Budget 2017 optimism amidst uncertainty

Dr. Mohd Afzanizam Abdul Rashid Chief Economist 03-2088 8075 afzanizam@bankislam.com.my Budget 2017 optimism amidst uncertainty It is still an expansionary budget The government has unveiled Budget 2017 yesterday. Fiscal deficits are expected to widen to RM40.3 billion in 2017 from an estimated RM38.7 billion in 2016. This was due to the expected rise in Operating Expenditure (OE) by 3.7% to RM214.8 billion. Grants and transfers to state government (3.8% of OE), retirement charges (10.1% of OE), debt service charges (13.4% of OE) and supplies & services (14.9% of OE) are the key OE items which are likely to register higher growth in 2017 (see Table 3). Similarly, Development Expenditure (DE) is envisaged to increase by 2.2% to RM46 billion in 2017. Transport (23% of DE) and education & training (12.8% of DE) are both expected to record 25.9% (2016: 25.8%) and 52.4% (2016: -18.6%) growth next year (see Table 4). Likewise, total revenue is anticipated to grow by 3.4% to RM219.7 billion led by tax revenue collection which accounted for 82.2% of total government revenue. Despite higher deficits in absolute terms, the deficits level appears narrowing to 3.0% of GDP in 2017 from 3.1% in 2016 owing to higher growth in nominal GDP of 7.4%. As such, we view the budget as expansionary. Table 1: Federal government finances RM Million 2013 2014 2015 2016F 2017F Revenue 213,370 220,626 219,089 212,595 219,726 % chg 2.6% 3.4% -0.7% -3.0% 3.4% Operating expenditure 211,270 219,589 216,998 207,126 214,800 % chg 2.8% 3.9% -1.2% -4.5% 3.7% Current balance 2,100 1,037 2,091 5,469 4,926 % chg -11.6% -50.6% 101.7% 161.5% -9.9% Gross development expenditure 42,210 39,503 40,768 45,000 46,000 % chg -10.1% -6.4% 3.2% 10.4% 2.2% Less: loan recoveries 1,526 1,052 1,483 804 730 Net development expenditure 40,683 38,451 39,285 44,196 45,270 % chg -8.2% -5.5% 2.2% 12.5% 2.4% Overall balance (38,584) (37,415) (37,194) (38,727) (40,344) Overall balance % of GDP -3.8% -3.4% -3.2% -3.1% -3.0% Sources: CEIC & Economic Report 2016/17 For Internal Circulation Page 1

Table 2: Federal government revenue RM billion %chg % share RM Billion 2015 2016 2017 2015 2016 2017 2015 2016 2017 Total revenue 219.1 212.6 219.7-0.7% -3.0% 3.4% 100.0% 100.0% 100.0% Tax revenue 165.4 167.1 180.6 0.8% 1.0% 8.1% 75.5% 78.6% 82.2% Direct tax 111.8 110.5 120.7-11.8% -1.1% 9.3% 51.0% 52.0% 54.9% of which: CITA 63.7 63.2 69.2-2.4% -0.8% 9.5% 29.1% 29.7% 31.5% Individual 26.3 28.2 29.9 7.8% 7.0% 6.0% 12.0% 13.2% 13.6% PITA 11.6 8.5 10.6-57.1% -26.3% 24.9% 5.3% 4.0% 4.8% Indirect tax 53.7 56.6 59.8 43.3% 5.5% 5.7% 24.5% 26.6% 27.2% among them GST 27.0 38.5 40.0 42.5% 3.9% 12.3% 18.1% 18.2% SST 8.3-52.0% 3.8% Excise duty 11.9 11.8 13.1-8.0% -0.7% 11.1% 5.4% 5.6% 6.0% Import duty 2.7 2.7 3.0 2.3% 0.1% 9.9% 1.2% 1.3% 1.4% Export duty 1.0 0.8 0.7-45.1% -21.8% -10.1% 0.5% 0.4% 0.3% Non tax revenue 53.6 45.5 39.1-0.5% -15.2% -14.0% 24.5% 21.4% 17.8% of which: License & permit 12.5 11.8 12.1-12.0% -5.6% 1.8% 5.7% 5.6% 5.5% Investment income 32.8 23.3 17.6-2.7% -29.0% -24.5% 15.0% 11.0% 8.0% Corporate Income Tax (CITA) Petroleum Income Tax (PITA) Goods & Services Tax (GST) Sales & Services Tax (SST) Source: Economic Report 2016/17 Table 3: Federal government operating expenditure RM billion %chg % share RM Billion 2015 2016 2017 2015 2016 2017 2015 2016 2017 Operating expenditure 217.0 207.1 214.8-1.2% -4.5% 3.7% 100.0% 100.0% 100.0% Emolument 70.1 73.9 77.4 4.6% 5.4% 4.8% 32.3% 35.7% 36.0% Retirement charges 18.9 19.0 21.8 3.6% 0.6% 14.6% 8.7% 9.2% 10.1% Debt service charges 24.3 26.6 28.9 7.5% 9.7% 8.4% 11.2% 12.9% 13.4% Grants & trfs to state govt. 6.9 6.9 8.1 6.0% 0.2% 16.3% 3.2% 3.3% 3.8% Supplies & services 36.4 29.7 32.0 6.2% -18.3% 7.8% 16.8% 14.3% 14.9% Subsidies & social assistanc 27.3 24.6 22.4-31.3% -9.6% -9.0% 12.6% 11.9% 10.4% Grants to statutory bodies 15.5 12.9 9.4-5.3% -16.4% -27.4% 7.1% 6.3% 4.4% Refunds & write-offs 0.9 0.9 0.8-29.1% -2.4% -13.2% 0.4% 0.4% 0.4% Others 16.8 12.5 14.0 23.0% -25.7% 12.5% 7.7% 6.0% 6.5% Source: Economic Report 2016/17 For Internal Circulation Page 2

