects implementation as well as the leakages and misappropriation of public funds.
The real multiplier impact of the DE projects is questionable. It would depend on how fast the allocation is disbursed and how effectively the planned projects and programmes are being carried out.
In 2021-2022 when the DE was increased by between 11.7% and 26.3%, public investment declined by 11.3% in 2021 and only increased by 2.2% in 2022, indicating the weak fiscal impulse.
There are risks to fiscal plan stemming from a weakening economic growth and high inflation which could affect the tax revenue collection, continued subsidies, higher contingency expenses, as well as calls for permanent increases in spending that exceed available resources.
Downside risks weigh on the economy in 2023
The Treasury expects the Malaysian economy (real GDP) to grow between 4.0%-5.0% in 2023, slowing from estimated 6.5%-7.0% in 2022. This is in line with our estimates of 6.5% in 2022 and 4.1% for 2023, reflecting the impact of weakening global growth, a normalisation of domestic demand as the consumption booster effect faded and also a restraint by the technical high-base effects.
We caution that growth risks in 2023 skewed to the downside given the considerable risks to the global economy, especially recession risk in the US economy and Europe, strong inflation pressures, continued military conflicts in Russia-Ukraine, and higher US interest rate induced negative spill-over disruption effects on domestic economy.
The worst-case scenario is real GDP growth could be around 2%-3% in 2023 if there is a deep global recession and domestic demand pulls back sharply.
The MOF estimates slower private consumption growth to 6.3% in 2023 from estimated 8.7% in 2022 while private investment will improve moderately to 3.7% in 2023 (3.0% in 2022). These estimates are higher than estimates by the Socio-Economic Research Centre (SERC) (private consumption: 5.9% in 2023; private investment: 3.0% in 2023).
Continued higher inflation and cost of living as well as interest rate increases would crimp consumer spending power. Unemployment rate will ease slightly to 3.5%-3.7% in 2023 from estimated 3.8%-4.0% in 2022.
The continued payment of Bantuan Keluarga Malaysia totalling of RM7.8 bil to benefit 8.7 million households and individuals and other financial assistance – including a reduction in personal income tax rate by 2% for the chargeable income band between RM50,000 and RM100,000 that results in income tax savings of between RM250 and RM1,000 – is expected to help relieve households’ financial burden.
This will release RM800 mil disposable income. Government servants too will get special salary increment costing RM1.5 bil; special financial assistance of RM700 (RM1.3 bil) and the 2023 Aidilfitri special financial assistance of RM600.
Private investment will remain on a cautious mode on increased costs, shortage of workers; external uncertainties and domestic political uncertainty. The proposed reduction in the preferential tax rate to 15% from 17% currently for SMEs on the first chargeable income of RM100,000 is expected to result in tax savings of RM2,000 for 150,000 tax payers.
We concur with MOF’s assessment that exports are expected to slow markedly to 2.2% in 2023 from estimated 17.4% in 2022. SERC is more cautious about exports estimated 1.8%, reflecting the dampening impact of weakening global demand, easing prices of energy and commodities as well as being challenged by the high base effects.
Brent crude oil price is projected to average US$90/barrel in 2023 (estimated US$100/barrel in 2022) while crude palm oil (CPO) price is expected to average RM4,300/metric tonne in 2023 (2022:RM5,000/metric tonne).
Inflation is estimated to range between 2.8%-3.3% in 2023 (estimated 3.3% in 2022) which is in line with SERC’s estimates of 3.5% in 2022 and 2.5-3.3% in 2023. This is to factor in a gradual move towards targeted subsidies mechanism amid easing energy and commodity prices.
Structural reforms
Faster implementation of structural reforms would bolster confidence and economic recovery; and also ensure the economy is fit and better able to realise its growth potential in a balanced and competitive way.
The Fiscal Responsibility Act is expected to be tabled in Parliament by end-2022 to deliver better fiscal outcomes, enhance governance, accountability and transparency in financial management.
However, we are disappointed that Budget 2023 did not commit a wholesale tax reform to broaden the tax base as current narrow tax base is unsustainable. In times of meeting revenue shortfall, the Government has implemented a piecemeal approach such as the windfall tax, prosperity tax or turned to PETRONAS as its last resort of banker, thanks to soaring crude oil prices.
But once the high crude oil prices fizzle out, the challenges for having a sustainable revenue stream to meet high committed obligations and expenditure remain.
There’s going to be sustained pressures on the Budget 2023 – public healthcare, education, social community services, fiscal support for aging population and aged care.
Debt service charges bill at 16.9% of total operating expenditure (RM46.1 bil) in 2023 Budget 2023 is under pressure in relation to total revenue of 16.9% (15.1% of revenue in 2022) which is higher than the 15% threshold in accordance to international best practices.
If the level of debt is not stabilised, the interest bill will rise significantly given rising bond yield.
Hence, the Government has to move forward with a tax reform system fit for purpose that takes on board all the pressures on the Federal Budget given this is critical to anchor expectations for sustainable fiscal and debt level.
Malaysia has incurred unbroken 26 consecutive years of deficits, resulting in a cumulation of RM1.04 tril Federal Government debt or 61.0% of GDP at end-June 2022. The overall debt is projected to be around 65% of GDP while statutory debt at 63% by end-2023.
To ensure a smooth implementation of the 12th Malaysia Plan (12MP), the Government may extend the statutory debt limit of GDP in the medium-term after the expiry of the Act 830 [Temporary Measures for Government Financing (Coronavirus Disease 2019) Act 2020] on Dec 31, 2022.
Total debt and liabilities of the Federal Government was estimated at RM1.42 tril or 82.9% of GDP as at end-June 2022.
The bloated subsidies and financial assistance of RM58.9 bil or 20.7% of total operating expenditure in 2022 has forced on the Government to implement a gradual subsidies rationalisation, moving towards a targeted regime based on needs and income from a blanket approach.
This is expected to reduce subsidies and social assistance by RM16.9 bil to RM42.0 bil or 15.4% of total operating expenses in Budget 2023. That said, the targeted subsidy mechanism was not announced in the Budget.
Subsidies come with huge “opportunity cost” to the society. It reduces the fiscal capacity as the huge financial resources spent on subsidies have diverted the budget’s allocation from other sectors such as education, healthcare, infrastructure and housing.
Subsidy programmes encourage waste and degrade environment. The implementation of the subsidy reform must have three important principles (3 “Cs”) – CREDIBLE, COMPENSATION and COMMUNICATION. – Oct 9, 2022
Lee Heng Guie is the executive director at Socio-Economic Research Centre (SERC) Malaysia.
