The subsidy dilemma

FOR years, subsidies have been the “steroids” for Malaysia’s private consumption, which contributed almost 59% to the national gross domestic product (GDP) in 2021.

With 50% of working Malaysians earning less than RM2,442 per month in 2019, even before Covid-19 struck, subsidies have been crucial in ensuring that the locals could afford basic necessities.

Subsidies have also largely sheltered Malaysians from great inflationary pressures. For example, headline inflation would have touched 11.4% in May, if it had not been for subsidies.

A minister also recently highlighted that Putrajaya will be subsidising about 54% for every litre of RON95 petrol sold over the next week.

In a tweet, Khairy Jamaluddin said the market price is RM4.52 per litre, but Malaysians are only paying a fraction of the price at RM2.05 per litre.

Without the interference by the government in controlling price pressures, many Malaysians would have been miserable financially.

Huge amount: Motorists are seen fuelling their cars at a petrol station in the peninsula. In 2022, Malaysia’s total subsidy bill is nearing RM80bil, the highest amount ever recorded, with the biggest chunk going to fuel subsidies.

The problem is, subsidies burn a big hole in the government’s finances.

The federal government’s budget deficit level is officially forecast at 6% for 2022, which means government revenue is unable to meet its expenditure.

However, Fitch Solutions recently said Malaysia is likely to see a higher deficit this year, estimated at 6.5% of GDP, amid heavy subsidies.

For the year 2022, Malaysia’s total subsidy bill is nearing RM80bil, the highest amount spent in the history of the country.

The biggest chunk of the amount comes from fuel subsidies, estimated at RM30bil this year. This is almost three-fold of what the government had spent in 2021, or to be exact, RM11bil.

It is also about six-fold of what the government had budgeted for fuel subsidies in 2022.

Malaysia is not alone in this case.

Worldwide, the global aggregate of government subsidies has been a rising trend since 2015 and more pronounced in 2020 following Covid-19 (see Chart).

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Quite fortunately for Malaysia, the higher subsidy bill has been manageable to an extent, considering that the country is also benefiting from the rally in commodity prices, namely, crude oil and crude palm oil (CPO).

Earlier in March this year, KAF Research estimated that for every US$1 (RM4.19) increase in the price of Brent-grade crude oil, the government’s revenue would increase by RM300mil.

However, the same increase will also raise the subsidy bill by RM440mil.

This translates to, according to KAF Research, “a net fiscal impact of minus RM140mil for every US$1 per barrel increase in oil prices, after subsidies kick in above the break-even point of US$55 (RM231) per barrel”.

By continuing to provide subsidies, especially via a blanket approach to all Malaysians regardless of their socioeconomic status, the government would be forced to make some compromises.

It is worth noting that subsidies can only be funded by tax and non-tax revenues, and not through borrowings.

This means the government would have to divert its cash meant for investments into major infrastructure projects or other development initiatives for the sake of sustaining subsidies.

Some ministries may have to take budget cuts in order to fund the rising subsidies. Less government spending would lead to lower growth as government expenditure makes up a big part of economic growth.

Dass: Phasing out subsidies has to be done gradually to ensure it does not impact the structure, sectoral performance and welfare of the economy.

Hence, the government has no choice but to scale back some of the subsidies in order to keep its coffers under control.

The subsidies for bottled cooking oil and chicken breeders have been removed effective July, with the government announcing direct cash transfers to qualified households.

Meanwhile, Finance Minister Tengku Datuk Seri Zafrul Aziz recently said that the government is currently testing targeted fuel subsidies.

The minister also said based on a study by Bank Negara, for every RM1 of fuel subsidy, 53 sen goes to the top 20% (T20) income earners, while only 15 sen is utilised by the bottom 40% (B40) group.

This is seen as a failure of a blanket subsidy mechanism, where the rich benefit more than deserving Malaysians.

Jason Loh Seong Wei, head of social, law and human research at EMIR Research, estimates that 30% to 35% of fuel subsidy beneficiaries currently are those who do not need the assistance, or the T20 and upper-M40 households.

As the government is working towards reducing the subsidy bill, one wonders whether the current administration is making the same mistake of past governments.

During his administration, Datuk Seri Najib Razak introduced the highly-unpopular goods and services tax and rationalised subsidies, even as headline inflation hit as high as 5.1% in March 2017.

This was done to bring the country’s fiscal deficit under better control, and while Najib’s efforts had begun to bear fruit with the deficit falling from 6.7% in 2009 to 3% in 2017, subsidy rationalisation raised the cost of living and led to the administration’s downfall in 2018.

Mixed views

Economists have mixed opinions on whether subsidies should be rationalised under current economic conditions.

EMIR’s Loh believes that the government should not embark on further subsidy rationalisation until the inflationary pressures have subsided and the economy is on a sustainable upside direction.

“To rationalise now in the short term would be premature and risks contributing to the cost-push inflationary pressure.

“Furthermore, subsidy rationalisation doesn’t deal with the demand-side of the equation.

“There’s no excess income or savings – financial buffers – that could be added to the pre-existing disposable income which in turn can be spent into the economy to generate inflationary pressures,” he says.

