{"id":7019,"date":"2023-02-14T23:59:40","date_gmt":"2023-02-14T15:59:40","guid":{"rendered":"https:\/\/ijaps.usm.my\/?page_id=7019"},"modified":"2023-02-23T21:57:24","modified_gmt":"2023-02-23T13:57:24","slug":"malaysias-fiscal-balance-chronicle-of-a-reckoning-foretold","status":"publish","type":"page","link":"https:\/\/ijaps.usm.my\/?page_id=7019","title":{"rendered":"Malaysia\u2019s Fiscal Balance: Chronicle of a Reckoning Foretold"},"content":{"rendered":"\n

Pritish Bhattacharya<\/strong>
&
Francis E. Hutchinson<\/strong><\/p>\n\n\n\n

ISEAS \u2013 Yusof Ishak Institute<\/strong><\/p>\n\n\n\n

Introduction<\/strong><\/p>\n\n\n\n

Since gaining independence 66 years ago, Malaysia has enjoyed rapid economic growth while maintaining a reasonable level of macroeconomic stability. The overall steady trends of most major indicators\u2014including gross domestic product (GDP), inflation, unemployment, and government finance\u2014suggest that the country\u2019s fiscal policy has played a vital role in meeting the development goals of both the public and private sectors.<\/p>\n\n\n\n

However, since the beginning of the new millennium, the country\u2019s finances have taken a turn for the worse, with persistent deficit spending and increasing levels of government debt. This has spurred the search for both immediate and long-term fiscal solutions, with the most attention-grabbing measure being the short-lived imposition of the goods and services tax (GST), whose implementation contributed to the toppling of the Barisan Nasional (BN) coalition in 2018. Nonetheless, the pressing need for fiscal reform remains and has been exacerbated by one long-term structural trend\u2014the decline in proportional terms of oil and gas (O&G) related revenue; and one sharp external shock\u2014the COVID-19 pandemic. Thus, at this juncture, Malaysia is even more in need of far-reaching fiscal consolidation measures.<\/p>\n\n\n\n

This article comprises five sections. After this introduction, the second section sets out the key aspects of Malaysia\u2019s fiscal policy in recent decades while the subsequent section looks at the key sources of revenue for the Malaysian government and in particular structural trends in the O&G sector. The fourth section analyses the impact of the COVID-19 pandemic, and the concluding section focuses on options for reform going forward.<\/p>\n\n\n\n

Background<\/strong><\/p>\n\n\n\n

Colonial Malaysia\u2019s economy relied almost exclusively on the export of primary goods such as tin, rubber, and timber to generate growth. But rapidly declining global commodity prices during the initial few years following independence in 1957 exacerbated rural poverty and unemployment statistics, forcing the government to put its weight behind agricultural diversification and import-substitution-based industrialisation. The adoption of a generally laissez-faire<\/em> approach to the domestic economy, however, did not give the much-needed boost that policymakers were hoping for. The situation was further complicated by the underlying racial and religious tensions in the country, which culminated in the deadly riots of 1969 (Ungku Abdul Aziz 1970; Wicks 1971; R\u00f6nnb\u00e4ck et al. 2022).<\/p>\n\n\n\n

Recognising the hazards of pursuing growth without equity, the government introduced the New Economic Policy (NEP) in 1971. One of the scheme\u2019s most salient features was that state intervention was no longer restricted to the primary sector and rural development, but also encompassed the industrial and commercial sectors. In order to facilitate the rise of Bumiputera<\/em> (indigenous) enterprises without fostering inequality among other minority ethnic groups, the government spent heavily to acquire corporations from international investors, as well as establish a spate of state-owned enterprises (SOEs) and holding companies in order to accumulate equity. The administration also streamlined taxes and other sources of revenue to fund these formative fiscal interventions (Torii 1997).<\/p>\n\n\n\n

The economic restructuring process accelerated dramatically after the discovery of massive oil fields in the country in the 1970s. Although a number of foreign oil giants had been allowed to operate in Malaysia since the early 1900s in return for royalties and tax payments, the combination of the 1973 Organization of Petroleum Exporting Countries (OPEC) Oil Crisis and rising economic nationalism convinced the government to secure greater sovereign control over its O&G resources. This substantial new source of revenue permitted the state to proceed with major subsidies and tariff protection measures without escalating its debt levels in the short run (Gale 1981; Yacob 2021).<\/p>\n\n\n\n

