Thoughts On Budget Recalibration

Assume you have 20 marbles. I take 4 and borrow 1 from you, for a total of 5. I then give back 5 to you. How many marbles do you have?

Start with the same 20 marbles. I take 3 and borrow 1, then give back only 4. How many marbles do you have now?

If the first scenario was the original government budget for 2016, last week's budget "recalibration" is the second. In aggregate terms, the revised budget is fairly neutral. With no change to the deficit, either in absolute or relative terms, the impact on the economy should be muted.

That's the theory anyway.

The problem the government has is that the reduction in revenue comes very narrowly from one sector (oil & gas), but the cuts in operating and development expenditure affect everybody. In essence, we have an income transfer from the rest of the economy to oil & gas. How the economy responds to that would depend on the consumption and investment differences between the oil & gas sector and the economy at large. Since the oil & gas sector employs a relatively small number of well paid employees, with a lower marginal propensity to consume, my sense is that just maintaining the fiscal deficit ratio would be growth negative, not neutral. The drop in government expenditure would have a bigger negative impact on the economy, than the reduction in tax revenue on the oil & gas sector would be positive, even though the revenue and expenditure reduction are symmetrical.

Which leads us to the EPF contribution cut of 3%, which is intended to partially offset the drop in government flows to the rest of the economy. This isn't a perfect solution to the problem - we'll also get inter-sector transfer effects here, and then there's the dubious jeopardising of long term pension savings for a short term consumption boost. Moreover, because EPF members have the option of retaining the pre-existing contribution rate of 11% (and most of the feedback I've gotten suggest most would prefer to stay pat), the actual cash injection into the economy could be considerably less than the government's theoretical max estimate of RM8 billion.

There's also the income tax effect of reducing the contribution rate (given the maximum tax relief of RM6000 on EPF contributions) while quite a few have noted that there's also a boost to GST revenue from higher consumption. This leads us in turn to the additional tax relief of RM2000 for incomes below RM8000 a month, which is enough from my back-of-the-envelope calculations to neutralise the tax effect of the EPF cut for those earning below RM5000.

Nobody said policy making was easy. Touch one thing, and a whole bunch of dominoes drop.

On the whole, I'd still think the overall impact on the economy will be negative, albeit slightly given the mitigating meaures. The other measures announced are more in the nature of addressing cost of living and housing issues more comprehensively, as well as improving the government delivery system (I for one can personally endorse the efficiency and effectiveness of UTCs), and don't have much macro implications.

In any case, even this budget recalibration might be overtaken by external events. As of this writing, Brent crude has rebounded above $35 a barrel. The longer oil prices remain at these levels, more supply will be taken off the market and investment in new fields is increasingly being shelved. A move down to $20 a barrel is possible but not sustainable, especially since demand continues to increase, however weakly. I suspect the pressure on government finances this year won't be as acute as the government has assumed here.