Malaysia’s long-awaited Budget 2023 was finally re-tabled by Prime Minister Datuk Seri Anwar Ibrahim on Feb 24. On balance, the budget was better than we had expected — it was expansionary but not overly populist.
For instance, civil servants were not given a pay rise, as has been the case with previous administrations (although there were some one-off allowances for those in lower grades and government retirees). The omission underscores the overall tone of this budget — necessarily fiscally prudent, given the country’s already-high debt burden. The government’s debt and liabilities totalled RM1.5 trillion (S$450 billion), or 81% of GDP, accumulated over decades of widening public deficits. The last time Malaysia ran a budget surplus was in 1997. Persistent deficits and rising debt have consequences, including, we believe, the secular depreciation of the ringgit.
Having said that, there were still plenty of giveaways in this revised Budget 2023. For example, there was a notable 40% increase in allocation for subsidies compared with the old budget tabled in October 2022 (just prior to the 15th general election). As we have explained before, democratically elected governments cannot afford to inflict pain on voters and expect to stay in power. Most are naturally biased against policies that will be unpopular with the masses.
Thus, as we had predicted, there was no Goods and Services Tax (GST), even though the consumption tax is broad-based and an efficient, albeit regressive, tax system. Going through the budget, we were glad that some issues were being addressed, but there are also some we do not agree with and yet others that we hoped might be included but were conspicuously absent.
In total, this budget has a larger allocation of RM386.14 billion — comprising RM289.14 billion operating expenditure and RM97 billion development expenditure — up about 4% from the RM372.34 billion in the old budget (see Table).
The budget deficit, however, is estimated at a lower 5% of GDP, compared to 5.5% previously, owing primarily to a higher GDP forecast of 4.5%, up from 4.2%. Mathematically, this is not surprising. A higher GDP forecast means the denominator (in the calculation) is now larger, plus, tax revenue forecast too will, accordingly, be higher on the back of the stronger economic activity. The new budget also pencilled in a RM5 billion increase in dividend revenue from national oil company, Petronas.
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Is the smaller fiscal deficit, underpinned by a stronger GDP growth estimate, realistic?
The recent World Bank forecast for Malaysia’s GDP growth is 4% while the International Monetary Fund’s forecast (made earlier in October 2022) was 4.4%. So, 4.5% is not out of reach at this point — the global economy has been holding up better than expected, so far.
Nonetheless, a lot of uncertainty remains. Central banks, particularly the US Federal Reserve, may have to raise interest rates higher than currently expected and keep it high for longer. This could result in a sharper deceleration in global economic growth later in the year. Interest rate hikes have lagging effects on the economy. One year in, the war in Ukraine could take a turn for the worse while oil prices are notoriously difficult to predict. Slower-than-expected global economic growth will have a negative spillover on the domestic economy.
We also suspect the tax revenue forecast may be too optimistic. For instance, corporate tax revenue was revised up by 9% while individuals tax collection could also end up less than expected, with the tax cuts for chargeable incomes of between RM30,000 and RM100,000. The estimated increase in individuals income tax, we believe, is to be driven mainly by the higher tax rates of 0.5% to 2% for chargeable incomes of between RM100,000 and RM1 million.
So, to answer the question of whether the budget deficit reduction is achievable, we cannot say for certain — perhaps, but maybe not to the extent that is forecast in this budget.
What was missing?
We are glad that the government is finally taking into consideration the cost-of-living pressures on middle-income households (M40), most of whom are taxpayers but so often neglected when it comes to financial assistance. The above-mentioned 2% tax rate reduction will slightly improve their disposable incomes.
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There was a glaring absence, however, of any measure to address falling housing affordability, which, as we wrote previously, is one of the most pressing problems for Malaysians.
In fact, there were few fresh initiatives to address elevated living costs, aside from subsidies and cash aid for lower-income households. For example, we had hoped for more deregulation of the economy, removal of approved permits (APs) and excessive licensing requirements — specifically, eliminate the rent-seekers — that will boost business efficiency and allow market competition to drive costs (and prices) lower.
Also, we would have liked to have seen more concrete details on plans to reduce red tape, unnecessary licences and approvals, streamline overlapping and multiple ministry/ agency jurisdictions for speedier and transparent processes in interactions with the private sector. All these would ease and reduce the cost of doing business and help temper price inflation.
What we do not agree with
In addition to the above-mentioned tax rate hike for high-income earners, Budget 2023 also introduced a Luxury Goods Tax, including on watches and luxury fashion items. The intention is to shift towards a more progressive — and, no doubt, populist — tax structure.
In this respect, the government will also study the feasibility of a Capital Gains Tax (CGT) for the disposal of unlisted shares by companies, starting from 2024, at a lower rate. This proposal is being viewed — with wariness — by the market as a precursor to a broader capital gains tax regime that could include estate tax.
We have always maintained that taxes should be levied on income, not capital. The practical reason being, how does one determine “gains”? Would capital gains be based on initial cost, book value (which is subject to accounting distortions), market value or some other valuations?
