Download Malaysia`s budget-Nothing to rock the boat

Multi-asset
Malaysia – Economics, FX, Rates

Malaysia’s budget
 Budget 2016 projects very conservative
revenue and expenditure growth
Nothing to rock the boat
 Fiscal deficit to narrow marginally to
3.1%, although we see risks of slippage
 We look at the implications for
Economics, Rates, and FX
Prime Minister Najib Razak has unveiled his government’s
2016 budget proposal; the first budget in a series of five
under the 11th Malaysia Plan intended to transform Malaysia
into a high-income advanced economy. Describing it as a
budget for “Prospering the Rakyat” (or “Prospering the
People”), PM Najib said this and future budgets aimed to
strike a balance between the Capital Economy and People
Economy.
24 October 2015
Su Sian Lim
Economist
The Hongkong and Shanghai Banking Corporation Limited,
Singapore Branch
+65 6658 8783
[email protected]
André de Silva
Head of Global EM Rates Research
The Hongkong and Shanghai Banking Corporation Limited
+852 2822 2217
[email protected]
Major initiatives include MYR5.9bn of cash handouts for
low-income households, a hike in minimum wages, higher
income tax rates for high-income earners and various
investments across a number of industries.
GDP is expected to slow to 4%-5% in 2016 from an
estimated 4.5%-5.5% this year; the fiscal deficit is expected
to narrow to 3.1% of GDP next year from 3.2% in 2015, just
shy of the long-held 3% target.
This multi-asset report looks at the budget from the
perspective of economics, FX, and rates strategy.
Joey Chew
Asian FX Strategist
The Hongkong and Shanghai Banking Corporation Limited
+852 2996 6568
[email protected]
 Economics: We remain cautious on the fiscal outlook,
and see risks of slippage from current official
projections
Prerana Seth
Associate
Bangalore
 Rates: We remain bearish on Malaysian government
bonds
View HSBC Global Research at: http://www.research.hsbc.com
Issuer of report: The Hongkong and Shanghai Banking
Corporation Limited Singapore Branch
MICA (P) 073/06/2015
MICA (P) 136/02/2015
MICA (P) 041/01/2015
Disclaimer & Disclosures
This report must be read with the
disclosures and the analyst certifications
in the Disclosure appendix, and with the
Disclaimer, which forms part of it
 FX: The budget is likely neutral for the MYR. But we
believe it remains too early to position for a sustainable
recovery in the currency. We expect USD-MYR to head
higher, reaching 4.30 by end-2015 and 4.40 by end-2016
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24 October 2015
Economics: Beware of
slippage
 PM Najib has unveiled a 2016 budget deficit of 3.1% of GDP, just
shy of the long-held government target of 3.0%
 We continue to see risks of fiscal slippage, forecasting a 3.2% gap
on more conservative growth expectations
 Slower development expenditure in 2016 means less boost to
growth; in terms of revenues, there is now a significant, but
precarious, reliance on the Goods and Services Tax (GST)
No 3% deficit in 2016 after all
Unveiling his “Prospering the Rakyat” budget
(translated as “Prospering the People”), PM Najib
proposed a deficit of 3.1% of GDP for 2016
(MYR38.8bn), versus a projected 3.2% this year
(MYR37.2bn).
While this is not far off the government’s longheld deficit target of 3% of GDP, we were
somewhat disappointed, considering that the
target was supposed to have been met this year,
but was postponed in January owing to the slump
in global oil prices.
Highly conservative revenue
and expenditure projections…
To be sure, both revenue and expenditure
projections remained extremely conservative, as
has been the case in the last few budgets.
Revenues are projected to rise just 1.4% to
MYR225.7bn, from a mere 0.8% rise this year.
Meanwhile total expenditure is forecast to rise
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1.7% to MYR265.2bn, following a 0.6% gain
in 2015.
In our view, it is likely that both revenues and
expenditures will overshoot government
projections, in both 2015 and 2016.
