Malaysian Prime Minister Najib Razak’s promise of measures to curb the budget gap and avert a credit-rating downgrade helped send three-year government bond yields to a four-month low. His resolve is about to be tested.
Najib, also finance minister, will deliver his 2014 budget speech to parliament on Oct. 25 after cementing his leadership in a May general election. Having given handouts to the poor and pay increases for civil servants to woo voters earlier, he may now introduce a potentially unpopular consumption tax, delay projects and raise the levy on property gains, according to United Overseas Bank Ltd. and DBS Group Holdings Ltd.
The ringgit gained the most among 24 emerging-market currencies this month partly on speculation Najib, 60, will follow through on politically unpopular revenue-generating measures. Failure to act would risk a decline in investor confidence, with Fitch Ratings cutting Malaysia’s credit outlook to negative in July citing rising debt levels and a lack of budgetary reform.
“Going into the budget, there is an expectation from the market that Malaysian authorities will take the right steps,” Vivek Rajpal, a Singapore-based strategist at Nomura Holdings Inc., said in an Oct. 17 interview. “We believe authorities will take the right steps. But in case they don’t, it should impact the bond markets negatively.”
The yield on the 3.172 percent notes due in July 2016 dropped one basis point, or 0.01 percentage point, to 3.15 percent, the lowest since June 10, data compiled by Bloomberg show. It retreated 14 basis points last week, the biggest five-day decline since the notes were sold in January.
The ringgit appreciated 2.8 percent this month, the best performance among 24 emerging-market currencies tracked by Bloomberg, and reached a four-month high of 3.1413 on Oct. 18. It has traded in a range of 3.15 to 3.25 per dollar since the U.S. Federal Reserve unexpectedly said Sept. 18 it would maintain monetary stimulus that’s boosted the supply of dollars and spurred demand for emerging-market assets.
“Budget 2014 will be a watershed moment for Malaysia as it embarks on bold fiscal reforms and economic restructuring to ensure sustainable and balanced economic growth ahead,” CIMB Group Holdings Bhd. economist Lee Heng Guie wrote in a Sept. 20 report. “Malaysia’s current fiscal and debt situation means that the prime minister is tasked with making some necessarily tough but thoughtful decisions.”
CIMB expects Najib to introduce a goods and services tax, the consumption levy that the government has considered for years without implementing. The banking group also predicts further gradual subsidy rationalization, changes in the state procurement system, and increases in excise duties for tobacco and alcohol.
The risk premium on Malaysian bonds will probably fall if Najib takes fiscal consolidation measures in the budget, Barclays Plc strategists including Rohit Arora wrote in an Oct. 17 note. Such steps could help the ringgit break out of the 3.15 to 3.25 per dollar range, Jonathan Cavenagh, a currency strategist in Singapore at Westpac Banking Corp., said in an Oct. 16 report.
The prime minister has already moved to show he’s prepared to contain government spending. His administration raised subsidized fuel prices for the first time since 2010 last month and has said it will delay some infrastructure projects. Najib said this month he believes that Malaysia can avoid a cut to its credit rating while the government will try its “level best” to prevent a breach of its self-imposed sovereign debt ceiling.
The country, which has a long-term foreign-currency denominated debt rating of A- at Fitch, has run annual budget deficits every year starting in 1998.
“Najib has shown his resolve to avoid the downgrade and improve fiscal conditions, and the budget will probably reflect that,” Koji Fukaya, chief executive officer and currency strategist at FPG Securities Co. in Tokyo, said in an Oct. 18 telephone interview. “Improving fiscal conditions are positive for Malaysia’s bonds.”
The government will further cut state subsidies, broaden its tax base and manage spending “prudently,” Najib said in an Oct. 11 interview. Cabinet will meet before the 2014 budget is released to decide if there’s enough public support to introduce a goods and services tax, he said.
Malaysia will probably implement an initial 4 percent goods and services tax that will generate 20.5 billion ringgit ($6.5 billion), or as much as 14 percent of total tax revenue, in the first year, according to an Oct. 16 report from DBS. The government earlier planned to introduce a 4 percent GST by 2011. It hasn’t said what the rate may be if it now goes ahead.
Fiscal austerity could pose political risks amid slowing economic growth and a slide in the National Front coalition’s popularity.
The economy is forecast by the central bank to expand 4.5 percent to 5 percent this year after growing 5.6 percent in 2012. Najib’s alliance retained power in the May election even as it lost the popular vote.
To improve the fiscal position, Najib would also eventually need to trim Malaysia’s civil service, according to Bank of America Corp., risking a key support base of the ruling party.
At 26.8 percent of GDP, Malaysia’s government expenditure is the highest among the five biggest Southeast Asian economies, according to a September report from the lender. Malaysia has the highest civil servants-to-population ratio in the Asia-Pacific region, it said, citing estimates from the Organization for Economic Cooperation and Development.
“There seems to be a lot of inefficiency and unnecessary fat,” Chua Hak Bin, a Singapore-based economist at Bank of America, said in an Oct. 8 interview. “Of course, it’s always politically more difficult to downsize the civil service.”
Najib is under pressure to push forward with measures to contain the budget and public debt nevertheless. Moody’s Investors Service said last month the budget deficit may exceed 4 percent of gross domestic product this year, warning the government’s fiscal targets will become “increasingly out of reach” without additional measures to contain it.
“The reforms announced in this year’s budget will shape the trajectory of fiscal and debt consolidation for the remainder of this government’s term,” Christian de Guzman, an analyst at Moody’s in Singapore, said in an Oct. 17 e-mail. “Looking ahead, if the resulting sovereign credit profile of Malaysia is no longer in line with an A3 rating, we will act accordingly.”