Table 4: Federal government development expenditure RM billion %chg % share RM Billion 2015 2016 2017 2015 2016 2017 2015 2016 2017 Development expenditure 40.8 45.0 46.0 3.2% 10.4% 2.2% 100.0% 100.0% 100.0% Economy 23.3 27.6 25.9-0.2% 18.6% -6.4% 57.1% 61.4% 56.2% of which: Transport 6.7 8.4 10.6-7.9% 25.8% 25.9% 16.4% 18.7% 23.0% Trade & industry 5.6 6.0 4.9 20.3% 6.3% -17.8% 13.8% 13.3% 10.7% Public utlities & energy 3.6 3.3 2.6 4.4% -10.1% -21.0% 8.9% 7.3% 5.6% Agri & rural development 3.1 2.9 2.4 8.0% -7.3% -16.0% 7.6% 6.4% 5.3% Social 11.2 10.8 12.2 6.4% -3.1% 12.7% 27.4% 24.0% 26.5% of which: Education & training 4.8 3.9 5.9-3.4% -18.6% 52.4% 11.7% 8.6% 12.8% Housing 2.0 2.5 0.9 224.9% 23.3% -64.9% 4.9% 5.5% 1.9% Health 1.4 1.5 1.5 4.1% 2.7% 3.4% 3.5% 3.3% 3.3% Security 4.8 5.0 5.3 9.7% 6.0% 4.9% 11.7% 11.2% 11.5% General administration 1.6 1.5 2.7 16.6% -2.7% 75.3% 3.8% 3.4% 5.8% Source: Economic Report 2016/17 Fiscal consolidation is progressing well but The government has been instituting unpopular decisions the past few years in particular the reduction in subsidies and the introduction of Goods and Services Tax (GST) in April 2015. With regards to GST, the total collection is expected to increase further to RM40 billion in 2017 from an estimated RM38.5 billion in 2016. Looking at chart 1, GST collection continues to exceed sales and services tax (SST) by a wider margin. For instance, total collection for GST was at RM27 billion between April and December 2015. This is higher compared to full year SST collection of RM17 billion in 2014. As of October 19, the GST collection has reach nearly RM30 billion (1H2016: 17.2 billion). Therefore, tax efficiency is greatly enhanced under the GST regime. We believe that the normalisation in consumer spending growth should help GST collection as the tax is predominantly dependant on consumption. The complete removal of fuel subsidy at the end of 2014 also helps to reduce expenditure on subsidies (see Chart 2). This is given the fact that fuel subsidy typically accounted for more than 50% of total subsidy. While fiscal consolidation is progressing well, the government should also look at other parts of OE which can be reduced or perhaps, attempt to improve their productive capacity. For instance, the government should look at how productivity among the civil servants can be further enhanced especially the support staff since emoluments accounted for more than one third of OE. In addition, the government also needs to think their strategy on addressing the retirement plan of its employees given that retirement charges continue to rise in tandem with the number of civil servants (see Chart 3). For Internal Circulation Page 3