Although the (real) economy is currently losing
momentum, the last time revenue growth fell
below 2% (to just 0.6%) was in 2010 – when the
economy was just emerging from the aftermath of
the Global Financial Crisis. Meanwhile, on the
expenditure side spending last saw significant
compression in 2013 (rising just 0.8%), when
Malaysia’s sovereign credit ratings first began to
come under pressure from rating agencies as the
public debt-to-GDP ratio looked in danger of
breaching the 55% statutory limit. By 2014,
spending had risen 2.4%.
Based on our expectations for nominal GDP
growth to pick up in 2016, and the view that
public spending – particularly on the operational
side – will be challenging to curb, we think
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24 October 2015
revenue growth could rise to 4.9% this year and
6.6% in 2016 (from 3.4% in 2014), while
expenditure could rise to 5.0% and 5.7%,
respectively (from 2.4% in 2014).
In net terms, however, our estimates still leave the
overall budget deficit larger than what the
government expects, at MYR39.5bn for 2015 and
MYR39.6bn for 2016, or 3.4% and 3.2% of GDP,
respectively.
… but very optimistic macro
assumptions
Oddly enough, despite the government’s highly
conservative revenue and expenditure projections,
the underlying macroeconomic assumptions for
2016 appeared rather sanguine. Real GDP growth
is projected to decelerate only a touch, from 4.55.5% this year to 4%-5% next year. While our
growth projection of 4.6% for this year sits within
the official forecast range, for 2016 we think real
activity could slow to 3.6%.
By industry, agricultural output is expected to
remain unchanged at 1.3%, while
mining/quarrying activity is forecast to accelerate
to 4.0%, from a projected 3.5% this year.
Manufacturing is expected to slow only a touch,
to 4.3% for 4.5%. Construction is forecast to slow
to 8.4% from 8.8%, while services growth is
expected to moderate to 5.4% from 5.7%.
On the expenditure side, the expectations are
similarly moderate. Private consumption growth
is pencilled in at 6.4% for 2016, versus 6.8% this
year. The slowdown in private investment is
expected to be a bit more material, at 6.7% versus
7.3% this year. Meanwhile, exports are predicted
to bounce 0.9%, versus -0.8% in 2015, while
imports are expected to accelerate to 1.5% from
0.8% this year.
Little bang for the buck
Risks are that Malaysia’s slowdown next year turns
out to be more significant than what the
government currently assumes. Amid the weakness
and volatility in the Malaysia ringgit, rate cuts to
prop up the economy are unlikely to be
forthcoming from Bank Negara Malaysia (BNM).
But today’s budget – quite predictably – also
underscored the fact the government, too, is
limited in what it can do to boost the economy via
fiscal policy, as it remains constrained by fiscal
and debt ratios. Following a 20% increase this
year (the first increment in five years),
development expenditure – the part of the budget
where the boost to economic growth really comes
from – is set to slow to a mere 5.4% in 2016, as
the government slows the tap on economic and
social services across the board. In fact, transport
as well as education services will see cuts in
spending, of 3.4% and 16.7%, respectively.
This casts a bit of a shadow over infrastructure
plans laid out by PM Najib, such as a MYR900m
effort to reduce congestion in the capital city of
Kuala Lumpur through a public-private
partnership, MYR1.4bn to build and upgrade
700km of rural roads nationwide, and a
continuation of negotiations with Singapore
regarding a high-speed rail between the two
countries. To be sure, a number of other LRT and
MRT projects also appear to be on track and will
start operating in various phases next year.
However, the outlays for these projects would
already have been made in prior years.
Meanwhile, it remains to be seen if on the
operational side the government can indeed stick
to its projection for a modest 0.9% rise, following
a 2.9% reduction this year. Although subsidy
spending will remain fairly flat following reforms
this year (-0.5% versus -34% in 2015), civil
service salaries and pensions will rise a further
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24 October 2015
2% (from 3.2% this year), while debt service
charges will pick up to 9.3% from 7.9%.
Revenues relying heavily on
the GST
With real activity set to slow in the absence of
monetary easing, not much additional new fiscal
stimulus, and oil likely remaining in a slump (the
official assumption is that crude will average
USD50/bbl over 2016, versus USD55 this year),
where revenues are concerned the government now
appears significantly more reliant on the GST.
