Inflation Fears May Slow Malaysia Government Subsidy Cuts, Economists Says

Malaysia may cut subsidies slowly to prevent triggering record inflation as it prepares to revamp a system that’s hampered efforts to reduce the budget deficit, Standard Chartered Plc and Citigroup Inc. said.

A taskforce is exploring ways to revamp the government’s entire portfolio of subsidies that keep the cost of essential items from flour to highway tolls low for consumers. An attempt to reduce the amount the state pays to cap fuel prices caused inflation to surge to a 26-year high in 2008 as gasoline became more expensive.

The government will learn from past experience and ensure its subsidy cuts will be a “very tempered, gradual process,” Alvin Liew, an economist at Standard Chartered in Singapore, said May 7. “They still have time on their hands. It’s not a Greek situation where they need a bailout, not yet anyway.”

Malaysia spends about 73 billion ringgit ($22 billion) a year on subsidies, Prime Minister Najib Razak said on April 6, calling the amount “not sustainable.” The government, which has said it is considering a global bond sale, aims to narrow its budget deficit to 5.6 percent of gross domestic product this year from a 22-year high of 7 percent in 2009.

Concerns the European debt crisis will spread sparked a global stock rout last week even as Greece’s parliament approved austerity measures demanded by the European Union and International Monetary Fund as a condition of its 110 billion euro ($139 billion) bailout.

Photographer: Sarni Ocampo/Bloomberg

Najib Razak, Malaysia's prime minister, speaks during an interview in Hong Kong in March. Close

Najib Razak, Malaysia's prime minister, speaks during an interview in Hong Kong in March.

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Photographer: Sarni Ocampo/Bloomberg

Najib Razak, Malaysia's prime minister, speaks during an interview in Hong Kong in March.

Bond Sales

In Asia, nations from Vietnam to the Philippines sold sovereign debt earlier this year as the region leads a global economic recovery. Malaysia may sell 10-year dollar denominated bonds in June, according to a finance ministry official with knowledge of the plan.

Faster growth will help the government cut its budget shortfall as revenue rises, state news agency Bernama cited Deputy Finance Minister Awang Adek Hussin as saying last week.

Malaysia pays suppliers to keep many consumer goods below their true market values. The decades-old system, aimed at helping the poor, has also benefited the rich and encouraged smuggling to neighboring countries where prices are higher. Sugar supplies ran short last year as profiteers took the sweetener across the border into Thailand, where it fetched double the price.

The government taskforce led by Idris Jala, a former Malaysian Airline System Bhd. managing director, is seeking feedback on how to revamp subsidies so that only the poor get help. Jala is now a minister in Najib’s office.

Greater Impact

Malaysia’s consumer price index, which has averaged 2.8 percent over the past four years, jumped to 8.5 percent in July and August of 2008 after the government raised retail fuel prices by as much as 63 percent in a bid to trim its subsidy bill as global crude oil prices soared.

“If just raising fuel prices affected inflation so much, can you imagine the impact this time?” Suhaimi Ilias, an economist at Maybank Investment Bank Bhd., said in a telephone interview. “I think the impact would be even greater. There must be an increase in income so people can cope.”

The government will tread cautiously and stagger its subsidy reforms, said Kit Wei Zheng, an economist at Citigroup in Singapore. Bank Negara Malaysia, which was among the first central banks in Asia to raise interest rates this year, may not need to respond aggressively to any inflationary pressure as a result of the revamp, he said.

“Their policy reaction is front-loaded, so they may not need to react so much” to inflation, Kit said in a telephone interview.

Rate Decision

The central bank next meets to discuss monetary policy this week, and will announce its decision on May 13. It increased its overnight policy rate to 2.25 percent from a record-low 2 percent in March after Southeast Asia’s third-largest economy emerged from a recession in the last quarter of 2009.

The inflation rate rose to 1.3 percent in March. Food prices climbed 1.7 percent after the government scrapped its subsidy on white bread and raised its cap on sugar prices in January.

The central bank raised the country’s 2010 growth forecast on March 24, predicting GDP will expand 4.5 percent to 5.5 percent. While faster growth should boost tax collection as company profits climb, the government has postponed a plan to introduce a goods and services levy. It also delayed a revamp of the fuel subsidy system from May to later this year.

“I’m worried for the government,” said Standard Chartered’s Liew. “Having such a huge amount of subsidies takes such a toll on its fiscal position and will not be sustainable in the long run.”

To contact the reporter on this story: Barry Porter in Kuala Lumpur at bporter10@bloomberg.net.

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