GST, Exports, and the Ringgit

This is something I had to explain a few times as well over the past couple of weeks, so again, committing this to writing.

The Pakatan Harapan manifesto promises to abolish the Goods and Services Tax (GST) and bring back the old Sales and Services Tax (SST). Analysts expect this (along with the other spending plans in the manifesto) to result in a sell down of the stock market, and a drop in the Ringgit. Contrary what people may think, this has nothing to do with “investor sentiment”. There are fundamental reasons for thinking this will happen, though I’ll only touch on the SST/GST effect.

To understand the impact, first understand the difference between the two systems:

1. GST is a consumption tax that is levied on the consumer. It is paid at point of sale, and businesses along the supply chain can reclaim from the government any GST they might have paid;
2. SST is also a consumption tax, but it is levied on the producer and paid at factory level. Ultimately, SST is also paid by the consumer, but businesses recover the tax paid through higher prices for consumers.

The immediate difference is obvious – GST is upfront and transparent to the consumer, while SST (or at least the Sales tax part of it) is not.

But there’s also another significant difference. Since GST is in principle charged on consumption inside a country, it is not charged and not enforceable outside a country. That means we must pay GST on imports, but exports are unencumbered. That’s not true of SST, where producers retain the tax liability regardless of whether products and services are consumed domestically or exported.

In other words, the replacement of GST with SST is a de facto tax on exports, which increases their cost and reduces demand. All things equal, this reduces export receipts, which in turn causes a down rating of the stock market (reduced earnings for exporters and export related sectors), an outflow of portfolio capital, and downward pressure on the Ringgit (from both capital outflow and lower export receipts). Economic growth will be a little slower as well.

In practice, since neither the rates nor the (positive) schedule of the goods falling under the Sales tax have been disclosed, there is a further level of uncertainty over which sectors will be impacted, though the likelihood is that it would be similar to the old rates and schedule. Regardless, that extra layer of uncertainty will cause financial markets to overshoot, even if the fundamental effect is relatively smaller.

I actually don’t think the final effect would be very big (maybe a 2%-3% depreciation in the Ringgit exchange rate), but the markets will adjust and overshoot, and it will be for policy uncertainty and fundamental reasons, not “investor sentiment” and certainly not “investor confidence”.