Budget 2007 and the world economy

The Malaysian economy’s strong links to the global economy were evident in the 2007 Budget presented last Friday. The oil price increase was the financial factor enabling the expansionary Budget, while the state of the US economy may affect the next few years’ economic performance.

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The 2007 Budget and its accompanying Economic Report tabled last Friday shows again how intertwined is the Malaysian economy with the global economy.

The Prime Minister was able to present an expansionary Budget for 2007 of RM159 billion, with operating expenses 11.6% higher and development expenses 31% higher than this year’s levels.

The government’s total spending in 2006 (RM141 billion) is in turn 10% more than the 2005 level (RM128 billion).

As expenses have exceeded revenues, there is an overall federal budget deficit. But the deficit has been going down as a percentage of Gross Domestic Product, from 3.8% in 2005 to 3.5% this year and 3.4% next year.

This was despite the hefty jumps in government spending. The reason is that revenues have also been climbing, and much of this is due to the rise in world oil prices (averaging US$71 per barrel in January-July 2006), which has translated into a government revenue bonanza.

Budget data show that the petroleum income tax rose from RM14.6 billion in 2005 to RM20.4 billion in 2006 and an estimated RM24.7 billion in 2007.

But the government also obtains other oil-related revenues, such as sales taxes and profits from Petronas. Total oil-related revenue this year will be RM45 billion, or 37% of total revenue, compared with RM31 billion in 2005, or 29% of the total revenue.

In other words, as the Economic Report points out, the jump in oil revenue has sustained the government’s expenditure without adversely affecting the government’s financial situation.

The Report however also has sobering news: Malaysia’s crude oil reserves stand at 5.25 billion barrels, with an expected lifespan of only 20 more years. In other words, the oil bonanza won’t last much longer and the country will become a net oil importer not too long from now. As for natural gas, reserves are expected to last another 34 years.

The good economic performance has also been underpinned by favourable trade conditions, with a surge in exports of manufacturing goods, primary commodities and minerals. The 2006 merchandise trade balance will have a huge RM138 billion surplus, enough to offset the payments to abroad from foreign-company profits and transfers by foreign workers.

The trade data give pride of place to electronics as the country’s main export earner by far. However, the net export earnings from this sector are far lower because the electronics exports contain very high import content (for example, parts for making integrated circuits and electrical machinery).

While the export figures for palm oil, rubber and petroleum exports are more modest, these products pack more “value added” and more “net revenue” into each ringgit of exports as there is little import content in them. What you get in revenue from these commodities is basically what you see in the export data.

The Economic Report also reveals a policy dilemma. On one hand, inflation has reared its ugly head, reaching 3.9% in the first seven months of this year, with increases in prices of transport, food, and utilities being the main cause.

The rising cost of living has given rise to grumbles and discontent, and the Budget went some way to appease the affected through an increase for public servants in COLA allowance and salary bonus, and a one-time payment to pensioners.

The response from union leaders and pensioners indicate the measures have not been enough to satisfy those affected, while farmers, smallholders and fisherfolk are also grumbling about the rising cost of production inputs.

The usual way to curb inflation is to raise the interest rates, and this is what the United States has done. But Bank Negara is reluctant to do this, as higher interest rates will have the effect of slowing down the economy as businesses and consumers will be discouraged from spending.

The overnight policy rate has been raised by only a little, a total of 0.5 percentage points this year, causing the banks’ base lending rate to rise to 6.34% in February and later to 6.72%.

Bad news for savers though: while the lending rates charged by the banks have gone up, the rates paid to depositers by the banks have been raised by much less (if at all). So the real return on deposits (interest rate minus inflation rate) is actually negative.

This is not only a disincentive to save, but a real injustice to savers. Surely the banks are making more than enough profits to enable them to pay higher deposit rates to savers, who should not be doubly squeezed by inflation and low interest.

Finally, while the 2007 Budget gives cause for optimism, the economy’s performance also depends on the state of the global economy.

Last week, there were signs of an economic slowdown in the United States, enough to curb inflation but not enough to slip into recession. This was welcomed with relief.

“But the time may come, soon, when investors, bankers and businesses will find little to cheer about in the good news,” warned a New York Times editorial on 2 September.

If indeed a slowdown is coming in the US and the global economy, the expansionary 2007 budget may play the role of cushioning the adverse effects.

In any case, it is always wise to tackle the weaknesses when times are good, so as to better face up later to conditions that are not so good.

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