Posted on October 13, 2013, Sunday
Budget 2014 is under watchful eyes as the nation’s fiscal deficit needs to be addressed
Current account surplus is likely to narrow further
All eyes will be glued keener than ever to Budget 2014 on October 25, fresh from a ratings downgrade to ‘negative’ by Fitch Ratings on July 30.
The Malaysian government is under pressure to address the weaknesses in its public finance. This balancing act has never been more crucial as Malaysia hopes to find the right point between addressing fiscal needs and retaining public support along the way.
The country is facing persistent fiscal deficits and high government indebtedness amid a falling current account surplus in its balance of payments, explained Fitch Ratings after the downgrade.
“Malaysia’s public finances are its key rating weakness. Federal government debt rose to 53.3 per cent of gross domestic product (GDP) at end of 2012, up from 51.6 per cent at end-2011 and 39.8 per cent at end-2008,” the agency forewarned.
“The general government budget deficit (Fitch basis) widened to 4.7 per cent of GDP in 2012 from 3.8 per cent in 2011, led by a 19 per cent rise in spending on public wages in a pre-election year.
“Fitch believes it will be difficult for the government to achieve its interim three per cent federal government deficit target for 2015 without additional consolidation measures.”
Fitch also anticipated risks even to the achievement of the agency’s 3.5 per cent deficit projection, as this already factors in one percentage point of GDP of spending cuts. This would leave Malaysia’s public finances more exposed to any future negative shock.
Tough, but thoughtful decisions
CIMB Group Holdings Bhd (CIMB) chief economist Lee Heng Guie pegged the Budget to be a ‘watershed moment’ for the government, with hopes of a five-pronged strategy to be laid out in Parliament on October 25.
“Budget 2014 is arguably the most anticipated budget in recent years,” Lee stated. “Faced with the risk of sovereign rating downgrades as investors fret over the prospect of twin deficits, Malaysia’s current fiscal and debt situation means that Prime Minister is tasked with making some necessarily tough but thoughtful decisions.
“We expect the essence of Budget 2014 on October 25 to bring about a responsible fiscal stance, putting the country’s budget deficit and debt on a firm downward trajectory.
“There is no question that Malaysia has reached a turning point given its fiscal challenge amid the risk of sovereign rating downgrades and investors’ focus on the vulnerabilities of the domestic and external sectors at a time of retrenchment of foreign capital, no thanks to the Fed’s potential tapering.”
Lee expect the government to target a fiscal deficit ratio of 3.5 per cent of GDP for 2014 (estimated four per cent in 2013).
Real GDP growth is estimated at 4.5 to five per cent for this year and 4.5 to 5.5 per cent next year, backed by strong domestic demand and a moderate pick-up in external demand.
Hoping for substantial fiscal reform measures
Meanwhile, local audit, tax and advisory services player KPMG Malaysia hopes the upcoming Budget 2014 will contain substantial fiscal reform measures aimed at reducing the country’s current deficit.
“Presently, the country has a wide lower to middle income group and aside from macro measures pertaining to fiscal reform, we also wish to see Budget 2014 meeting the needs of the average man on the street,” said Mohamed Raslan Abdul Rahman, managing partner KPMG Malaysia.
“In doing so, there is a greater necessity for the budget to address the growing social costs and distribution which range from the inequality of income to opportunities and environmental degradation for economic growth.”
Implementing tough economic reforms would be necessary to maintain commitment to address the unbalanced tax structure and reducing unsustainable subsidies coupled with a budget deficit position inherited from the past.
The government needs a Budget that looks into a fair and equitable distribution of benefits for national growth; that is not only fair but is also seen to be fair. The welfare of the majority amongst all race, ethnic groups and particularly the minority and lower income groups should be given emphasis for the development of the ‘rakyat’ as a whole
With public debt expected to be around RM546billion or 53 per cent of GDP by end 2013, fiscal reform measures should encompass more than mere subsidy reduction. In addition to the recent implementation of higher fuel costs and extra non-tax revenues, revamping the subsidy system to reach targeted groups are some of the reforms required.
The country’s 12 National Key Economic Areas (NKEA) ranging from Oil and Gas to Financial Services were designated to propel the country towards a high-income economy.
KPMG Malaysia expects that Budget 2014 will continue to focus on private investment growth and incentives for high growth industries such as the financial services, healthcare and ICT sectors, thus contributing to overall economic growth.
Raslan commented, “As the federal debt level inches to 55 per cent of the GDP, finding ways to fix the debt issue and ensuring that proper system and governance is in place would be crucial.
While honest discussions towards forward-looking tax reforms would be a silver lining to the federal debt issue, firm approaches to tax reform is required.
“One example is looking at funding of major infrastructure projects beyond just foreign direct investment. Creating public private partnerships to fund such large scale projects is a policy which is easier to implement as organisations with strong cash bank has the capacity to affect positive outcomes.”
With stronger financial infrastructure coupled with good corporate governance, sustainability and transparency, Malaysia will be able to attract more foreign direct investment.
