Friday, January 16, 2015

2015 Budget “Restructuring”

A quick note on this (excerpt):

Budget 2015 review

PETALING JAYA: Budget 2015 is to be re-examined, with spending cuts likely to be made in the face of plummeting global oil prices.

Prime Minister Datuk Seri Najib Razak said there was a possibility that the budget tabled last Oct 10 would be restructured.

He told reporters that a statement on this restructuring would be issued next week.

Critics noted that the country’s Budget 2015 totalling RM273.9bil has become increasingly untenable as global oil prices drop below US$50 a barrel.

Budget 2015’s projected revenue was based on global oil prices of US$100 to US$105 and increased tax revenues. Since late June, prices of both US West Texas Intermediate (WTI) and the global Brent crude benchmarks have more than halved on a combination of a supply glut and softening demand stemming from the uncertain global recovery.

Fitch Ratings said in a report on Monday that sustained weak crude oil prices in the international market could threaten to delay, or even derail, the Government’s fiscal consolidation efforts….

What I hear was that this was supposed to have come out a couple of weeks earlier, but got postponed due to the PM catching e. coli while visiting the flood zones. We’ll be hearing the details next Tuesday, with a dialogue session planned for the week after.

In any case, my take on this is that it makes fiscal and financial sense. With the pressure on markets and the Ringgit, on top of the news about 1MDB, restructuring the budget by cutting expenditure is the sensible thing to do to support investor confidence.

That’s the kindest thing I can say, because it makes no sense at all from an economics perspective.

Given the drop in oil & gas export revenues and the cuts that have and will probably be announced in O&G capex spending, simultaneously cutting government expenditure to conform to the drop in revenues virtually guarantees slower growth. I hadn’t been inclined to cut my growth forecast for this year, but now it looks inevitable.

Worse, slower growth means government revenue will also be even lower than expected. The lessons of the Eurozone crisis and fiscal austerity programs aren’t being heeded. Trying to maintain fiscal consolidation in the face of slowing growth is nothing but a painful race to the bottom. Now the burden of maintaining the economy’s growth path has been tossed back to BNM, who don’t seem inclined to reverse last year’s rate hike given the concerns over still high household debt.

Of course, we’re talking about marginal changes here, which shouldn’t be too negative for growth. The cuts required to keep to the 3.0% deficit target aren’t, in the grand scheme of things, very big. Nevertheless, this would not have been my preferred policy solution mix. I would’ve kept government spending as planned, fiscal deficit be damned.

And Fitch? I hear the kite flying is pretty good in Greece this year.


  1. If only the rating agencies and fund managers shared your optimism, Hisham!

    I especially like your comment "fiscal deficit be damned".

    It would be churlish to tag you as being "fiscally irresponsible", but are you dismissing the adverse effects of a plunging Ringgit, reduced revenue from oil and gas exports, Petronas' reducing of capex and opex and the negative impact on the terms of trade?

    1. @anon 7.18

      The "plunging" Ringgit is actually positive, and strangely enough the latest trade data (November) shows the terms of trade for oil & gas actually going up.

      From a macro stability point of view, the impact of reduced export revenue and reduction in domestic demand should be met by increased government expenditure and borrowing. I'm not dismissing these, just prescribing the correct policy response.

  2. The cuts will happen, from what I gather. But what will be cut? Hopefully not the infrastructure or other development projects that may help fuel our way out of this mess. But I won't keep my hopes up.

  3. Anon @ 7:18, what adverse effects are you referring to??

    Zuo De.

    1. A possible "double miss" of targets - fiscal deficit possibly exceeding 5 per cent and GDP growth projections for 2015 going as low as 4.5 per cent with "downside risks".

      BOA Merrill Lynch economist Chua Hak Bin: "Malaysia needs to wake up to this reality check, but it doesn't seem to have occurred".

      The oil and gas sector accounts for 10 per cent of the Malaysian economy. This is before factoring supporting services. It is almost a given that Petronas and the other oil companies operating in Malaysia will be cutting their capex and opex, with a consequent impact on the O&G sector.

      BOA Merrill Lynch has warned that the worst is yet to come. Malaysia exports far more gas than oil and gas prices track oil prices with a six-month lag. If gas prices fall precipitously, those buyers who have inked long-term supply contracts will push for those contracts to be renegotiated or arbitrated downwards.

      The 2015 Budget tabled in October 2014 was based on an oil price of US$105. In it's economic planning, did the government rely on this oil price to work out expected revenues?

      Nurhisham Hussein, an economist with the EPF wrote recently that "the nation's net export of oil and gas and reliance on palm oil without mature downstream activity led to "uncomfortably high" exposure to price fluctuations of these primary commodities.

      He wrote: "If Malaysia doesn't...limit its vulnerability to lower commodity prices, it may find 2015 marks the start of a much more difficult economic story."