For 2016, GST collections are projected to surge
to MYR39bn, from MYR27bn this year (the tax
was introduced only in April). Interestingly, this
MYR12bn jump – a sizeable 1% of GDP – almost
offsets the projected decline in oil-related
revenues. According to PM Najib, the
contribution from state oil agency Petronas
(including its dividend) and other oil-related
activities will come to MYR31.7bn in 2016, from
MYR44bn this year – a MYR12.3bn drop.
Clearly, the GST has been a success in the context
of fiscal reform, with collections this year having
exceeded expectations (the original projection was
MYR21.7bn). However, the downward pressure
faced by oil-related revenues this year and the next
means that the government has to lean all the more
on the GST to pick up the slack. This is a
potentially precarious dependency, considering
that GST collections are also subject to the
economic cycle. Furthermore, as part of its plans
to ease the cost of living for Malaysians, in 2016
the government will increase the range of zerorated goods. The brands of medicine that will be
zero-rated will be doubled to 8,630 from 4,215;
various food items such as soybean-based milk
and organic-based milk for infants and children,
dhal, and mustard seeds will also be zero-rated.
Others who will be able to receive GST relief
include oil and gas companies or those in the
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promotion, research, or exhibition industry that are
re-importing certain types of equipment, as well as
consumers purchasing prepaid mobile services.
Other key takeaways
As expected, an area that the budget attempted to
address was the rising cost of living, which has
been cited as the foremost concern among
Malaysians. To that end, the government
increased its cash handouts for low-income
households (known as the 1Malaysia People’s
Aid, or BR1M) to MYR1,000 from MYR900.
Families with incomes between MYR3,001 and
MYR4,000 will also receive higher handouts,
with the BR1M assistance in total benefiting 4.7m
households to the tune of MYR5.9bn.
Minimum wages will also be raised from 1 July
2016, to MYR1,000 a month from MYR900
currently in Peninsula Malaysia, and to MYR920 in
Sabah and Sarawak. For civil servants, the minimum
starting salary will be raised to MYR1,200.
Conversely, high-income earners will be taxed
more. The taxable income band for the highest tax
rate was increased to 26% from 25%, for those
earning an income of between MYR600,000 and
MYR1m. For those earning above MYR1m, the
tax rate will increase to 28% from 25%.
Some serious money will also be poured into
various projects to boost investment, although we
expect multiplier effects from these to be apparent
only over the medium to long term. These include
an MYR18bn allocation next year for the Refinery
and Petrochemical Integrated Development
Project (RAPID) Complex in Pengerang, Johor;
the development of an airport township or KLIA
Aeropolis over 1,300 acres, which is expected to
attract an investment of MYR7bn; development of
the Malaysian Vision Valley over 108,000
hectares between Nilai and Port Dickson as
announced in the 11th Malaysia Plan, with an
initial investment of MYR5bn next year; and
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implementation of Cyber City Centre in
Cyberjaya with a development cost of almost
MYR11bn over a period of five years.
hikes and the list of sizeable investment projects
potentially seen as providing weakening domestic
demand a much-needed boost.
Meanwhile, sovereign wealth fund, Khazanah,
will also be investing MYR6.7bn in nine “highimpact” domestic projects, in sectors such as
healthcare, education, tourism, communication
software, and infrastructure.
But we have our doubts over how long any upturn
in sentiment can last. Admittedly, cash hand-outs
and wage hikes might provide some relief to
households in the short term. But there currently
exists a high level of precaution among consumers,
particularly with regards to the labour market
outlook – an area that the budget did not address.
Consequently, it is difficult to see the hand-outs
and wage hikes suddenly translating into
sustainably stronger private consumption. Higher
minimum wages will also be an additional burden
on firms, many of whom are already grappling with
excess capacity amid a fall-away in both external
and domestic demand, as well as rising import
costs (due to the ringgit’s weakness).
