Regaining fiscal space via subsidy rationalisation

AFTER months of speculation, and in its effort to get the ball rolling, the government finally floated the price of diesel in the market at RM3.35 per litre, a big 55.8% jump from the previously fixed price of RM2.15 per litre.

According to the Finance Ministry (MoF), the real intention is to generate savings from apparent smuggling activities and leakages, which cost the government more than RM14bil last year.

As the government is expected to continue providing concession to key economic sectors via a fleet card system as well as direct cash transfers to individuals, the real impact in terms of savings from the new diesel market price is expected to be minimal, as some 80% of diesel users are expected to continue to be subsidised.

As it is, the MoF may also be adding other transport operators impacted by the jump to ensure that there would not be an impact on the price of goods and services.

In addition, the new market price is only applicable to Peninsular Malaysia, while the regions of Sabah, Sarawak and the Federal Territory of Labuan will continue to enjoy the subsidised price of RM2.15 per litre.

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Based on the information provided by the government, the floating of diesel price to reflect the current market price will save the government some RM4bil annually.

These savings in return are expected to be redistributed to lower income groups in the form of cash transfers as well to fund the recently announced salary increase for civil servants.

Real savings?

The question one would ask the government is where is the real savings from the subsidy rationalisation move?

How would it impact Malaysia’s effort to reduce the budget deficit, which is expected to hit 4.3% this year?

As it is, while we had spent some RM14bil subsidising diesel, the bigger subsidy burden that Malaysia carries is certainly on RON95 petrol, which is another RM45bil thereabouts or approximately 2.3% of gross domestic product (GDP).

Taken together, Malaysia spends approximately RM60bil a year in providing fuel subsidies, which is almost two-thirds of the expected budget deficit level this year.

While much of the savings will be derived from a reduction in leakages or smuggling activities, the current market price of diesel at RM3.35 per litre is still not good enough as it provides an opportunity for smugglers to continue their ways to take advantage of higher diesel prices that are sold in neighbouring countries, especially in Indonesia and Thailand.

As it is, as the Borneo states are still adopting the full subsidised price of RM2.15 per litre, the current market price in Indonesia, which is equivalent to RM4.44 per litre, is more than double the price in these Borneo states, and hence, smuggling activities are likely to remain unabated if enforcement is lacking.

Up north in Thailand, the current diesel price is approximately RM4.23 per litre and based on the current market price in Malaysia, there is still an opportunity for smugglers to continue their activities as there is still money to be made from the price discrepancies.

Too cheap

Before the move to float the diesel price early this week, Malaysia’s price was the 10th cheapest in the world. With the jump to RM3.35 per litre or 71 US cents per litre, we are now the 21st cheapest.

Minus Singapore and Brunei, Malaysia’s new diesel price is approximately 25% cheaper than the average price of RM4.49 per litre in the region and to reach the current average price, the true price of diesel should be at least 34% or RM1.15 per litre higher at RM4.50.

This RM1.15 per litre increase in actual fact translates to a tax on the fuel, which will directly go to the government’s coffers – a practice that is a norm globally.

Another way to measure how cheap diesel is in Malaysia is to look at the Purchasing Power Parity (PPP) measurement which will take away the direct price comparison and measure the exact unit of money needed to purchase diesel.

Based on data converted from a PPP table and the current diesel price, Malaysia remains relatively inexpensive when it comes to diesel prices in other Asean countries.

Hence, even when converted to PPP, the regional market price is between 28% and 41% higher than in Malaysia.

Interestingly, diesel is really expensive when measured on a PPP basis in countries like Myanmar and Laos, while in the rest of Asean, even if we were to incorporate Singapore, the market price is approximately RM4.28 to RM4.74 per litre.

What next?

Two things – one is, of course, will the monthly cash handout of RM200 paid to 30,000 individuals be a static figure or will it be adjusted depending on the market price?

Two, addressing the elephant in the room – removing the subsidy for RON95. Will the government take a similar approach as how it has done for diesel?

Now that there is a mechanism for cash transfers for individuals who are impacted by the removal of diesel subsidy, will RON95 private vehicles enjoy the same RM200 monthly handouts?

How about those using motorcycles? Will they be exempted from paying the market price? Will Borneo states again be exempted?

Subsidy rationalisation is key to government reform efforts and it must be carried out for us to regain back our fiscal space.

This will enable us to not only contain the growth of federal government debt but at the same time to stay on course to achieve our targeted budget deficit target of 3% soonest possible.

Based on 25 billion litres of RON95 consumed annually, every 10 sen change in the market price enables the government to improve its revenue by RM2.5bil, which in return reduces the government budget deficit by approximately 0.13 percentage points. This is on the assumption that there is no cash back to consumers, especially the lower-income group.

Assuming RON95 is priced at RM3.25 per litre today, which is RM1.20 higher than the current market price and a similar absolute price increase as we have seen in the price of diesel, the government will save approximately RM30bil per annum in subsidy alone.

If 60% of the savings are returned to the lower income group, the RM12bil direct savings will improve the government’s budget deficit by 0.6 percentage points to 3.7% from 4.3%.

Certainly, this is doable and positive for Malaysia. Regaining fiscal space via subsidy rationalisation is a positive step for Malaysia.

Pankaj C. Kumar is a long-time investment analyst. The views expressed here are the writer’s own.