Tuesday, September 3, 2013

Subsidy Rationalisation Rebooted

It’s about time (excerpt):

RON95 goes up by 20 sen

PUTRAJAYA: The price of RON95 petrol and diesel has been increased by 20 sen, as one of the measures to rationalise subsidies by the Government to reduce the country’s fiscal deficit.

Prime Minister Datuk Seri Najib Tun Razak announced the decision, saying that it would save the Government RM1.1bil from September to December this year and RM3.3bil annually.

Before the revision, the price for RON95 was RM1.90 per litre and RM1.80 for diesel. The [sic} price increase for RON95 was in 2010.

Let’s put this into perspective shall we?

That 20 sen cut in the subsidy is a 10% increase in the transportation fuel bill. But the petrol bill for the average Malaysian household is around just 9% of annual expenditure (actually 8.77%). The actual annual toll on household budgets is therefore just 1% per annum.

But of course, no household is “average” – mine certainly isn’t. The subsidy cut will disproportionately effect higher income households, not lower income households which spend a lot less on transportation (15.9% overall versus 12.3% for households earning less than RM3k per month). Strangely enough, rural households will also suffer more than urban households (slightly higher portion of transport costs).

To balance the distributional books even more, the annual savings from the 20sen subsidy cut is enough to almost double next year’s BR1M payout, which would more than compensate lower income households for the higher fuel burden.

This is almost precisely the kind of exit scenario I’ve been envisioning for petrol subsidies, though I would have been a bit more diligent about signalling the policy intent and timetable beforehand. Surprising the voting public is a bad idea, as the Government learned in 2008.

As to why cut and why now, average global crude oil prices jumped 5% in the last month alone, and are 15% higher over a year ago. That’s well above the average the government was planning for in this year’s budget – if the deficit target was to be met, something had to give.


  1. I was kinda waiting for your comment on the issues because I can't wrapped my head around the justification of fiscal deficit as argument for cutting subsidies provision.

    The argument is that by cutting subsidies we could save around RM 1.1b this year and a yearly around RM 3.3b which would perhaps be in effect next year. However, since the government decided to increase BR1M gradually to RM 1200. Suppose Starting next year they were to announce an increment of RM 250 of BR1M that would account of up to RM 1.xx billion. Not including additional budget allocation directed to the same group.

    It seems to me the spending slash itself would be negated by more spending. Yes it may help those of low income earner but it doesn't really contributing anything to fiscal deficit.

    1. @akubas86,

      Because the current subsidy for petrol and diesel are "blanket" subsidies, its skewed to higher income households. Overall, only 25% of government funds spent on social assistance actually goes to the bottom 20%. That's enormously wasteful.

      Cutting petrol subsidies and diverting them to only lower income households means you can effectively provide the same assistance, but at half the cost or less.

      I figure my wife and I are in the top 1% of income earners, yet because of the petrol subsidy, we're effectively getting RM400-RM500 a month from the government. That's public money that could be better used somewhere else.

      As for the deficit problem, the government is in a bind. I believe the current hike basically just keeps the status quo as far as the subsidy outlay is concerned, because of the recent increase in global oil prices. Otherwise, there would be no way to meet the 4% deficit target, because this year's budget was built on the assumption of an average oil price per barrel of around USD100. WTI is currently around USD107, Brent crude is even higher.

    2. I think why we cut other expenses that might not affect inflation because many studies stated that oil price is closely associated with inflation. increasing prices of goods will burden all the poor. Giving BR1M, does it benefit the poor. Households' debt is about more than 80% out of GDP. and doesn't it exaggerate. every policy should consider many aspects to ensure that everybody better off and nobody worse off yet there is no panacea for economic problems.