It is important to note that the openness of the Malaysian economy made it susceptible to the vagaries of global economic conditions. This was first felt in the mid-1980s, when the country\u2019s oil-fuelled meteoric growth came to a sudden halt after interest rates were cranked up in the U.S., triggering a collapse of world commodity trade. As prices of tin and palm oil\u2014the country\u2019s major exports at the time\u2014nosedived and the demand for manufactured goods plummeted, the prohibitively-priced heavy industry programme that the government had embarked on also slowed down. Additionally, the crashing crude oil prices meant that public borrowing against future oil reserves was not sufficient to run the programme. As government debt ballooned, Malaysia entered into a recession in 1985, with its GDP contracting by 1%. The unforeseen crisis was a tough lesson on the need to rein in the expenditure spree that the government had embarked upon as a means to enhance growth rates (Athukorala 2010).<\/p>\n\n\n\n

The recovery phase was marked by greater fiscal discipline, especially in the form of selective privatisation. But the progress was marred by the Asian Financial Crisis (AFC) of 1997\u20131998. The impact of the Thai baht coming under speculative attack quickly reached the Malaysian ringgit too, whose value took a major hit against the U.S. dollar. With swift outflow of foreign capital, the stock market crashed and companies with foreign-denominated debt began defaulting in quick succession. As the value of non-performing loans (NPLs) climbed, a full-fledged banking crisis ensued. However, the setback was short-lived, and the government managed to pull off a V-shaped recovery through a generous fiscal stimulus package and long-term restructuring of both financial and non-financial institutions (Ariff and Abubakar 1999).<\/p>\n\n\n\n

The Malaysian economy fared relatively well in the early 2000s, with an average annual growth rate of 5.5%, at least until the Global Financial Crisis (GFC) of 2008\u20132009. Due to the highly integrated nature of the country\u2019s financial market, the GFC, which began in the U.S., created giant ripples in the domestic economy as well. Malaysia fell into another recession, with its growth contracting by 1.7% in 2009. But limited exposure to subprime-related assets and another hefty fiscal stimulus package to provide countercyclical support for growth helped cut down the recovery time (Doraisami 2011).<\/p>\n\n\n\n

From 2010 to 2019, the economy performed well and relatively consistently, with its annual growth hovering at around 5%. While still very respectable by most standards, this was significantly below the heady days of the late 1980s and early 1990s, when the figure stood closer to 7% per annum (The World Bank 2021). This was not unexpected, given the country\u2019s higher income base and shifting economic model\u2014away from exclusively export-oriented industrialisation to a more diverse economic structure and a greater domestic orientation.<\/p>\n\n\n\n

The experience of the past six decades shows that Malaysian lawmakers have relied on a consistent fiscal policy framework to either grow or steady the economy (Figure 1), seamlessly alternating between conservatism and relative profligacy. While this approach has been very successful in stabilising the primary macroeconomic indicators, the consequent continued rise in Malaysia\u2019s government budget deficit (Figure 2) and public debt (Figure 3) cannot be overlooked for long. A rapidly rising budget deficit, from 3.0% of GDP in 2017 to 6.5% in 2021 means that the government will have to borrow more to fund its expenditure, including its debt repayment obligations (Bank Negara Malaysia 2017, 2018, 2019a, 2020, 2021). And the simultaneous increase in the debt ceiling will allow this loop to continue.<\/p>\n\n\n\n

For a very long time, Malaysia had conventionally maintained the debt ceiling at 50% of the GDP, raising the level to 55% only in 2009 in response to the GFC. However, when the COVID-19 crisis gripped the nation, the government decided to further increase the limit\u2014first to 60% in August 2020 and then to 65% in October 2021 (Salim 2021). This debt-to-GDP ratio is not as startling as the Japanese or American numbers, it is nonetheless relatively high for an emerging market and significantly above that of comparator economies such as Indonesia, whose debt is a modest 32.3% of GDP (Bank Indonesia 2022).<\/p>\n\n\n