Chart 1: GST vs. SST (RM billion) 45.0 40.0 35.0 SST GST 38.5 40.0 30.0 27.0 25.0 20.0 15.0 12.1 13.6 15.1 16.0 17.2 10.0 8.3 5.0-2010 2011 2012 2013 2014 2015 2016 2017 Sources: CEIC & Economic Report 2016/17 Chart 2: Subsidies (RM billion) and daily average of Brent crude (USD per barrel) 50.0 45.0 40.0 Subsidies (Left hand scale) 98.3 Daily average of Brent crude (USD per barrel) 111.7 108.7 111.0 99.4 120.0 100.0 35.0 30.0 25.0 20.0 15.0 55.2 66.1 72.7 62.6 80.3 53.6 43.7 80.0 60.0 40.0 10.0 5.0 20.0 - Y05 Y06 Y07 Y08 Y09 Y10 Y11 Y12 Y13 Y14 Y15 Y16 Y17 - Sources: Bloomberg, CEIC & Economic Report 2016/17 For Internal Circulation Page 4

Chart 3: Retirement charges vs. number of civil servants 20.0 18.0 Retirement charges (RM bn) 16.0 Civil servant in '000 (RHS) 14.0 12.0 10.0 8.0 6.0 4.0 2.0-1,400 1,200 1,000 800 600 400 200 - Sources: CEIC & MOHR Macroeconomic projection somewhat bullish The government is projecting GDP growth of between 4% and 5% in 2017 from 4% and 4.5% in 2016. However, looking at the absolute figure, the 2017 GDP growth projection is effectively at 4.6% from an estimated 4.2% in 2016. Growth drivers would come from two sources i.e domestic and external demand. Domestic spending is anticipated to rise 4.9% in 2017 led by gains in consumer spending amidst sustain growth in private investment. Meanwhile, net exports are expected to grow 1.9% after contracting for two consecutive years. Other macro variables, current account balance is envisaged to maintain a surplus balance at around 1.1% of GDP in 2017 from an estimated 1.3% in 2016 while unemployment rate is anticipated to improve to 3.2% from the current level of around 3.4%. Similarly, inflation rate is expected to range between 2% and 3% in 2017. Judging from the projection numbers, the government appears to be putting strong emphasis on the revival of the external sector particularly on the commodities space such as CPO and Crude Oil. We also noticed that nominal GDP is anticipated to grow by 7.4% in 2017 which is higher compared to an average of 7.1% between 2011 and 2015. Budget 2017 also indicated that CITA rates will be cut by several percentage points for Year Assessment (YA) 2017 and 2018 which contingent upon the company s earnings growth. This would imply the government is somewhat bullish about the state of Malaysian economy in 2017. Our concern is that the government may need to recalibrate the budget should forecast assumption does not pan out as plan. For Internal Circulation Page 5

Table 5: Gross domestic product (GDP) growth % Growth 2013 2014 2015 2016F 2017F GDP 4.7% 6.0% 5.0% 4%-4.5% 4% - 5% By expenditure: Domestic Demand 7.3% 5.9% 5.1% 4.7% 4.9% Consumption 6.9% 6.4% 5.7% 4.9% 5.1% -Public 5.8% 4.3% 4.4% 0.2% 0.4% -Private 7.2% 7.0% 6.0% 6.1% 6.3% Investment 8.1% 4.8% 3.7% 4.1% 4.2% -Public 1.8% -4.7% -1.0% 1.7% 1.1% -Private 12.8% 11.1% 6.4% 5.3% 5.8% Exports 0.3% 5.0% 0.6% 0.7% 2.5% Imports 1.7% 4.0% 1.2% 1.4% 2.6% Net Export -9.8% 13.2% -3.8% -4.7% 1.9% By industry: Agriculture 2.0% 2.1% 1.2% -3.3% 1.5% Mining 1.2% 3.5% 4.7% 1.1% 1.4% Manufacturing 3.4% 6.2% 4.9% 4.0% 4.1% Construction 10.6% 11.7% 8.2% 8.7% 8.3% Services 5.9% 6.6% 5.1% 5.6% 5.7% Sources: CEIC & Economic Report 2016/17 Table 6: Other macro variables 2013 2014 2015 2016 2017F Current account % of GDP 3.5% 4.4% 3.0% 1.3% 1.1% Unemployment rate 3.1% 2.9% 3.2% 3.4% 3.2% Inflation rate 2.1% 3.1% 2.1% 2.3% 2% - 3% B40 is the main beneficiaries Below 40% income group (B40) are the clear winners in the Budget 2017 as 1Malaysia People s Aid (BR1M) allocation will be raised to RM6.8 billion from RM5.9 billion in the previous budget. A total of 7 million recipients will benefit from 2017 BR1M as compared to 7.4 million previously. This will certainly help to promote consumer spending as lower income group tend to spend more for every additional increase in their income. This is premised on BNM study on household for each income group whereby those who earn below RM1,000 per month will have Marginal Propensity to Consume (MPC) of 0.81. This would mean for every RM1 increase in income it will translate in 0.81 cents of spending (see Chart 4). While BR1M can increase spending, the fear is that it may compromise productivity and the resultant of moral hazard which can be harmful to the economy in the long term. Indeed there is no quick solution to this issue especially when consumer sentiments remain weak. In this regard, promoting BR1M recipient to generate additional income via ride-sharing is a step in a right direction. By using BR1M and rebate of RM4,000 to own Proton Iriz (those who does not own a vehicle) to come up with the down payment is an effective use of such cash transfers as this will allow the low income group to have supplement income. For Internal Circulation Page 6