    3. Trying hard to see the glass both half-full as well as half-empty, here are some thoughts:
      1. While agreeing that blanket subsidies [are] skewed to higher income households, we shouldn’t forget that they are also the main contributors of the revenue that allows the Govt to provide for the subsidies in the first place. Having already ‘contributed’ (voluntarily or otherwise), they should be regarded as just as qualified as the ‘non-contributors’ when it comes to enjoying the social benefits. Since they’re now also precluded from the corollary ‘hand-outs’ – hey, that’s double-jeopardy!
      2. Cutting the subsidies to prevent abuse by non-qualified beneficiaries like those naughty Singaporeans & Thais who sneaked off with the odd litres (OK, much more than that) smacks of another excuse for poor enforcement – much like the police force blaming the increase in violent crimes on the abolition of the EO (which conveniently avoided the need to explain or even address the crux of the problem - their lack of success in solving crimes). That ‘leaked’ RON95 is probably only the tip of the ice-berg: the tons of ‘leaked’ subsidized diesel seems to be a problem everyone is well aware of but nobody has tried to solve – again, the issue of enforcement.
      3. There’s going to be at least one more double-whammy coming – when GST hits the price of petrol and everything else!

    4. @pohLam

      1. Income tax paid by individuals is just a little over 10% of government revenue.

      2. More efficient and cheaper not to have to enforce it at all.

      3. At this moment, it has not been decided whether GST will be levied on petrol. As for the rest, the impact will depend on the rate set. Some of the price changes might be surprising - at 5% GST, prices of cars for instance should drop 5%.

    5. 1. True, but a contribution is a contribution – as opposed to no contribution at all. Being denied the hand-outs is one thing, but being denied some ‘rebate’ in the form of subsidies must hurt doubly. And what rubs salt into the wound is that the hand-outs have been given the appearance of the largesse of the political entity rather than the Govt itself, as witness the venues of the hand-outs and the personalities doing the hand-outs.
      2. True again, but that’s bolting the stable doors after the event, then blaming the horse for running away and finally deciding not to keep horses anymore. Not a peep about the stable minders, or what to do with the stables, or (more significantly) all those dependent people up- and down-stream. That stands as a sad commentary on the approach: forget the structure, let’s do this -- because we can.
      3. ‘More efficient and cheaper not to have to enforce it at all.’ Well, when it comes to the GST, that won’t hold anymore.

    6. @pohLam

      1. Only the top 10% of the income distribution pays any tax. Surely you are not advocating that high income households should have subsidies?

      On the political slant taken with BR1M however, I fully agree. This is not a matter that should be politicised.

      2. I don't understand how your analogy fits the situation. Better enforcement doesn't solve the broader and more important wastage resulting from a blanket approach to subsidies.

      3. Not sure what you mean here either. GST is more efficient (less wastage and less leakage) than SST is. It's also more tax resistant.

    7. 1. Taxation of income is generally intended as a redistribution of wealth; hence there is social (albeit, grudging) acceptance of income tax. Having paid the tax, one should be entitled to the general benefits of being part of the society. Hence, the perception of double jeopardy.
      2. I'm not in any way suggesting that higher income households should have subsidies, and I agree with your view about blanket subsidies. But if the Govt chooses a policy of subsidies, then everyone should be given equitable treatment. Saying that they are withdrawing the subsidy of petrol and diesel but compensating the 'poor' by giving more handouts brings us back to square one: enforcement.
      2. One of the reasons stated by the Govt for raising the price of petrol was that the subsidized petrol was being purchased by people who were not entitled to do so, citing also that lots of diesel was being smuggled out.
      3. Avoidance and evasion of GST / VAT is a well-documented clear and present danger in other jurisdictions; unless there's skilled and stringent enforcement, there will be leakages.

    8. pohLam,

      1. Taxation of income is accepted for funding of public goods - education and security come to mind. These are goods that are beneficial to the whole of society, for which there are strong economic and social arguments. No such benefits accrue from energy subsidies, in fact just the opposite, and there are plenty of arguments against them. The consensus is that energy from fossil fuels should be taxed, not subsidised.