\n
\"\"<\/a><\/figure><\/div>\n\n\n

Figure 1: Malaysia\u2019s annual growth rate (percentage), 1961\u20132021.
Source<\/em>: Authors\u2019 creation based on The World Bank (2021) data.<\/p>\n\n\n

\n
\"\"<\/a><\/figure><\/div>\n\n\n

Figure 2: Malaysia\u2019s government budget deficit (as percentage of GDP), 1990\u20132021.
Source:<\/em> Authors\u2019 creation based on figures extracted from the CEIC database.1<\/a><\/sup><\/p>\n\n\n

\n
\"\"<\/a><\/figure><\/div>\n\n\n

Figure 3: Malaysia\u2019s government debt (as percentage of GDP), 2002\u20132021.
Source<\/em>: Authors\u2019 creation based on figures extracted from the CEIC database.2<\/a><\/sup><\/p>\n\n\n\n

The O&G Sector and its Contribution to Government Coffers<\/strong><\/p>\n\n\n\n

Malaysia\u2019s federal government revenue can be sorted under two sources\u2014tax revenue and non-tax revenue\u2014each made up of several components, as shown in Table 1.<\/p>\n\n\n\n

Table 1: Malaysia\u2019s federal government revenue sources<\/p>\n\n\n\n

Tax revenue<\/strong><\/td><\/tr>
   Direct tax<\/em>
\n
    \n
  • Companies income tax (CITA)<\/li>\n
  • Individual income tax<\/li>\n
  • Petroleum income tax (PITA)<\/li>\n<\/ul>\n<\/td><\/tr>
   Indirect tax<\/em>\n
    \n
  • Sales and services tax (SST)<\/li>\n
  • Excise duties<\/li>\n
  • Import duty<\/li>\n
  • Export duty<\/li>\n<\/ul><\/td><\/tr>
Non-tax revenue<\/strong><\/td><\/tr>
   Licences and permits<\/em><\/td><\/tr>
   Investment income<\/em><\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

Source:<\/em> Authors\u2019 compilation based on the Ministry of Finance Malaysia (2022a) data.<\/p>\n\n\n\n

Among the different earning streams, the share of O&G-related revenue stands out. As mentioned in the previous section, since the O&G sector\u2019s take-off in the 1970s, this natural bounty has yielded myriad benefits to Malaysia, proving to be a reliable source of funding for the government\u2019s most ambitious projects. And Petronas, the state-owned corporate giant, holds exclusive ownership rights over all oil and natural gas exploration and production activities in the country. The sector\u2019s fiscal contribution comes in a variety of forms, which are:<\/p>\n\n\n\n

    \n
  1. petroleum income tax (PITA) paid by petroleum-related firms;<\/li>\n\n\n\n
  2. royalties from petroleum and gas companies;<\/li>\n\n\n\n
  3. export duties on petroleum products; and<\/li>\n\n\n\n
  4. dividends remitted by Petronas.3<\/a><\/sup><\/li>\n<\/ol>\n\n\n\n

    Tables 2 and 3 present the changing composition of O&G revenue over the past 50 years. The first three revenue sources are long-standing. However, since the mid-1980s, Petronas has paid dividends to the Malaysian government. From around 15% in 1985, this has increased to approximately half of the total of petroleum-related revenue in recent years. Consequently, the relative importance of established contributions such as the PITA and petroleum and gas royalty has decreased in relative importance, and the more variable\u2014and more discretionary\u2014Petronas dividend has become the largest source of oil-related revenue over time (Bhattacharya and Hutchinson 2022).<\/p>\n\n\n\n

    Table 2: Breakdown of Malaysia\u2019s total O&G revenue (in RM million), 1975\u20131995<\/p>\n\n\n\n