Tourism clearly remained a key pillar of the
economy, with PM Najib describing the sector as
having “the highest potential to generate
economic activities in the currency situation.” For
2016, the government targets 30.5m tourists,
which is expected to contribute MYR103bn to the
economy. For this, a sum of MYR1.2bn will be
allocated to the Ministry of Tourism and Culture.
Online visa applications will also be implemented
beginning with China, India, Myanmar, Nepal, Sri
Lanka, the US and Canada; by mid-2016, and EVisa will be implemented. To take advantage of
the current level of the ringgit and in efforts to
attract more tourists, the 100% income tax
exemption on statutory income for tour operators
will be extended from year of assessment 2016
until 2018.
Agriculture – and in particular food production –
also received a leg-up, with the Ministry of
Agriculture and Agro-based industry receiving a
MYR5.3bn allocation for 2016. This will go
towards programmes on cultivation, research,
agricultural infrastructure and food subsidies.
Furthermore, more companies in the food
production business will receive various tax
deductions and exemptions for investing in
subsidiaries, undertaking new food production, or
undertaking project expansion.
Meanwhile, from the fiscal angle this budget does
not “rock the boat” in any sense, and does just
enough to keep the ratings agencies at bay for
now. A 3.1% budget deficit to GDP ratio is not
great, but not terrible either – assuming the
government does indeed manage to achieve a
narrower gap of 3.2% this year as well.
Nevertheless, as we have highlighted, there
continues to be risk of fiscal slippage both for
2015 and 2016, given ongoing pressures on both
revenues and expenditure. Potentially overly
optimistic projections on items such as GST
collections and low operating expenditure leave
the government little room for error.
In conclusion
In the very near term, the budget may well
provide a fillip to Malaysian markets, with factors
such as the BR1M hand-outs, minimum wage
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Rates: Still bearish
 HSBC Rates Research stays bearish on government bonds as
risks of overshooting the fiscal deficit target still remain
 Net bond supply is projected to rise; government bond curve is
likely to steepen
 Stay paid 5yr MYR ND IRS due to the political uncertainty and
prospect of further ringgit weakness
HSBC Rates Research retains a bearish stance on
Malaysia bonds as risks of overshooting the fiscal
deficit target still remain given the reliance on tax
revenues. Further, we note that there is a
possibility that the Budget may not be passed in
parliament due to domestic political developments
(Malaysia Chronicle, 19 October). Continued
political uncertainty and concerns over reserves
adequacy are likely to linger, impacting the
outlook for government bonds.
Net bond supply to rise in
2016; curve likely to steepen
Based on 2016 budget estimates, gross issuance is
expected to slightly shrink to MYR87bn, down
from the targeted issuance of MYR90.5bn in
2015. This is mainly due to lower bond
redemptions in 2016. However, net bond supply is
projected to rise from an estimated MYR37bn in
2015 to MYR39bn in 2016. The complete auction
calendar for 2016 is not due until December 2015.
Based on the maturity profile of the government
bonds and the issuance trend seen over the past
three years, the proportion of long-dated issuance
(7yr and above maturity) is expected to rise
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further in 2016, adding to a steepening bias of the
MGS curve.
There are five more auctions for the rest of 2015.
The Ministry of Finance has raised MYR77bn via
government bonds year to date. Fiscal revenues
have improved this year and as such, the size of
upcoming auctions could be smaller than average,
resulting in a slightly lower-than-expected gross
issuance of MYR90.5bn (versus our original
estimate of MYR94bn) in 2015. The bias for
short-dated bonds is likely to remain as three out
of the five remaining bond auctions are for
longer-dated tenor bonds.
Foreign liquidation could continue due to
currency weakness but it is unlikely to be as large
as before as there are no bond redemptions
scheduled in the last quarter of the year. The next
MGS redemption is not due until July 2016.
Onshore investors have also been providing
decent support at the government bond auctions.
This is evident from the average bid-to-cover
ratios this year that are almost the same as last
year and higher than in 2013. Based on the
quarterly disclosure, the Employee Provident
Fund's holdings of Malaysian government bonds
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24 October 2015
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(Malaysian Government Securities and
Government Investment Issue) jumped by
MYR12.5bn in the first half of the 2015, taking
their share of total government bond holdings
from 22.3% in 2014 to 23.2% in June 2015.
