Malaysia’s latest central government budget sustains a modest pace of fiscal consolidation by shifting toward a more selective subsidy spending regime, and highlights the complexity the officials face in balancing spending pressure and fiscal consolidation efforts, says Fitch Ratings.
The budget, which was unveiled on 13 October, it said remains tilted to the expansionary side, with the government projecting a fiscal deficit of 4.3% of GDP in 2024, compared with 5.0% in 2023. Fitch said this was largely in line with expectations when it affirmed Malaysia’s sovereign rating at ‘BBB+’/Stable in February 2023.
However, the medium-term fiscal framework 2024-2026 included in the budget targets an average deficit of 3.5% of GDP, while the Fiscal Responsibility Act, passed on 11 October, mandates the federal government deficit to fall to 3% of GDP in the next three to five years, implying more substantial measures are likely needed to achieve the medium-term targets.
The budget contains various measures to broaden the tax base and increase non-petroleum revenues, such as imposing capital gains tax on disposal of unlisted shares by companies and raising the service tax rate to 8% from the current 6%. These measures will help drive revenue growth in 2024 but fall short of underpinning sustainable increases in revenue base as a proportion of GDP in the medium term. The medium-term framework 2024-2026 projects the ratio of average non-petroleum revenue to GDP to improve to 12.9% in the next three years from 11.8% in 2022, while the average total revenue to GDP ratio at 15.6% still compares unfavourably with the rating category peers (‘BBB’ median: 21.2% in 2024).
Officials expect operating expenditure to grow by 1.2% in 2024, while development expenditure is also expected to rise when excluding the repayment of a 1Malaysia Development Berhad (1MDB) bond in 2023. Fitch said it believes the upward trend reflects the government’s efforts in driving economic growth, which we expect to slow to 4.0% in 2023 and 4.2% in 2024, and the spending pressure it faces to garner support. The unity government retained three states in the state elections but lost votes to the opposition alliance, and, in September, lost its two-thirds parliamentary majority after a junior coalition partner withdrew support.
The government plans to scale back subsidies by reducing subsidies for electricity, which has already started in 2023, and phasing out diesel subsidies. The authorities will also lift price controls on chicken and eggs amid stabilising supply. This, coupled with lower subsidies and a higher service tax rate, is likely to put upward pressure on inflation. Part of the resulting savings will be channelled to cash handouts targeting the bottom 40% and middle 40% of households to mitigate the financial impact on them. This aligns with our view that a broad and immediate removal of subsidies may be politically challenging and unlikely in the near term.
Gradual fiscal consolidation outlined in the 2024 budget supports a moderate decline in Malaysia’s public debt in the medium term. The country’s debt level at 72.8% of GDP as of end-2022 remains significantly higher than the rating category peers (‘BBB’ median: 55.1%). Our debt figures include “committed guarantees” on loans by government-linked companies and 1MDB net debt, which in 2022 totalled 12.5% of GDP. The country’s rating could come under downward pressure if the general government debt to GDP ratio continues to increase as a result of looser fiscal policy or an unanticipated economic shock. Meanwhile, a downward trend in general government debt/GDP to closer to peer medians – for instance, due to the implementation of a strong fiscal consolidation strategy – could drive upward rating pressure.