    Revenue component<\/td>1975<\/td>1980<\/td>1985<\/td>1990<\/td>1995<\/td><\/tr>
    PITA
    <\/td>    		322
    [80.5%]<\/td>    		1,736
    [63.0%]<\/td>    		3,130
    [49.5%]<\/td>    		2,644
    [35.0%]<\/td>    		2,185
    [32.5%]<\/td><\/tr>
    Petroleum and gas royalty
    <\/td>    		78
    [19.5%]<\/td>    		345
    [12.5%]<\/td>    		619
    [9.8%]<\/td>    		627
    [8.5%]<\/td>    		710
    [10.5%]<\/td><\/tr>
    Petroleum export duties
    <\/td>    		0
    <\/td>    		677
    [24.5%]<\/td>    		1,639
    [26.0%]<\/td>    		1,910
    [25.5%]<\/td>    		751
    [11.0%]<\/td><\/tr>
    Petronas dividend
    <\/td>    		0
    <\/td>    		0
    <\/td>    		930
    [14.7%]<\/td>    		2,300
    [31.0%]<\/td>    		3,100
    [46.0%]<\/td><\/tr>
    Total O&G revenue<\/td>400<\/td>2,758<\/td>6,318<\/td>7,481<\/td>6,746<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

    Note: <\/em>Percentage in brackets.
    Source<\/em>: Authors\u2019 calculations based on data from figures extracted from the CEIC database.4<\/a><\/sup><\/p>\n\n\n\n

    Table 3: Breakdown of Malaysia\u2019s total O&G revenue (in RM million), 2000\u20132020<\/p>\n\n\n\n

    Revenue component<\/td>2000<\/td>2005<\/td>2010<\/td>2015<\/td>2020<\/td><\/tr>
    PITA<\/td>6,010 [46.7%]<\/td>14,566 [47.2%]<\/td>18,713 [33.8%]<\/td>11,559 [26.5%]<\/td>20,800 [41.0%]<\/td><\/tr>
    Petroleum and gas royalty<\/td>1,763 [13.7%]<\/td>3,293 [10.7%]<\/td>4,900
    [9.0%]<\/td>    		5,142
    [11.8%]<\/td>    		4,300
    [8.4%]<\/td><\/tr>
    Petroleum export duties<\/td>996
    [7.7%]<\/td>    		2,029
    [6.6%]<\/td>    		1,745
    [3.2%]<\/td>    		989
    [2.2%]<\/td>    		800
    [1.6%]<\/td><\/tr>
    Petronas dividend<\/td>4,100 [31.9%]<\/td>11,000 [35.5%]<\/td>30,000 [54.0%]<\/td>26,000 [59.5%]<\/td>25,000 [49.0%]<\/td><\/tr>
    Total O&G revenue<\/td>12,869<\/td>30,888<\/td>55,358<\/td>43,690<\/td>50,900<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n

    Note: <\/em>Percentage in brackets.
    Source<\/em>: Authors\u2019 calculations based on data from figures extracted from the CEIC database.4<\/a><\/sup><\/p>\n\n\n\n

    While the O&G sector, together with its substantial derivatives, has undeniably benefited Malaysia, going forward, there are two major challenges facing it. The first concerns the sector\u2019s inconsistent fiscal contribution. Oil prices are influenced by a multitude of supply, demand, and public policy factors\u2014ranging from conventional output decisions made by OPEC or private oil-producing nations to central bank interest rates, or disruptions brought about by natural calamities or political unrest. The global experience over the past three years has shown that unforeseen economic, health, and geopolitical crises can contribute to the variability, too. The issue is further compounded by the cyclicality inherent in oil price movements. The volatility of oil prices significantly affects the government\u2019s fiscal revenue, with price rises adding to the public purse and price crashes depleting it. This fluctuation can be clearly seen in the varying proportion of the revenue derived from the O&G sector in Malaysia\u2019s total government revenue (Figure 4).<\/p>\n\n\n

    \n
    \"\"<\/a><\/figure><\/div>\n\n\n

    Figure 4: O&G revenue as percentage of total government revenue, 1975\u20132020.
    Source<\/em>: Authors\u2019 calculations based on data from figures extracted from the CEIC database.    4<\/a><\/sup><\/p>\n\n\n\n

    Second, it must be acknowledged that Malaysia\u2019s hydrocarbon resources are not unlimited. The production capacity of the O&G sector in the nation has been on a downward trajectory for some time now, mainly because of maturing large fields. In 2016, total fuel production was 757,000 b\/d, while in 2020, this had gone down to 655,000 b\/d (British Petroleum 2021). In fact, several studies have tried to determine the precise number of years of oil reserves left in Malaysia. A 2016 estimate claimed that, without net exports, the country would have just enough reserves to last until 2030 (Worldometer 2016). This claim was reinforced in 2019, when the Economic Affairs Ministry announced in parliament that local O&G fields were expected to be depleted by 2029 (Malaysiakini 2019). A slightly more optimistic image emerged in a Petronas report, with records indicating that the national oil reserves would last for 28 years\u2014and 38 if contingent resources were accounted for (Petronas 2019).<\/p>\n\n\n\n