      2. I'm not going to pretend that social assistance programs (as in any government led program) will be devoid of leakages. Nevertheless, wastage here will be orders of magnitude less than what we currently have with blanket petrol and diesel subsidies.

      3. Diesel smuggling is a factor, but not that big of one. The overall cost-benefit of energy subsidies is of much greater importance.

      4. Funnily enough, I asked the GST implementation unit pretty much the same question recently - are you ready to tackle potential fraud? They are aware of the potential issues, and have been training their auditors in preparation. How much good that will do I cannot say.

      Having said that, VAT/GST is proven to be more resistant to tax evasion and fraud than the current sales tax structure.

    9. On enforcement: We shall have to wait and see, won't we?

      One of the benefits of being late adopters of GST/VAT is that we can learn from the experience of earlier implementers. But knowing is one thing, doing the right thing is quite another thing altogether. I'm inclined to be pessimistic, given the Govt's track record in respect of corruption, cronyism, et al.

      [One exception: The IRB has a pretty decent record (bias accordingly acknowledged) but then, they're not going to administer the GST.]

      Oh, there may yet be a glimmer of hope for the high income group: the much hinted reduction in personal income tax rates.

  2. Let’s put this into perspective shall we?

    If the price of RON97 is also raised, wouldn't the saving be more ?

    Then why only the poor (I assumed the rich do not used RON97) are affected and had to cut savings on other essentials like foods, childrens etc ?

    Smart thinking by the PR advisers ?

    1. As Mohamed says, there is no subsidy on RON97, not since November 2010

    2. I believe R97 price are no longer subsidized but are based on a managed float of International crude price...

      Why do the rich won't use R97...more importantly why would the poor wanted to use R97...

    3. What's the point of raising the price of RON97 instead of RON95? How many % of consumers actually use RON97?

      If RON95 price is kept at RM1.90 but RON97 is increased, then people will just switch to RON95. It is not that RON97 has fixed demand. More subsidies will then need to be paid by the Government due to the switch.

      "Smart thinking by the PR advisers?" I don't think so..

      BUT I think it is ok if the Govt want to introduce tax to RON97 (by increasing the price) together with the increase in RON95 price. Might help a bit to lessen the burden of overall subsidies.

    4. "Then why only the poor (I assumed the rich do not used RON97)" Typo error? You mean the rich do not use RON95?

      Who says? Even by UK standard, I am considered an "Elite" class but I will fill up my car with RON95. Why on earth would I want to unnecessarily spend more on petrol? That's how the rich gets richer you know. We don't spend on unnecessary stuffs.

      I'm ok with the increase of 20 sen. If it is up to me, I will remove all subsidies. It really irks me when I see people waste resources just because the prices are artificially cheap - water, electricity, petrol, cooking gas.

      It irks me more when I see foreigners queuing up enjoying our subsidies! Some even smuggle our subsidised items and make money out of it. Why should we taxpayers fund the criminals?

  3. FYI, RON97 is already being floated to market price by the Government. In the price of RON97 will be reviewed on monthly basis to reflect the actual market price.


  4. Hi, Hisham

    About comparing the price of petrol and diesel to per capita income for Malaysia and Singapore?

    Then one might be able to explain the queues of Singapore-registered vehicles filling up their tanks at petrol stations in Johor Bahru!

    Not just bread-and-butter vehicles, but Ferraris and Lambos, plus dime-a-dozen Audis, BeeEms and Mercs.

    On a more serious note, I wonder why it's taken the government so long to bite the bullet on the subsidies regime? The long-term viability of subsidies was always going to be an issue and a drag on government finances.

    Here, I must add that the Opposition is being both gormless and feckless in opposing the rationalisation of subsidies!

    Plugging the "leakages" is well and good. But that's something that should be done anyway.

    If we can't get it right on subsidies, then the whole issue of "fairness" goes out the window.

    1. Hi Jasper,

      Singapore and most other advanced economies sensibly tax petrol, and if I had any say in it, we would too.