    2. @anon2.58

      Hah! Throwing my own words back at me. I was actually referring to medium term risks over the next decade, not short term risks for 2015. I really don't see the deficit rising much (most estimates point to fractions of a percent, not a full 2%), and the impact on real growth will be perhaps 0.5%. Nominal GDP is another story.

      The big risk factor is really the potential of American natural gas exports, as oil is not really what brings in the revenue for Malaysia. The Americans are building up their export capacity, but it will be a few years before they become a true competitive threat. So we have some time to restructure before that happens. But it's crucial that we do.

  4. And so what so bad about the "double miss".

    Life has to go on in Malaysia. Malaysian has to eat.

    And who are these "investor". Real (brick and mortar) or just "financial hedge fund" investors. I believe real investors would not care much about the "double miss.

    As Hishamh said, fiscal deficit be damn.

    Zuo De

    1. You seem to be very optimistic.

      Have you thought about the consequences if US interest rates go up and funds are pulled out of emerging markets as a consequence?

      It may be insignificant for the equities market, but for foreign investors who hold Malaysian bonds and MGS paper, what's to prevent them from dumping their holdings?

      Will local institutions be tapped as the buyers of last resort?

      You seem to be sanguine that "real investors" will continue to invest in Malaysia? Why should they of the region is their oyster and if Malaysia offers them no compelling value proposition?

      As it is, the restructuring of the Malaysian economy up the value curve is way overdue.

    2. @anon 10.16

      Actually, from the feedback I've gotten, it's the equity investors that are pulling out. Bond investors are staying put. If they follow standard practice, fixed income investors are partially or fully hedged, so currency movements aren't a big concern. The bid to cover ratio in the last couple of government auctions certainly suggests foreign bond investors aren't really worried. I had a breakfast meeting with an HK economist this morning - he didn't think bond investors would pull out either. The yield differential is too great. Also, interest rate hikes in the US are almost fully priced into the market already.

      As far as local institutions as buyers of last resort, I can tell you from my own knowledge the answer is no. But they'll go in when prices make sense to them, which in itself would cap any market decline. What the current decline in the markets have achieved is to take Malaysia's equity and bond markets from ridiculously over-priced to merely expensive.

  5. The MGS (Malaysian Government Securities) 10 years yield is 3.9% (Jan 16); 4.14 (Jan 9). USGovt Bond 10 years yield 1.84% (Jan 16). MGS has a premium of 2.06%. Now tell me why would anyone just want to sell MGS for USGB just based on an opinion (only) that FED will increase interest. Assuming it actually come to pass, and what would the increase be? 2.06%? 3%, 5%. I have an opinion, it will probably be at most 0.5%. So sell MGS for that 0.5%??? And not forgetting the exchange loss??? As a rational person, I would sell USD and buy RM to get MGS yield, no? Ah you will said MG may default. Again that is an opinion. I also have an opinion, the probability of USG defaulting is much higher than MG as now Congress and Senate is under Republican and President is Democrat and he has a veto power.

    Real investors will look at infrastructure of a country - ease of getting material in and finished product out. Telecommunication to talk to the rest of the world to ensure products are made to order, educated labour forces, tangible stuff, etc rather than opinion on double miss.

    And finally Malaysian, ordinary Malaysian needs is paramount to Fitch, Moody and other foreign rating agencies, be damn, fiscal deficit BE DAMN.

    Another opinion to close - 6 months from now, booming economy -

    Have a nice day all.

    Zuo De

    1. It boggles the mind. Your latest post, that is.

      Ask any fixed income boss in local or foreign banks why MGS has to have a better interest rate than US Treasuries. It is because the issuers of MGS have to offer a premium to sell their paper. If they didn't, investors would park their funds in ultra safe US Treasuries, SGS or Swiss paper.

      And why would a foreign bonds buyer want to accumulate Ringgit when the local currency is on a downward path against the USD, GBP and SGD? To buy Malaysian fixed assets? To do M&A plays in Malaysia?


      I like your point about "real investors". But you didn't answer the question - what is Malaysia's compelling value proposition for "real investors"? Educated workforce? State-of-the-art infrastructure? Minimum red tape and government bureaucracy? Safety and security? An environment that welcomes foreign talent? A big domestic market? Etc etc.

      If securing investments from "real investors" from outside Malaysia is an easypeasy cakewalk, then Mida and Miti wouldn't be sweating their pants off chasing after FDI!

      Or perhaps that thought didn't cross your mind?

    2. Settle down boys.

      1. Actually, the interest rate differential between the US and Malaysia tends to fluctuate between +2% to -2%.

      2. As I stated in my previous comment above, most fixed income investors are at least partially hedged, so currency movements are not really a big factor.

      3. Most also have mandates based on benchmark indices. As one of the biggest bond markets in Asia, like it or not, most of these investors are here to stay.

      You can also not discount the role of the "official" sector, which is BNM's euphemism for other central banks. They're here for the same reason BNM has a diversified reserve portfolio - to cover liquidity and settlement requirements.