“Tax reform is an important issue that is generating global discussions. The need to reduce the problem of non-compliance and boosting tax administrative efficiency to enhance revenue collection is immensely critical.
“The rising middle class and moreconfident urban population in Malaysia demands greater transparency from the government; they want to know how contracts are given, social aids are allocated, accurate and transparent reporting.
“The government should adopt the approach on addressing tax morality issues to restore the country’s fiscal position and reestablish trust and confidence between the government and civil society,” Mohamed Raslan concluded.
Anticipated sectoral impacts from Budget 2014
Consumer segment
“Our concern remains that the proposed GST and subsidy rationalisation programme (which are likely to be among the key topics discussed in the Budget 2014) could introduce further cost inflationary pressures that would compress margins.
“Should the companies under our coverage fail to shore up margins in seasonally stronger 2H13, we may have to downgrade the consumer sector from our current neutral rating,” highlighted Kenanga Research.
“Having said that, we see selective stocks that may in fact benefit from a higher cost inflationary environment.”
Continued boosts in construction
For the construction sector, Kenanga Research analyst Iqbal Zainal anticipates for Budget 2014 to announce value-for money projects.
“As the government is addressing the fiscal position, we are not expecting any new big mega projects to be announced in the Budget 2014. Nonetheless, the government indicated that it will announce ‘value-for-money spending initiatives’ during the upcoming Budget 2014,” he explained.
This, he said, was based on the recent press report quoting the Second Finance Minister Datuk Seri Ahmad Husni Hanadzlah.
“We also believe that the government will continue to announce public-private partnerships or private finance initiative projects in Budget 2014 as these projects are not entirely funded by government but give higher multiplier effects to the economy.
“Furthermore, we also expect allocations for East Malaysia’s basic infrastructure projects to continue to be announced in the Budget 2014 as to accommodate the growing industrial activities in the region.
“Should the government impose GST, there could be inflation risks due to higher building material prices and hence, margin compression. Nonetheless, we believe contractors have already fixed the price with the building material suppliers before the project started (based on quotations).
“Also, in terms of newly secured contracts, we believe, going forward, the master pay (clients either Government or Private) will absorb the additional costs arose from GST.”
Property players anticipate hike in RPGT
Increased bank lending to broad property sector
“For the upcoming Budget-2014’s potential impact on property sector, we are only expecting real property gains tax (RPGT) hikes of 30 per cent from 15 per cent for properties sold within two years, 15 per cent from 10 per cent for properties sold within three to four years, 10 per cent remains unchanged for properties sold in the fifth year and zero RPGT for properties sold in the sixth year onwards,” Kenanga Research elaborated.
“We believe this has been largely been discounted and priced-in somewhat, but we do expect some slight knee-jerk reactions for a couple of weeks post announcement.”
The research firm does not expect any other overly harsh measures (such as stamp duty hikes, banking measures) as these may have severe repercussions on the economy. Historically, the government only implements one drastic fiscal measure within a year.
“This also applies to Bank Negara Malaysia’s (BNM) measures and so far, we have already seen one which is the reduction of mortgage tenures to 35 years from 45 years in July 2013. We also expect more measures on increasing affordable housing supply to be announced in the Budget.”
If GST is implemented in 2015, expect pre-implementation ‘panic buying’ in 2014, Kenanga Research is assuming no major changes in the banking sector policy affecting the sector, based on experience from other countries seeing such trends in anticipation of future cost push inflations on asset
prices. This, it added, will be beneficial to developers’ 2014 sales, as financing terms for the primary market is more favourable compared to that of the secondary (like DIBS, rebates, LTVs, lending rates, property valuations and so forth)
“We do expect developers to front-load their launches in 2014 on the back of higher demand, which will be a big booster to future earnings,” it added.
“However, if the GST implementation timeline is not announced during Budget-2014, we may revisit our stock/sector calls.”
F&B sub-sector
“For the F&B sub-sector, we expect inflationary pressures to stem from not just the GST, but also the government subsidy rationalisation programme which could impact the prices of imports and raw materials (taxed at the standard rate),” explained Kenanga Research.
“At the same time, increases in the prices for energy items could also have a spill-over effect on not just company earnings, but also company’s revenues as consumers’ disposable incomes erode.
“This comes on the backdrop of potential continuation of its rich valuations de-rating, absence of any earnings surprises, and appreciation of the US dollar against the ringgit.”
Oil and gas to see muted moves
High dependence on oil-related revenue
(estimated 31.1 per cent of total revenue in 2013)
Meanwhile, the oil and gas (O&G) industry believes the Budget 2014 will potentially be a non-event for the sector. Kenanga Research affirmed that the downstream segment was the main beneficiary in the previous Budget 2013.
Previously there were two initiatives proposed.The first was an investment tax allowance of 100 per cent for the period of 10 years for qualified companies that invest in refinery activities on petroleum products.
The projects include the Petronas Refinery and Petrochemical Integrated Development (RAPID), oil and gas storage Terminal in Johor, Regasification Plant in Melaka as well as oil and gas terminal in Sipitang, Sabah.