      As for why the government took so long, we appear to have had an election a few months back :)

    2. We can have another alternative such as enforcement. We can't blame the government giving subsidies on petrol if foreigners come to use our subsidized oil. The owner of petrol station should be blamed. we should strictly enforce the law. giving stern punishment those who break the law will act as a deterrent.

  5. Well higher income household will be affected. But I believe the mostly affected will be the struggling urban middle income household. This is because they are the group that use as much fuel as the higher income and yet less affordable. No wonder we see why the current government failed to attract the urban and middle income voters because they are those who mostly affected by the government policies.

    1. Grand Marquis,

      Yes, middle income households are likely to be more affected, though strangely enough, many people who think they are "middle-income" are actually in the high income bracket.

    2. No thanks to the state of the public transport system in the country!

      The rich and famous have their limos (using subsidised fuel more often than not) and drivers while the less-privileged have to rely on abysmal public transport or bite the bullet and shoulder the overheads of having a car.

      Because they have little choice in the matter.

      The whole system of subsidies is out of whack, if you ask me.

      And human nature being what it is, it's always "gimme more". Take the "more" away and face retribution at the ballot box.

      No matter how sound the logic is for subsidies rationalisation.

      There's a lesson in this somewhere, but I am not sure that many Malaysians understand it.

  6. Annon 11:54,

    ..."(I assumed the rich do not used RON97)" i trust you meant RON95.

    Well i personally seen a lot of rich (who drives RM200k+ cars) buying RON95. The subsidy benefit the rich more than the poor as per IMF report highlighted in this blog some months ago, here is the link: http://www.imf.org/external/np/pp/eng/2013/012813.pdf

    I support this rationalization. This should also reduce the rampant leakage of subsidy fuel to surrounding countries.

    Hishamh thank you for the further explanation on the effect on the urban poor and rural poor.

    Zuo De

  7. Just this morning, the nasi lemak lady increased her price from rm1.20 to rm1.50! All because of the fuel price hike, she said. Wonder where she learned her costing? I did the next best thing, that is stayed away from her stall. My point is, how do we stop/control all this irresponsible hikes in other necessities? Advice pls.

    1. In my hawker centre. One lady increase her Teh O ais from Rm1 to Rm1.20 in just few days. People stop buying from her stall. Months later, she change back to Rm1. But its too late... Now she change her stall name to "Jangan tinggal daku".

      Tak percaya? Go to Laman at Menara Maybank.

    2. @anon5.57

      As ro says, if someone increases the price without sensible justification, don't buy i.e. you did the right thing. It's called voting with your wallet. The demand response will help mitigate profiteering to some degree, and enforcement will help as well, especially since the legal framework is now in place.

      I wouldn't call nasi lemak a necessity though. Personally, my family tends to pack breakfast most mornings anyway. It's not only cheaper, it's probably a heck of lot healthier too.

  8. deaf hishamh,

    one of hour so called economist and also a Dr(so ada PhD la kot) colleague in pa alif sin says that the 20 sen incfease will cause inflasi berganda.

    can ah?

    1. @anon 7.11

      It depends on what is meant by "inflasi berganda".

      If it means that the fuel price increase will cause a secondary increase in the prices of other goods and services, the answer is yes. If it means that the underlying rate of inflation itself will increase, the answer is no.

      See here for a more detailed discussion.

  9. Hi Hishamh,

    What is the definition of middle vs high income class for Malaysia? I would be interested to know the percentage of Malaysian per income bracket, e.g. below 12k pa, above 150k pa.


    1. @anon 10.33

      BTW, those figures are by household, so you should divide by 1.78 for individual income. You are in the middle income category as of 2012 if you are earning less than RM2,500 per month. The bottom 40% on average earn just over RM1,000 per month.

      Basically speaking, if you have a degree, work in an executive occupation, and pay income tax even minimally, you're already in the high income bracket.