    <\/p>\n\n\n\n

    The Lingering Impact of COVID-19<\/strong><\/p>\n\n\n\n

    The growing levels of budget deficit and government debt, along with the diminishing fiscal contribution of the O&G sector, raise a number of serious questions regarding Malaysia\u2019s long-term macroeconomic stability. The COVID-19 pandemic dealt an unprecedented blow to the economy, and it would be irresponsible to not recognise that this global health crisis exacerbated an already perilous fiscal arrangement.<\/p>\n\n\n\n

    According to Bank Negara Malaysia, the country\u2019s annual GDP grew by 4.3% in 2019\u2014the lowest rate since the GFC in 2008\u20132009\u2014and the fiscal deficit reached 3.4% of GDP. The lower-than-expected figures were attributed to shrinking domestic private consumption, and to supply disruptions and lower external demand in light of the worsening trade ties between the U.S. and China (Bank Negara Malaysia 2019b).<\/p>\n\n\n\n

    When the first few COVID-19 cases were recorded in the country, no one could have predicted the scale and duration of the pandemic\u2019s deleterious effects. However, as daily cases began to be quoted in thousands and then tens of thousands, it became clear that the impact would be deep and long-lasting. The government acted fairly swiftly to contain the spread of the virus, announcing stringent restrictions on mobility and physical contact. The first set of sectors to absorb the immediate impact of the \u201cMovement Control Order\u201d (MCO) included retail, aviation, hospitality, and food and beverage. Several studies have concluded that workers employed in these sectors were disproportionately affected (Yong and Sia 2021; Alamoodi et al. 2022).<\/p>\n\n\n\n

    In order to save lives and livelihoods during the course of the crisis, the state focused on fiscal injection in the form of various stimulus packages to accompany the cordon sanitaire<\/em> measures. While some schemes provided direct relief to poor households, others were aimed at assisting small businesses with loans and cash flows. Table 4 presents a summary of the major support measures put in place to deal with the economic fallout of COVID-19.<\/p>\n\n\n\n

    Table 4: Major economic support packages launched by the Government of Malaysia<\/p>\n\n\n\n

    Control measure<\/td>Period<\/td>Stimulus package<\/td><\/tr>
    Pre-MCO<\/td>27 Feb 2020 \u2013
    17 Mar 2020<\/td>    		\n
    • Economic Stimulus Package 2020 (RM10 bn)<\/li><\/ul>\n<\/td><\/tr>
    MCO<\/td>18 Mar 2020 \u2013
    3 May 2020<\/td>
      \n
    • Prihatin Rakyat<\/em> Stimulus Package (RM250 bn)<\/li>\n
    • Additional Prihatin<\/em> SME Stimulus Package (RM10 bn)<\/li>\n<\/ul>\n\n\n<\/td><\/tr>
    Conditional MCO<\/td>4 May 2020 \u2013
    9 Jun 2020<\/td>    		 <\/td><\/tr>
    Recovery MCO<\/td>10 Jun 2020 \u2013
    31 Mar 2021<\/td>
      \n
    • Short-Term Penjana<\/em> Economic Recovery Plan (RM35 bn)<\/li>\n
    • Additional Kita Prihatin<\/em> Stimulus Package (RM10 bn)<\/li>\n<\/ul>\n\n<\/td><\/tr>
    State-level MCOs<\/td>11 Jan 2021 \u2013
    31 May 2021<\/td>
    • Pemerkasa<\/em> Stimulus Package (RM20 bn)<\/li><\/ul>\n<\/td><\/tr>
    Total lockdown<\/td>1 Jun 2021 \u2013
    14 Jun 2021<\/td>    		\n
    • Pemerkasa Plus<\/em> Stimulus Package (RM40 bn)<\/li><\/ul>\n<\/td><\/tr>
    National Recovery Plan<\/td>15 Jun 2021 \u2013
    31 Dec 2021<\/td>    		\n