Stay paid MYR 5yr ND IRS
Post FOMC, there has been a downward
retracement in MYR swap rates, tracking the
decline in EM rates. Given the potential for
further ringgit weakness, this relief rally in MYR
swap rates is unsustainable unless the central bank
eases monetary policy. However, judging from
the central bank’ activity in the money market, a
rate cut does not seem likely at this juncture. After
reducing the supply of short-dated instruments in
the first seven months of the year, the BNM restarted issuing central bank bills from August. As
a result, the overall outstanding of central bank
bills (BNMNs) rose in September, for the first
time since November 2014, by MYR7.5bn. This
is likely done to sterilize the ringgit liquidity
added via the central bank's foreign exchange
intervention. Nonetheless, the decision to sterilise
underscores a preference to keep domestic interest
rates stable. Furthermore, the 3-month interbank
rate has edged slightly higher from 3.69% on 21
August 2015 to 3.74% currently. Surprisingly, the
central bank has not been issuing more longerdated reverse repos to reverse this upward
movement. This is in contrast to their behaviour in
the beginning of the year. We therefore believe
that the BNM is comfortable with current ringgit
liquidity conditions and is unlikely to pursue a
more accommodative stance for the time being.
As such, we maintain our preference to pay 5yr
MYR NDIRS with a target of 5% due to the
political uncertainty and prospect of further
ringgit weakness.
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MYR: Still on probation
 The 2016 Budget is probably neutral for the MYR
 But it remains premature to position for a sustainable recovery in
the currency
 The requisites for such a recovery have not yet been fulfilled
The 2016 Budget is probably neutral for the
MYR, in our view. Policymakers may have
mitigated the fiscal impact of lower oil prices with
timely subsidy cuts and rollout of GST earlier in
the year, but these do not address the longer-term
growth prospects in the resource-rich economy.
There are also implementation risks in the budget
and 11MP investment plans given rising political
uncertainty, as reflected in the sharp widening of
Malaysia's CDS spreads since July (Chart 1).
The MYR has rebounded by 4% since 2 October,
among the outperformers in EM FX. Equity
inflows have resumed for the first time in many
months amid a pick-up in global risk sentiment
(Chart 2). Some investors are also now taking
note of the regional outperformance by Malaysia's
non-commodity exports, helped by MYR
undervaluation (Chart 3).
8
But we believe it may be pre-mature to position
for a sustainable recovery in this currency just yet.
Three conditions are necessary for that: 1) an
improvement in the commodity price outlook and
global growth conditions; 2) a decline in political
uncertainty; and 3) more normal liquidity and
trading conditions in the onshore and offshore
NDF markets (Chart 4; see MYR: Tough
questions, 9 September 2015). Political concerns
could also rise in the coming weeks – there are
media reports of a potential no-confidence vote on
the Prime Minister and/or this budget in
Parliament (The Star, 22 October).
1. Political uncertainty has weighed on the MYR
2. The external backdrop has turned more positive
Source: Bloomberg, HSBC
Source: Bloomberg, HSBC
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3. Malaysia's non-commodity exports are doing fine
4. MYR rebounds amid low trading volumes
Source: CEIC, HSBC
Source: Bloomberg, HSBC
The turnaround in the MYR is unlikely to be
decisive and significant at the initial stages, in any
case. BNM is intent on rebuilding FX reserves
when the opportunity arises again, which would be
prudent, in our view. Our year-end forecasts for
USD-MYR are 4.30 for 2015 and 4.40 for 2016.
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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the
opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their
personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: Su Sian Lim, Andre de Silva and Joey Chew
Important Disclosures
This document has been prepared and is being distributed by the Research Department of HSBC and is intended solely for the
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without the prior written permission of The Hongkong and Shanghai Banking Corporation Limited Singapore Branch. MICA (P) 073/06/2015 , MICA (P)
136/02/2015 and MICA (P) 041/01/2015
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