      The latest household income data is available here.

    2. Hishamh,

      Poor degree holder consider a high income bracket. I think base on the multiply (of monthly salary) to owning a car, a house, a degree holder is so many time worse off compare to some developed countries.

      This surely need to be re-look at.

      Zuo De

    3. Hishamh,

      Thanks for the data. It is worst than I had thought. It is mind boggling that some of the richest states in Msia have the highest percentage of people living in poverty.

      Anon 10:33

  10. One thing puzzles me..

    Ron97 is rm2.70/litter.no subsidy and following market price
    Ron95 without subsidy is rm2.79. RM2.10+0.63

    how does that work exactly ya?

    1. @anon 1.52

      RON97 prices are governed by an "automatic pricing mechanism", so it's not exactly mark to market. The price is adjusted on a monthly basis, so if you're using RON97 enjoy the current price while it lasts because its going up at the end of this month.

  11. Hi Hisham

    I always think that cutting off subsidies is only a matter of time. But I really need is for the Government to give me the option i.e. sound public transportation system (and I mean, really improving the entire system including a more extensive scope, coverage, efficiency, integratedness and punctuality of it). At the current environment, People will just have to tolerate i.e. consume the normal quantity and paying at the more expensive price, which I personally think is not fair to the People.

    Take into account of the price push factor. Petrol expenditure may seem miniscule if we were just to calculate the petrol consumption over total expenditure, but to see the real impact to the People is to consider the 'would be' overall impact which inlcudes general increase in prices (your clothes and even nasi lemak) which will be caused by increased petrol cost. True, I may have some option of voting with my wallet, but that's not always the case isn't it?

    1. @anon 2.18

      That's what all the money spent on MRT and the LRT extension are for. But stuff like that takes time.

      However, I don't think people will just consume the "normal" quantity. There will be a demand response, the "voting with the wallet", not just in terms of cutting down on expenditure but a greater awareness of conservation and reducing wastage.

  12. Bro Hisham, from the GDP point of view, is this petrol hike going to help increase or lower the GDP ? All I can see is that the private consumption will be badly affected in the future, whats more with more measures such as GST to be introduced as well as expectation of rising imported foods and commodities prices in the last quarter this year. Not forget to mention the chained reaction from the petrol hike to other transportable goods.

    Im just worried the government is not reacting in the right way to overcome the fiscal deficit and merely acting under pressure from outlook comment form rating agency. The fact is that hot money is leaving the country because there is better alternative out there, higher yield in the US, not so much about the state of our economic, although there is some concern of our narrowing current account surplus. Yet, I doubt that the long term fdi has actually been affected.

    Most countries these days face fiscal deficit problem, including Singapore, its just that for us we are funding much of our deficit from foreign funds. Just want to ask your opinion of this, what if the investment from this outgoing hot money is replaced and absorbed by local institutional investors, such as EPF, Tabung Haji for example, can it work ? Afterall, this funds are investing oversea and contributing towards capital outflow.

    Because I think the government should focus on the underlying economic, how to boost export, and reduce spending etc rather than fulfilling the demand of this unreliable international rating agencies. I even heard the news that the government want to stop some of the ETP project, which is strange, as most of ETP project is private initiative and doesn't involve government spending.

    Please share your opinion, as Im not an economist, there probably something that Im missing. Thanks.

    1. @anon 10.31

      Whoah, that's a long laundry list of requests.

      One by one:

      1. The reduction in subsidy should be redistributive, not positive or negative. Consumers pay more for fuel, but buy less of other things - zero-sum. The government pays less for petrol subsidies, but offsets through cash transfers - again, zero-sum. The lag effects might be tricky though.

      2. Absolutely right on the current situation, though since it kickstarted subsidy rationalisation again, I won't complain about the motives.

      3. Technically we are not funding our fiscal deficit through foreign funds. Over 95% of government borrowing is domestic and in Ringgit terms. It's only that we allow foreigners to buy into the government securities market. There's a big difference.