On the contrary, MARC Ratings Bhd chief economist Firdaos Rosli applauds the government for rationalising subsidies, as it reduces price distortion in the market.

Describing it as a “bold” move, Firdaos notes that Malaysia’s output gap is still negative despite a good pick-up in private consumption since early this year.

“That said, there are consequences to subsidy rationalisation in the present circumstances.

“Firstly, the urge to increase income support and price capping is higher to placate public grievances when household incomes have either dropped or hardly moved due to the pandemic.

“There is a tendency for demand-pull to be more prevalent due to the former, whereas the latter is only effective as a stop-gap measure and unsuitable for the long haul.

“As such, the government should clarify why this is a preferred policy option, assuming that the net effect of subsidy rationalisation is neutral on public finances,” he says.

Firdaos adds that it is unclear how subsidy targeting would affect the M40 households in states such as Selangor, Kuala Lumpur, Penang and Johor.

Therefore, he says that universal cash transfers (UCT) to households would have to be high enough to cover low-M40 households in these states.

Concurrently, it should also cover a significant percentage of households in low-income states such as Kelantan, Sabah and Sarawak.

“If the B40 and low-M40 are the target recipients, UCTs should cover at least four million households (or 8.6 million recipients) based on the latest Bantuan Keluarga Malaysia (BKM) tally,” according to him.

Currently, cash transfers by the government including in the form of BKM do not cover households earning above RM5,000 monthly, bachelors earnings above RM2,500 and single senior citizens earning more than RM5,000.

Based on the Statistics Department’s data as of 2019, B40 is categorised as those households earning below RM4,850 per month.

Almost all M40 households would not be covered under the cash transfer programmes, but considering that many such households are “borderline M40s” with kids and are domiciled in urban areas, they would be negatively affected by subsidy rationalisation.

AmBank Group’s chief economist Anthony Dass, while acknowledging that subsidy rationalisation is vital in the long run, says it must be based on the principles of minimising the burden to the people.

“Phasing out subsidies has to be done gradually to ensure it does not impact the structure, sectoral performance and welfare of the economy.

“Delaying the removal of subsidies will exacerbate disadvantages and reduce Malaysia’s competitiveness if market prices continue to rise.

“Tolerating delayed subsidy removal will only create more economic problems and the option recommended is to rationalise gradually to reap more efficient fuel utilisation and efficiency in the future,” he says.

Dass further adds that government subsidies are government payoffs aimed at keeping prices lower than the market value.

“While government subsidies can help certain favoured industries to gain additional business and help consumers to obtain products at lower prices, there are also many disadvantages of government subsidies that must be taken into account.

“The disadvantages are product shortages, difficulty to measure success, inefficient transfer to recipients, and higher taxes,” he says.

EMIR’s Loh, on the other hand, opines that subsidies do not necessarily distort the market, which according to him, is a common refrain of many economists.

Of monopolies and oligopolies

“What distorts the market are monopolies and oligopolies – market concentration of or by a few players – that contribute to the inflationary pressure because of the periodic (from time to time) or episodic (such as festive periods) price hikes and mark-ups.

“Subsidies, of course, can represent the bloated part of the national budget which puts pressure on public finances,” he says.

Loh says this can be mitigated by ensuring that the tax gap is narrowed and by having a dedicated Inflation Stabilisation Fund.

Under this idea, he says all the funds earmarked or allocated for subsidies, stockpiles and bulk purchases for buffer stocks to be sold at discounted prices or released into the market to bring down prices can be derived from a single source.

Having a single source has certain advantages as it would allow for the hypothecated deployment of taxpayers’ money.

Furthermore, the raising of taxes can be directly allocated to the fund, which will ensure that the revenue can be effectively deployed.

“When no longer in use due to the reversion to normality, the fund can be readily kept in reserve on its own or under the National Trust Fund (Kumpulan Wang Amanah Negara) where it can earn interest at Bank Negara or invested in financial assets and, thereby, accumulate capital.

“These top-ups – as self-generating – will ensure that less taxpayers money would need to be used in the future to supplement the fund,” he says.

Loh also adds that subsidies do work for industries as such strategic measures – as an integral aspect of industrial policy – allow them to be more competitive on the global front because the final prices can then be cheaper or lower than rivals.

Looking ahead, despite the political and public backlash, Malaysia seems to be headed for more subsidy rationalisation.

All eyes will be on RON95 and diesel, which collectively, consume the most subsidies.

It is unlikely that fuel subsidies will be entirely removed, although the price ceiling may be raised.

MARC’s Firdaos estimates that for every 1% increase in the RON95 price, the consumer price index (CPI) will increase by 0.08%.

“If RON95 is adjusted higher to RM2.15 (up by 10 sen), the CPI will be 0.38% higher than the baseline year-on-year (y-o-y).

“The CPI could have come in at 3.2% y-o-y instead of 2.8% y-o-y in May 2022 if RON95 is priced at RM2.15 per litre.

“Bear in mind that the estimate excludes the impact on CPI resulting from ongoing subsidy rationalisation and a higher price cap,” he says.