Table 7: 1Malaysia People s Aid (BR1M) Category Income BR1M 2017 e-kasih RM1,200 (2016: RM1,050) Households <RM3,000 RM1,200 (2016: RM1,000) RM3,000 - RM4,000 RM900 (2016: RM800) Individual <RM2,000 RM450 (2016: RM400) Source: Budget 2017 Touch points Chart 4: Marginal Propensity to Consume (MPC) 0.9 0.8 0.81 0.74 BR1M recipient 0.7 0.6 0.5 0.4 0.54 0.48 0.4 0.37 0.3 0.25 0.2 0.1 Housing the nation 0 RM0 - RM1,000 RM1,000 - RM2,000 RM2,000 - RM3,000 RM3,000 - RM4,000 RM4,000 - RM5,000 RM5,000 - RM10,000 Source: The Marginal Propensity to Consumer across Households Income Group, December 2013, BNM Working Paper Series. >RM10,000 Based on 11 th Malaysian Plan (11MP), a total of 653,000 units of affordable houses will be built between 2016 and 2020. As such, Budget 2017 will ensure such target will be met through various initiatives: To build 5,000 units of MyBeautiful New Home for the B40 with price range of RM40,000 RM50,000 costing RM200 million in total. The government will finance RM20,000 and the balance will be paid in installments by the owner. These houses will be built on their own land, land permitted by the landowner and land awarded by the state government. To build 9,850 new and to complete 11,250 houses under the People s Housing Programme (PPR) with total allocation of RM710 million To build 30,000 units of houses on government s land which strategically located at a price of between RM150,000 RM300,000 To build 10,000 units houses in urban area. Eligible youths may rent up to maximum five years at a lower than the market rate. Step-up end financing for PR1MA programme to allow higher financing to the borrowers. Stamp duty exemption to be increased to 100% from 50% for first time house buyers with house prices up to RM300,000. The exemption will commence between 1 January 2017 and 31 December 2018. For Internal Circulation Page 7

Second Generation House for FELDA (RM200 million), FELCRA (RM100 million) and RISDA (RM100 million) Table 8: Targets for Public Affordable Housing during 11MP Programme Accronyms Housing Unit Program Bantuan Rumah PBR 47,000 Pogram Perumahan Rakyat PPR 50,000 Perumahan Rakyat 1Malaysia PR1MA 380,000 Perumahan Penjawat Awam 1Malaysia PPA1M 88,000 Rumah Mesra Rakyat 1Malaysia RMR1M 55,000 Rumah Wilayah Persekutuan RUMAWIP 33,000 653,000 Source: 11MP Budget 2017 by sectoral 1. Construction Gross DE will be raised from RM45 billion to RM46 billion with a target sectoral growth of 8.3% in 2017 from an estimated 8.7% in 2016. This is critical for sustaining domestic demand growth as it will have spillover effects to other sector namely manufacturing and services industries. The projects include: The implementation of 600km East Coast Rail Line (ECRL) project connecting Klang Valley to the East Coast to improve connectivity among the township such as Port Klang, ITT Gombak, Bentong, Mentakab, Kuantan, Kemaman, Kerteh, Kuala Terengganu, Kota Bharu and Tumpat. Total project cost is RM55 billion. To build and upgrade new hospitals and clinics in Perlis, Kuching, Mukah, Jempol, Muar & Johor Bahru To upgrade the drainage system and construct two Overhead Motorcycle Ramps at the Federal Highway in Selangor. Total allocation of RM29 million. To upgrade estate road to facilitate palm oil smallholders. Total allocation RM20 million Reconstruct destitute schools (60 in Peninsular, 30 in Sabah and 30 in Sarawak) and to upgrade 1,800 science laboratories. Total sum of RM570 million will be provided. A sum of RM1.2 billion will be allocated to improve connectivity of villages, towns, and cities (616 KM of village roads & bridges). For Internal Circulation Page 8

