This article first appeared in The Edge Malaysia Weekly, on January 18 - 24, 2016

THE new year has barely begun and already crude oil prices have slumped to a low of US$29.75 per barrel, proving the soothsayers right. And this is despite tensions in oil-rich Saudi Arabia and Iran escalating.

Fortunately, the government has been quick to react to the situation this time around. Prime Minister Datuk Seri Najib Razak has announced that Budget 2016 will be recalibrated to reflect the current economic climate. According to Treasury Secretary-General Tan Sri Mohd Irwan Serigar Abdullah, the revised budget will be unveiled on Jan 28.

It is also refreshing to hear that the government remains committed to maintaining the fiscal deficit target at 3.1% of GDP for 2016, although the global economic headwinds are blowing harder.

The government seems to be on thin ice and any wrong step would likely make economic issues even more challenging. Prudence in spending taxpayers’ money is of utmost importance but, realistically, how will the government trim the budget without jeopardising economic growth — which is already showing signs of slowing down — and at the same time meet the fiscal deficit target and ensure the well-being of the rakyat? It is a tall order, indeed.

Meanwhile, Petroliam Nasional Bhd (Petronas) is expecting crude oil prices to average US$30 per barrel this year, which is some US$18 per barrel below the Budget 2016 assumption of US$48 per barrel. Economists estimate the shortfall in oil revenue in Budget 2016 to be around RM5.4 billion, which they say is “manageable”.

The sensitivity of a decline in oil-related revenue, excluding Petronas’ dividends, amounts to RM300 million for every US$1 decline in oil prices, says United Overseas Bank (M) Bhd economist Julia Goh.

It is worth noting that the national oil company’s commitment to pay RM16 billion in dividends for 2016 has ensured a further decline in oil revenue. In fact, Petronas’ dividends will account for half of the potential total oil revenue collection this year.

RHB Research economist Peck Boon Soon opines that the government will seek other revenue sources to make up for the shortfall in oil revenue and an option is getting government-linked companies (GLCs) to dish out more dividends this year.

He acknowledges though that this may not be easy for the GLCs to do, given the bleak global economic outlook, and that they may have to tap their reserves. “Khazanah Nasional Bhd increased its dividend payout to the government by RM150 million for a total of RM1.05 billion last year from RM900 million previously despite making a smaller profit. There are other GLCs from which the government could seek a dividend increase. But this is definitely not a long-term solution,” he says.

According to another economist, there is a possibility that the government could raise the Goods and Services Tax (GST) that was implemented only nine months ago. His reasoning is that there is little room for the government to manoeuvre in terms of further expenditure cuts to meet the fiscal deficit target. He adds that 2017 might be a tricky year to raise GST, should the government choose to, given that it is closer to the election year in 2018. This makes this year a more likely time for a further tax hike.

Peck, however, thinks this is highly unlikely. “If we look at GST implementation around the world, it usually takes the government a few years before it can raise taxes again. On top of that, consumer spending will be severely impacted, given the current economic environment,” he says.

A point to note is that about 80% of the yearly budget expenses go to operating expenditure while development expenditure takes up the remaining 20%. Economists think the government will most likely continue to trim operating expenses, like it did last year when it revised Budget 2015.

Interestingly, there was no mention of cuts in development expenditure by the economists The Edge spoke to. It was a different story last year when they were sure that development expenditure would be trimmed first in order to meet the fiscal deficit target for 2015.

An economist with MIDF Investment Research opines that the government will most likely make slight cuts in the expenditure of the various ministries, especially for supply and services.

Peck says the cuts could likely be in procurement, which would see the government changing its spending habits. “If that happens, it is actually a positive for the country because the government would be cutting down on unnecessary expenses and making more efficient use of its resources.”

An economist who declines to be named says the cut in operating expenditure would probably be higher than in the revised 2015 budget, adding that subsidies might be trimmed further, although targeted subsidies like Bantuan Rakyat 1Malaysia (BR1M) will likely remain untouched. BR1M accounts for RM6 billion of the RM26.1 billion subsidy allocation for 2016.

Yet other economists feel there is really not much left to trim in terms of subsidies, given that the government has been deflating the ballooning subsidy budget over the last few years.

As much as the critics of the Najib administration like to voice their opinions, they cannot deny that the prime minister has bitten the bullet and done away with blanket subsidies for petrol, sugar and, very soon, cooking oil and flour. He also allowed the highway concessionaires, including the government-owned PLUS Malaysia Bhd, to raise toll rates instead of having to pay them compensation.

However, all this has resulted in the rakyat struggling to cope with the rising cost of living.

The rakyat are also aware that the largest expense under operating expenditure or one-third of it comprises “untouchable” emoluments. Many have urged the government to trim the civil service but that is easier said than done.

The idea of slashing expenditure might seem like a good idea but Peck points out that this has to be done with caution. Any expenditure cut will, inevitably, impact economic growth because fiscal spending becomes the key driver of a domestic economy when other growth engines, such as consumer spending and private investments, sputter.

While a potential loss in oil revenue is a serious challenge for Malaysia, economists believe the sluggish global economy should worry the administrators of this country much more.

The MIDF economist highlights that recent indicators suggest the global economy may be slower than anticipated. “If this were to happen, our economy will be slower than the government’s previous estimate and this would eventually affect government revenue, particularly its tax collection, and the GDP forecast. As our fiscal deficit is also dependent on our GDP, the fiscal deficit will increase if the economy grows slower than expected.”

UOB’s Goh concurs, saying the collection of other types of revenue, such as direct tax and indirect tax, could be affected. “I suppose the question now is how the global economy will fare if oil prices continue to drift below US$30 per barrel on a sustained basis. As deflationary risks become more entrenched globally with a further slide in oil prices combined with worsening sentiment and investments, then we could see further negative effects on a global scale. This would affect external demand and Malaysia’s growth. Thus, the other revenue components will also shift down.

“I believe keeping to a fiscal deficit target of 3.1% of GDP would no longer be the key objective at that point as growth risks take centre stage. The priority would shift towards managing the economy and the welfare of the people.”

It goes without saying that the government has an arduous task ahead of it. Luckily, it had the foresight to implement GST and subsidy rationalisation earlier on, however unpopular the moves were, which increased revenue and cut expenditure. Perhaps, the real test now is whether the government can plug the leakages in operating expenditure and step up its efficiency.

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