The second initiative was the Global Incentive for Trading (GIFT) programme will be enhanced with a 100 per cent income tax exemption on statutory income for the first three years of operations for LNG trading companies.
Commodity trading approved under GIFT will be extended to include other commodities such as agriculture, refined raw materials, base minerals and chemicals.
“However, given the turn of events, unless there are further positive updates for the project, we foresee muted impact from any initiatives proposed in the coming Budget 2014.”
Neutral stance on retail sub-sector
Kenanga Research also maintained a neutral stance on the retail sub-sector and continued to be cautious on its earnings prospects.
“While the 4Q13 would see more outlet expansions, most industry players are still cautious on their outlook and prospects for the quarters ahead. This comes amid signs that the selective spending habits of consumers have become the new paradigm,” it stated.
“Nevertheless, we favour multi-level marketing (MLM) companies which amid a challenging retail environment would attract more participation by the low-middle income group. We anticipate the MLM segment to deliver decent earnings growth in addition to the high dividend yields of more than five per cent.”
Minimal impact for planters
Still soft CPO and crude oil palm outlook in 2014
Another sector expecting minimal impact from Budget 2014 is the plantations sector, says Kenanga Research analyst Alan Lim.
The only impact that could be expected is some allocation provided to encourage biodiesel production locally in Malaysia.
“Recall that the Malaysia government has targeted to implement B5 programme nationwide in July 2014 upon which palm biodiesel consumption will be increased to 0.50 million metric tonnes (mt) annuall – from 0.25 million mt in 2012,” he explained.
“We also also believe some allocations will be made for oil palm replanting programme which are aimed to increase fresh fruit bunch yield to 26.2mt per hectare by year 2020. However, public-listed planters would not benefit as these are mainly targeted at smallholders.”
Should the GST materialise, Lim believed it will increase the overall CPO cost of production (CP) due to expected rise in transportation cost of about 15 per cent of total cost.
However, he added that fertiliser cost (30 per cent of total cost) and labor cost (25 per cent of total cost) should not be affected.
“Hence, we think the increase in total CPO CP should be manageable at about two per cent. We also expect no impact on CPO prices which is influenced more by global demand and supply (instead of local factors).”
GST to burden REITs
BURDEN ON TENANTS: As for office or industrial REITs, Kenanga Research said the bigger burden will also be on tenants who would be required to pay GST on rental. — Bernama photo
With the strong possibility of GST in Budget 2014, this will indirectly impact tenants and suppress strong rental reversions for real estate investment trusts (REITs).
“Our house strategist anticipates the announcement of GST implementation by mid-2014 to early-2015,” outlined Kenanga Research.
Should GST be implemented, the research firm believed the biggest impact of GST will be on the end user of the product/service as it is based a ‘pass on mechanism’.
“We expect a short term decline in consumer spending for our retail Malaysian REITs as soon as GST is implemented, which may squeeze retail tenants in shopping malls post implementation, thus limiting strong rental reversions for retail REITs such as CMMT, Sunway REIT, KLCCSS-Suria KLCC in the future,” it forewarned.
“This may nibble into our future earnings estimates as tenants operating costs are expected to increase.”
As for office or industrial REITs, Kenanga Research said the bigger burden will also be on tenants who would be required to pay GST on rental.
Similarly, this may have implications on rental reversions, not to mention the pressure of oversupply of offices in Klang Valley will limit rental reversion opportunities.
Additionally, REITs also pay a six per cent service tax to service providers (such as cleaning and maintenance), and this will eventually be replaced with the GST, namely no material impact to earnings on this front.
KLCCSS is also exposed to the office segment although a large chunk of it is based on fixed step-ups over a long-term lease such as Petronas Twin Towers and Menara 3 Petronas office.
“We believe the effects of GST will be less detrimental on office or industrial REITs as their tenants are locked in for longer lease periods, and have lower step up rates compared to heavier retail REITs such as Sunway REIT and CMMT, providing more earnings resiliency.
“At this juncture, we believe there is no direct impact on REITs. However, we do foresee an indirect impact on tenants with an increase in operating cost, which may suppress rental reversions going forward.
“We are maintaining earnings estimates for now and will be monitoring the situation closely. We have provided a sensitivity analysis for the REITs under our coverage.”
Education sector
In order not to burden the lower income group, certain basic foodstuff (such as rice, sugar and flour) and essential services such as private education are not subject to GST, according to the Royal Malaysian Customs Department.
“Hence, we believe that the potential GST implementation may only have a muted impact on the education industry,” explained Kenanga Research.
“Nonetheless, in the long-term, we believe the education sector may potentially undergoes a challenging period as the drastic rising public cost of living post-GST may somewhat indirectly influence the market to look for cheaper education options such as distance learning programmes.
“Similar to last year, we believe the government will continue to focus on strengthening education and human capital development in the upcoming 2014 budget, in line with the official launch of Malaysia Education Blueprint 2013-2025 by the Ministry of Education recently.”
(estimated 31.1 per cent of total revenue in 2013)
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