As such, if a tax has to be levied, it would be far more efficient if it were structured as a transactional tax, such as stamp duty. The amount of tax payable is clear and transparent, based on specified tax rates — which could be a flat rate or progressively higher rates — and value of the transaction (instrument of transfer). This would remove the vagaries and complications of valuations and avoid the entire issue of what constitutes profits/gains.
Putting aside valuation problems, an even more critical issue is the impact of CGT. We have written extensively about the underlying structural issues driving Malaysia’s loss of competitiveness in attracting foreign direct investments (FDIs) in the region since the Asian financial crisis (AFC). One big reason, we believe, was the then government’s policy choice in responding to the crisis — by implementing capital controls.
While capital controls alleviated short-term pain for the people, we believe they severely damaged the country’s long-term attractiveness to investors, both foreign and domestic. In his budget speech, the prime minister alluded to Malaysia’s falling position in the World Competitiveness Rankings by the International Institute for Management Development (IMD) — to rank 32 currently. This is the lowest ranking for the country since the AFC (see Chart).
We are starting to sound like a broken record, but investment is the life blood for sustainable economic growth, job creation and raising the people’s income levels. With falling investments (as a percentage of GDP) in the ensuing post-AFC years, Malaysia suffered premature deindustrialisation. Per capita income growth slowed, the national savings rate declined and household debt soared. The country failed to achieve the status of a developed, high-income nation, as envisioned, by 2020.
Reversing this secular decline in competitiveness is no small task. It includes tackling deep-seated issues such as deteriorating quality of the education system, brain drain and a small talent pool for the knowledge economy, the depreciating ringgit and the lack of competitiveness of many homegrown companies in the global market, owing in no small part to protectionist policies and the prevalence of rent-seekers. Adding a CGT now, we fear, would only compound the problems — and make Malaysia even less attractive to investors compared to our regional peers. And that, ultimately, would be self-defeating, as low investments lead to slower economic and income growth — and lower tax revenue for the government.
We suspect the origin of the CGT proposal may be the intention to close a perceived tax loophole, whereby companies disposing of unlisted shares will escape paying taxes on them. This is a misconception.
All companies, whether listed or unlisted, pay corporate taxes under the prevailing tax system. After an unlisted company is sold, this company will continue to pay corporate tax on profits in the future — just as it had before the sale. The identity of the new owner has no significance in the calculation of taxes payable.
The price of the shares sold would be based on the company’s intrinsic value. Remember, intrinsic value is equivalent to the present value of its future cash flows (profits). In other words, the seller is monetising the unlisted company’s future expected profits, today. To levy a tax on this disposal would be akin to taxing this unlisted company’s profits twice — once now and then, again, on its profits every year into the future. There is a reason that dividends received are not taxable — because profits attributed to shareholders are already net of corporate taxes. In short, there is no loophole.
Last but not least, there are numerous measures in the budget aimed at attracting investments in high-impact, high-technology sectors. We agree that moving up the value chain is crucial to raising productivity and creating high-paying jobs. However, the proposal to restructure existing investment incentives towards tiered tax rates based on outcomes (such as creating high-value jobs, embedding local firms into the supply chains, and creating new industrial clusters) should be given careful consideration.
Yes, as the Bank Negara Malaysia study has shown, the benefits from FDI have been narrowing, following higher incentives against low value-added investments — in average terms. (Perhaps Malaysia is attracting low value-added investments because of the perception of a weaker risk-rewards trade-off, as a result of the factors affecting the country’s competitiveness mentioned above) As long as the marginal returns of the FDI are positive, however, it will contribute to the economy — therefore, every effort must be made to secure that investment, even if it is deemed to be low value-added. Malaysia cannot afford to lose investments at this point.
The Global Portfolio fell 1% for the week ended March 1. Shares in Tencent Holdings rose 3.5% while Grab Holdings (-11.4%) was the biggest loser, after its latest results prompted downgrades on expectations of intensifying competition and rising costs. Oversea-Chinese Banking Corp (-3%) and DBS Group Holdings (-2.1%) too closed lower for the week. Total portfolio returns since inception now stand at 23.6%, trailing the MSCI World Net Return Index’s 40.4% returns over the same period.
We invested most of our idle cash into Bursa-listed Velesto Energy last week. The stock had fallen sharply after reporting earnings results that missed market expectations, and triggered a wave of downgrades from analysts. Contrary to the chorus of negative sentiment, we believe the company’s turnaround remains intact, short-term losses (due in part to one-off items) notwithstanding.
We think oil prices will stay elevated in the near-medium term as will activities in the oil and gas sector. Indeed, it remains market consensus that demand for the company’s fleet of offshore drilling rigs is strong, driving utilisation and charter rates higher. This would bode well for Velesto, given the relatively high operating leverage nature of the industry. Thus, we saw the selloff as an opportunity. Positively, its share price appears to have stabilised and rebounded marginally, by about 5.7% from our cost of investment.
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