2. Telecommunication Measures to promote ICT as catalyst for productivity gains as well as to enhance the learning process among the students and to the society at large are articulated in the Budget 2017. As it is, penetration rate for broadband has improved significantly from merely 8% in 2006 to 78.7% in 2016. The measures are as follows: Lifestyle tax relief of RM2,500 per year includes purchases of smart phones and tablets, printed newspaper, internet subscription and gymnasium membership fees. Computer loan facility for the civil servants to include the purchase of smart phones. The facility can be used once for every three years. Effective January 2017, fixed line service providers will offer services at a higher speed for the same price. Malaysian Communications and Multimedia Commission (MCMC) will provide RM1 billion to ensure the coverage and quality of broadband nationwide reaches up to 20 megabytes per second Chart 5: Broadband penetration rate (%) 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0-8.0 06 06 07 07 08 08 09 09 10 10 11 11 12 12 13 13 14 14 15 15 78.7 16 Source: CEIC 3. Education Allocation for TVET of RM4.6 billion a sum of RM132 million is provided to improve access to preschool education in government schools for free, benefitting 200,000 children Schooling Assistance Programme of RM100 each to students from families earning up to RM3,000. A total 3.5 million will benefit from the programme. Special Needs Student Allowance of RM150 monthly, involving 67,000 students Allocation of RM600 million to Special Fund for Improvement and Maintenance of Schools For Internal Circulation Page 9

A sum of RM7.4 billion is allocated for 20 public universities to be globally recognized universities by focusing on research and increase publication as well as intellectual properties. Replace book vouchers with student debit card worth RM250 which can be used to purchase books, computer accessories and internet access. This will benefit 1.3 million students. Scholarships will continue to be awarded with an allocation of RM4.3 billion in 2017.This will include: RM1.6 billion through Public Service Department; RM2 billion through Majlis Amanah Rakyat (MARA); RM250 million through Ministry of Higher Education; RM208 million through Ministry of Health; RM194 million through Ministry of Education; RM28 million through Ministry of Human Resources; and RM21 million through Ministry of Youth and Sports. Allocating RM30 million to coordinate tahfiz education through National Tahfiz Education Policy. 4. Islamic finance Income tax exemption to entities carrying out Islamic banking and Takaful business through the International Currency Business Unit (ICBU) in foreign currencies as well as stamp duty exemption on instruments of such activities will be extended to the year of assessment 2020. Our view In a nutshell, striking the right balance between achieving sustainable growth as well as keeping government finances well in check are the key themes for Budget 2017. Meanwhile, global economy remains highly uncertain although positive signs coming out from the US and, to some extent EU, could provide significant impetus to overall growth. Therefore, risks of budget recalibration should not be totally discarded in the event baseline scenario suddenly take a different turn. Again, communication with the stakeholders is paramount to ensure that timely and relevant information are disseminated steadfastly to avoid misunderstanding. For instance, issues on self-imposed debt limit of 55% of GDP are frequently discussed in the public forum. However, there is not enough emphasis on the debt instrument which is used to compute the limit. For Internal Circulation Page 10

In actual fact, there are several legislations that empowers Federal Government to borrow or to raise funds. A case in point would be Loan (Local) Act 1959 [Act 637] and Government Funding Act 1983 [Act 275] which set the debt ceiling at 55% of GDP. The debt instruments is confined to the outstanding of Malaysian Government Securities (MGS), Government Investment Issue (GII) and Malaysian Islamic Treasury Bills (MITB). The recent statistics showed that ratio of the three debt instruments to GDP is about 48% as of September. Therefore, the debt ratio is well below than the self-imposed limit. That aside, fiscal reforms should focus on other than subsidies and the government should look at other OE components such as emoluments, retirement charges and supplies & services to ensure that the tax payers money are well spent and GDP accretive at the same time. Persistent reduction in subsidies within short period of time could tantamount to negative shocks. This could undermine growth given the nascent recovery in consumer sentiments. Lastly, the government needs to seriously consider Waqf as the potential economic policy instrument. Already we have seen some of the Budget 2017 measures like using government land to build affordable houses does resonate the principle of Waqf. In fact, it was stated in 11MP document that National Housing Department (NHD) will collaborate with the respective state Islamic religious councils to identify suitable waqf land that can be used to develop affordable houses using the concept of Waqf. With proper plan and execution, perhaps the government could achieve a balanced budget by 2020. At the current rate, achieving a balanced budget in the next four years can be an uphill task in our view. For Internal Circulation Page 11

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