      3a. As far as local funds are concerned, they do have the capacity to absorb any sell down by foreign investors. As of July 2013, total foreign holdings of government securities of all types totaled RM200b, of which 60% are in MGS, with the rest mainly in BNM Bills (which have tenures less than 12 months anyway). BNM says that most of these foreign holders are "official" i.e. foreign government funds or central banks who are unlikely to sell, because the investment motive is primarily diversification.

      For the rest, EPF is perennially below its legally mandated ratio of government securities holdings and the banking system has an excess domestic liquidity position of nearly RM270b and a net foreign asset position of RM36b (down from RM62b in January).

      MGS rates are up, but almost exclusively at the long end (up to 50bp since January), which means the selldown is affecting borrowing rates but domestic funds are picking up some of the slack. BTW, Tabung Haji is not a big player and can't invest in MGS because of the interest element, while PNB and Khazanah operate exclusively in equities.

      4. While most of the projects under the ETP are privately led, the big ticket items are all government related e.g. MRT, TRX and RAPID. Fitch specifically mentioned the increase in government guarantees as part of the reason why they changed their outlook to negative.

  13. Hey Hisham

    although we recognize that subsidy should be removed. the secondary price increase is really hard to swallow.

    take for example, this.

    a 20 sen subsidy removal contributed in pushing house prices up 10%. and there's 63 sen to go.

    that's excluding other goods' price increase. doubtful voting with the wallet and enforcement can solve this.

    it seems for subsidy removal to work, this current generation of Malaysians need to suffer.

    1. @anon 12.26

      Sounds like a load of BS to me. While oil has gone up, most other commodity prices have either stayed stable or declined. The worker shortage might be a factor, but then they shouldn't have been using illegals in the first place. It's more an excuse to pressure the government into letting them get away with higher prices.

  14. Hishamh,

    If Singapore and Japan can afford to have fiscal deficit even larger than us, why cant we do the same?

  15. Hi,

    Just wondering since Malaysia produce oil, can the government produce the oil for own consumption instead of influenced by global crude oil price?



    1. GP,

      1. The oil Malaysia produces is low in sulfur, what they call light "sweet" crude, which is highly valued. So it makes more sense for us to sell our more expensive oil, and buy the cheaper "sour" crude for our domestic use.

      2. Even assuming the above was not the case, it would make little difference to Govt finances. If we use domestic oil to produce petrol, it just means we forego the revenue we could have gotten from selling it.

      Petronas and other oil producers via income tax, royalties, and dividends contribute over 30% of Govt revenue. That would be gone if we use our oil for making local petrol.

      3. There's also the unfortunate fact that Malaysia is now a net oil importer i.e. we use more than we sell.

  16. Hishamh,

    Thanks for the reply!

    I'm assuming the revenue that Govt earned is more than the spending on fuel subsidy?

    It just doesn't make sense if the spending on fuel subsidy is more than Govt revenue from Petronas & etc. Might as well Petronas produce petrol for Msia own use at a controlled lower price and import more to meet the demand?

    1. guiping,

      Yes the revenue is greater. But the general consensus is that revenues from a depleting, finite natural resource should be "invested", not "consumed".

  17. Hi Hishamh,

    Great articles we have here!

    I think most people (at least people around me) are not happy with how money being spent in government offices (just have a look at any of our AG reports) more than the 20sen hike. If all the nonsense wastage at government offices were avoided, having a balanced budget is a no-issue while the savings from the subsidy rationalisation will be allocated to more productive areas.

    I doubt the BR1M will be sufficient for the lower income group (although i do agree that they do need help) as the hike will trigger higher inflation across almost everything. As evidence, few days after the Petrol Hike, the hawker center that i always go to increase the nasi/meehoon/mee goreng by 50sen. And walking away is not that easy as all hawkers did the same thing (sigh).