Challenges Mount for Malaysia’s Government in 2015

After a year of solid achievement on the economic front, Malaysia’s leaders will face difficult circumstances as they implement reform in 2015.

One of the more impressive achievements of the Malaysian government in 2014 was the resolve it demonstrated in trying to balance the budget. Prime Minister Najib Razak inherited a budget situation characterised by a lack of fiscal discipline from previous administrations, and he made a concerted effort to address this problem.

After a year of solid achievement on the economic front, Malaysia’s leaders will face difficult circumstances as they implement reform in 2015.

One of the more impressive achievements of the Malaysian government in 2014 was the resolve it demonstrated in trying to balance the budget. Prime Minister Najib Razak inherited a budget situation characterised by a lack of fiscal discipline from previous administrations, and he made a concerted effort to address this problem.

He has implemented policies that will see a reduction in the fiscal deficit from 3.5 percent of GDP in 2014 to 3.0 percent of GDP in 2015. The government has also rationalised subsidies. It cut petrol and diesel subsidies by about 20 sen (about 6 US cents) per litre on 2 October. Fortuitously, the global price of oil has been falling, lending a fine sense of timing to the subsidy cuts best executed when market prices are declining, as they are now.

Equally commendable was the decision to introduce a goods and services tax (GST) in April 2015. The announcement timing for this plan was clever. With the elections safely behind him, and with the 14th general elections not for another five years, Najib can undertake unpopular reforms in 2015, like introducing the GST, and then work to improve his political goodwill in the next few years, with the hope that most will forget the GST by the time the elections are due. Timing is again in Najib’s favour, since, although low oil prices will slash government revenue, compensated to some extent by the broad ranging GST revenue collection that will begin in the months to come.

Concerns about public and household debt have haunted Malaysia last year. Household debt currently stands at about 87.1 percent of GDP and government debt is about 53 percent of GDP. Government spending needs to be further scrutinised and reviewed, the size of the public sector (a vote bank though it may be) has to be reconsidered, and the worthiness of large projects have to be questioned with the circumspection of a fussy accountant.

There are undeniably many good targets from which to cut. The Auditor-General’s report on government spending in 2013 documents enormous cost blowouts: computers worth RM3,000 (US$850) being procured for RM 84,000 ($2400), facilities costing millions not being used, and a whole plethora of items whose inflated prices suggest gross mismanagement. If the Auditor General’s report is any indication of the extent of public sector mismanagement, then the government should be tackling issues of project management, transparency in procurement and efficiency and productivity in the public sector even before it rolls out the GST.

Inflation rates moderated in the last few months of 2014. Early last year inflation was running at about 3.4 percent and softened to about 2.7 percent towards the end of 2014. Though these rates appear reasonable, actual inflation, experienced by the Malaysian people (or felt inflation) is higher; and public perception of the rising cost of living is, indeed, critical.

At any rate, the official inflation rate expects to spike in May 2015 with the introduction of the GST, possibly as high as 4.5 percent. This is to be expected. International experience suggests a one-time price spike of anything from an additional 1 to 2 percent following the implementation of the GST. In the case of Malaysia, household spending in 2015 will be constrained because of limited disposable income and eroded purchasing power due to the GST-induced price hikes.

The external sector does not seem ready to lend any solace. The Malaysian ringgit is taking a beating against the US dollar. Declining confidence in the ringgit, mainly because of the decline in oil prices, could stretch for the next few months. That might do Malaysian exports, particularly those from the electrical and electronics sector, some good.

But there are dark clouds hanging over the markets for Malaysian exports. China, Malaysia’s biggest trade partner, will experience domestic reforms that are more inward-oriented. The anticipated lower growth rate in China, forecast to be 7 percent or slightly less, will lower demand from China, which in turn will have an impact on Malaysia’s economy.

The forecast for Japan’s growth next year is not terribly encouraging at 1 percent and the European Union is expected grow at about the same rate, touching perhaps 1.2 percent. The IMF has downgraded its global growth forecast for 2015 to 3.8 percent from 4 percent. The savings grace will come from stronger US markets. While the improving US market will help Malaysian exports, it will result in higher interest rates in the US, and the resulting interest rate differential will see funds flow out of Malaysia. All these factors in combination could cause the growth rate in Malaysia to weaken, perhaps within the range of 4.8 to 5 percent.

All of these factors will combine to produce a tough political environment for Najib’s government to navigate as it pursues reform.

The last days of 2014 were tragic. The Air Asia crash followed two other crashes. Then there were the massive floods that have affected several states, displacing more than a 100,000 people and resulting in over 20 lost lives. The cost of compensation, resettlement and redevelopment will be a huge burden on the government, but one that will necessarily have to be borne.

On the external front, Najib will also have to be decisive about the Trans-Pacific Partnership agreement, since fears on the agreement have gone un-allayed politically, particularly for the potential losers who would constitute a small but powerful group. Then there is management of the ASEAN Economic Community agenda and the Regional Comprehensive Economic Partnership agreement while Malaysia holds the chair of ASEAN. The chairmanship will be a demanding task in its own right.

Thus 2015 will be a busy year for the Najib government.

The tricky economic tasks facing Najib Razak is republished with permission from East Asia Forum