Posted Date: October 27, 2021

On August 31, 2021, the government unveiled its maiden Pre-Budget Statement (PBS) aimed at offering greater fiscal formulation transparency. In the document, the Ministry of Finance (MOF) noted that Budget 2022 would comprise the following themes: i) protecting lives and driving the recovery of livelihoods; ii) rebuilding economic resilience; and iii) catalysing socio-economic reforms. We think these themes are apt in light of recent developments.

The PBS noted that while expenditure for the year until July 2021 had taken up to 59.1% of the total budgeted, revenue collection had come in lower than expected (direct tax: 56.2%; indirect tax: 59.0%). The fiscal performance has certainly reflected the impact of the different iterations of the movement control order (MCO), which took up at least seven months this year. The different pace at which states moved from one phase of the National Recovery Plan (NRP) to another — e.g. it took the Klang Valley only about a month to move from Phase 2 to the final phase (Phase 4) of the NRP — suggests the balancing act involved in managing the progress of economic reopening and impact of the lockdowns.

Despite rapid economic reopening, the unemployment rate remained high (August: 4.6%) with the jobless rate among workers aged 15-30 years inching further upwards to 8.8% from 8.5% in July. Given this, it is not surprising that demand deficiency remains an issue. Inflation has fallen from its year-high of 4.68% in April 2021 to above 2% in July 2021 where it has remained since. However, prices of many food items remain high.

While international financial institutions have upgraded the outlook of many global economies in recent months, challenges in the coming year may dilute Malaysia's efforts towards recovery. Malaysia's major trading partners, China in particular, continue to face economic headwinds including yet another wave of COVID-19 infections, among other things. The ongoing energy crisis has pushed China's purchaser's price index to a decade-high of 114.2 points. At the time of writing, Singapore is also experiencing rising COVID-19 cases. International tourism remains subdued. Furthermore, persistent inflation appears to be a common theme in many global economies as supply continues to play catch up with demand amid high oil prices. Against this backdrop, we believe that the Budget 2022 formulation process has become more complicated.

We foresee Budget 2022's fiscal stance to remain strongly expansive, with government spending presumed to be further escalated. Recovery prospects appear to be difficult particularly due to an anaemic labour market, among other things. Observing the uncertainties surrounding the pandemic, we see that this scenario would constrain household spending and potentially subdue private investment. As such, Malaysia's gross domestic product (GDP) may be expected to remain well below pre-pandemic levels until mid-2022. Hence, further fiscal support, with broader and stronger measures, will be necessary to mitigate long-term economic scarring and ensure a strong foundation for sustainable recovery. This should subsequently help reduce the risk of weak recovery prospects becoming a trigger factor for a sovereign rating downgrade.

As central banks across the world pivot towards a more hawkish stance, fiscal policy will likely continue to take centre stage in Malaysia to support the economy. We, therefore, do not anticipate further monetary easing easing from Bank Negara Malaysia (BNM), considering possible adverse side effects such as those seen in previous economic downturns, namely rising asset prices and household indebtedness.

As the case for sooner-than-expected monetary policy normalisation continues to gather steam among major central banks due to rising global inflation expectations, the government will need to factor in the eventuality of interest rate normalisation in Budget 2022. With this, stronger policy measures to offset the negative impact of higher interest rates on growth are expected.

We expect COVID-19-related government aid to continue, as indicated by moves to raise the statutory debt limit to 65% of GDP. In fact, the statutory debt level might even expand due to the government pursuing private consumption as the primary engine of GDP growth. Going forward, we expect debt service charges to rise, though low borrowing costs will help to mitigate some of the pressures for now. By 2021, debt service charges as a percentage of revenue is expected to come in higher than the 15.3% in 2020. To clarify, the ratio is already 50 basis points higher than the administrative ceiling of 15%.

As Budget 2022 will likely be the last budget before the 15th General Election, we expect the slew of populist measures currently in place will remain and may even be further enhanced. This could include various handouts to firms and households affected by the pandemic, which will be critical to sustaining the recovery momentum of the economy going into 2022. The populist splurge is also likely to manifest itself in the form of more funding for the government's welfare support, primarily to address the inequalities exacerbated by the pandemic. Although we laud policies to support sluggish demand, we believe that it has to be complemented with supply-side liberalisation efforts in order to tame prices.

That said, the government will likely downplay the issue of revenue constraints in Budget 2022. It is likely, though, that hints suggesting the reintroduction of the goods and services tax (GST) could surface in the following fiscal plan.

Given the expected economic headwinds in 2022, policies to address both the demand and supply sides of the economy are crucial for higher growth. All in all, we are cautiously optimistic that the Malaysian economy will return to its pre-pandemic quarterly growth rates after mid-2022.

Firdaos Rosli, +603-2717 2936/ firdaos@marc.com.my.