Insight - Economy needs strong booster dose from budget

Lee Heng Guie: We reckon that the worst of economic output contraction is behind us as the incoming high frequency data continued to mend gradually from the historic slump.

The economy needs a strong booster dose from the upcoming budget since considerable risks remain that may temper the early signs of stabilisation and recovery.

Budget 2021 on Nov 6 will be presented at a time when the economy is still reeling from the Covid-19-induced worst economic contraction of 17.1% year-on-year (y-o-y) in the second quarter (2Q 2020).

We reckon that the worst of economic output contraction is behind us as the incoming high frequency data continued to mend gradually from the historic slump.

The economy has moved from stabilisation to a recovery phase, which had started to trickle in at the end of second quarter, continued into the third quarter. But, the recovery is tentative and uneven until the recent spike in the number of infection cases nationwide, with high infection rates occurring in some areas and districts in Sabah, Kedah and Selangor.

Mirroring uncertainty around the likely trajectory of a third wave of coronavirus, there is still substantial uncertainty surrounding the strength and path of an economic rebound in 2021.

The state of worry, anxiety and stress about the rising numbers of new infection cases would dent a full restoration of consumer sentiment and the still sluggish business confidence.

If the third wave of Covid-19 worsens, leading to a wide scale targeted precautionary measures and stricter lockdowns, it would temper the anticipated economic recovery in 4Q 2020 and in 2021.

The current uneven and weak economic and business conditions cannot withstand another “sudden stop” in activities due to a total lockdown.

With soft oil prices and domestic economic recession resulting in lower-than-expected federal revenue collection relative to higher expenditure and fiscal stimulus to fight the Covid-19 and blunt the deep economic fallout, pressure on the fiscal deficit and government’s direct debt (RM854.1bil or 53.2% of GDP at end-June 2020) has made the task much more difficult for the Finance Minister’s resolve in ensuring a steady and firmer economic recovery in 2021.

The federal government has already injected direct fiscal budget of an additional RM55bil or 3.7% of GDP pushing the budget deficit to GDP ratio to hit estimated between 6.0% and 6.5% this year, to arrest the sharp economic fallout inflicted by the pandemic crisis.

We expect the Finance Ministry to calibrate a targeted expansionary budget deficit estimated 5.5-6% of GDP in 2021, increase spending, provide selective tax relief and break as well as targeted incentives to support private domestic demand.

The healthcare sector will continue to be given higher budget allocation to support Health Ministry and other relevant ministries’ unwavering efforts in battling against the Covid-19. Confidence in the future path of virus development and the availability of vaccines is needed for a full recovery.

Fiscal prudence should give way to help revive demand even if the fiscal deficit is going to be much higher than anticipated.

Once growth revives, fiscal deficit can be managed in the coming years through the implementation of a credible and sound fiscal consolidation framework over the medium-term. A five-year Fiscal Stability Framework must be formulated to reset fiscal consolidation path. These include the rationalization and optimisation of operating and development expenditure, the broadening of revenue base, strengthening of tax efficiency, plugging the tax gap and shadow economy as well as containing both direct debt and contingent liabilities of the Federal Government.

This calls for the legislation of the Government Procurement Act and Fiscal Responsibility Act.

We believe that global rating agencies will give the government breathing space to fix the economy despite a temporary fiscal slippage as long as the government remains committed towards fiscal consolidation when the economy recovers.

The government had demonstrated a good past track record of fiscal consolidation during two distinctive periods:

> The painful fiscal structural adjustment measures undertaken in early 1980s had resulted in six consecutive years of budget surpluses ranging between 0.2% of GDP and 2.1% of GDP during 1992-1997; and

> In the aftermath of the 2008-09 Global Financial Crisis, the budget deficit ratio was brought down progressively for eight years in a row, from 6.5% in 2010 to 2.9% in 2017.

This is the first part of a two-part commentary. Lee Heng Guie is an economist. Views expressed here are his own.

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