Malaysia: Subsidies Crunch Time

This is an interesting write-up from Reuters. 


21 May 2010-The Cabinet is to meet next week to discuss politically unpopular changes to its subsidy regime for petrol, natural gas, food and road tolls.

Subsidies alone chewed up RM24.5 billion in 2009, 15.3 per cent of the total operating spending, pushing Malaysia’s budget deficit to a more than 20-year high of 7 per cent of gross domestic product.
Plans to cut subsidy spending to RM20.9 billion ringgit this year were dealt a blow by the government’s failure to implement planned petrol price hikes in May.
If you add in other social spending in areas like education grants and health, total transfer spending is around treble the declared figure for subsidies.


Following are the options the government may consider.
Complete withdrawal of subsidies in one goA big bang approach would impress investors in Malaysian bonds but is unlikely to be popular with voters as it would likely involve petrol prices, for example, rising by 15 sen per litre from their current RM1.80.Smarting from a by-election loss in Sarawak, Prime Minister Datuk Seri Najib Razak is unlikely to opt for this choice, especially with Sarawak state polls looming this year. Sarawak provides a fifth of the government’s MPs and the state served as a bulwark against record losses to the opposition in Election 2008.[Sarawak saves us again!]
A sudden withdrawal of all subsidies would mean that Malaysia’s economic recovery could be halted. Asia’s third most export-dependent country relative to the size of its economy grew 10.1 per cent in the first quarter of this year.A “big bang” approach would also cause inflation to spike and could prompt Malaysia’s central bank to hike rates, although in the past Bank Negara has “looked through” food and fuel price spikes. It left rates on hold from April 2006 to November 2008.If this happened there would likely be a big rally in Malaysian bonds.A gradual approachThis is far more likely. It would reassure markets fearful of budget indiscipline and limit political damage for Najib who must call a general election by 2013.A small initial hike in petrol prices by say 15 sen per litre would not immediately hit wallets or derail economic recovery. Prices could then be hiked over a period of years on a regular basis. The timeframe for price hikes would have to be credible.Savings from raising petrol prices alone in mid-year could be as much as RM1.4 billion in 2010, based on a 15 sen hike.To assist poorer people the government could pay cash benefits to owners of smaller cars or motorcycles.The risk is that regular price hikes on a semi-annual or annual basis could cause a continual drip of discontent with the government. For markets, the risk would be that the government would lose heart in the face of public opposition.
Electricity price hikes could be mitigated by putting a base consumption level under which people would not pay extra charges.
If electricity was hiked by 2.4 sen per kilowatt-hour, that could save RM800 in 2010.There would be a spike in annual inflation as a result of the start of the subsidy regime changes, although the base effect would diminish their effect over time. Inflation could spike up to 4.5 per cent at the start of 2011 if petrol, gas, electricity and toll road prices were hiked.Bullish for bonds if implemented. Could boost electricity company Tenaga’s stock price.
Just make minor changes or do nothingTempting for a government that has deferred planned price hikes due to fear of a voter backlash.
The fact that Najib has outsourced all of his economic reforms to independent bodies shows that there is little support within the government for painful decisions. Failure to implement two electricity price hikes have hit credibility.
With Malaysia’s economy rebounding strongly, tax receipts will grow and the need for government stimulus measures will fall so the budget gap will narrow more quickly than the government’s forecast of 5.6 per cent of gross domestic product this year.