Malaysia 2014 Budget Preview: New Tax To Address Weak Fiscal Position And Slowing Economy

Malaysia could see some much-needed fiscal reforms when the government announces its 2014 budget on Friday, including a goods and services tax likely to take effect in 2015, which will help the Southeast Asian nation address its weakening fiscal position and alarming debts.

In July, Fitch downgraded Malaysia’s sovereign credit rating outlook to negative, citing rising debt levels – 54 percent of GDP at the end of the second quarter -- and the lack of fiscal reforms. Prime Minister Najib Razak, who is also the finance minister, is expected to deliver his 2014 budget speech on Friday, and is likely to announce broad changes to address growing concerns about Malaysia’s financial woes.

The most significant of Najib’s reforms will be the introduction of a goods and services tax in place of the existing sales and services tax, which could generate additional revenue for the government.

“Introducing the GST will effectively broaden the tax base, as currently income tax is collected from only 8.3 percent of the workforce and tax collection from small to medium enterprises (the majority of the private sector) remains poorly enforced,” analysts for the Eurasia Group, a political and economic risk consultancy, wrote in a research note published on Monday.

The sales and services tax raises about 15 billion Malaysian ringgits ($4.73 billion). Ballpark calculations suggest that a 4 percent GST would pull even, and a 7 percent GST could raise 25.7 billion ringgits, the equivalent of 3.4 percent of Malaysia’s GDP, a Bank of America Merrill Lynch research note said.

The sorely needed tax has been a long time coming, but still may not be implemented until 2015, as new revenue-generating measures are never popular and may invite public protests. While the announcement for the tax seems certain, its precise magnitude and timeline is not likely to be revealed in this initial stage.

The government may also raise revenue by hiking the property gains tax or stamp duties, and tighten macro measures, which will also cool a housing market that has seen prices rise over the last few years as affordability ratios (property price over household income) worsened.

Revenues aside, Najib is also expected to continue to cut costs – in particular, the nation’s 24 billion ringgits worth of annual fuel subsidies will be reduced gradually. An 11 percent fuel price hike in September will save the government 1.1 billion this year, and additional hikes are expected in the second or third quarter of next year.

But even as the administration commits to fiscal reforms, certain populist policies will likely be maintained. The race-based bumiputera policy, for example, with regulations that mandate ethnic Malays own 30 percent of shares in most domestic firms, has a decidedly negative impact on Malaysia’s economy, but any moves to weaken the program will alienate the ruling party’s support base and weaken Najib’s position, the Eurasia Group note said.