This article first appeared in The Edge Malaysia Weekly on January 30, 2023 - February 5, 2023

Prime Minister Datuk Seri Anwar Ibrahim, who is also finance minister, is set to table the revised Budget 2023 on Feb 24. As is the norm, there are speculations — and wish lists — in the run-up to the announcement, of what policy measures that could, or should, be included. We decided to write this article a full month early, in the hopes that the views and facts here will be considered.

If you recall, the original Budget 2023 was tabled in October last year, just days before Parliament was dissolved to pave way for the 15th general election. The rest, as they say, is history. Notably, this proposed budget was for a record high allocation of RM372.3 billion, of which RM272.3 billion was to be for operating expenses and RM95 billion for development. The budget deficit was estimated at 5.5% of GDP and, critically, the current budget surplus was more than halved to just RM230 million, from the RM517 million projected for 2022 and just 10% of the RM2.2 billion in 2021.

There is no question that Malaysia needs to address the worrying trend of rapidly shrinking current budget surpluses — where revenue is just barely sufficient to cover operating and interest expenses. The prime minister himself has said as much. Falling into a current budget deficit means the government will have to borrow to make interest payments. Debt servicing costs will snowball — with more and more borrowings required to cover higher and higher interest expenses. Development investments will have to be sacrificed. The country will lose its competitiveness, and eventually become a failed state.

We have discussed this growing risk in depth in our article entitled “There’s no free lunch in economics — it’s who receives and who pays” (Issue 1438, Sept 12, 2022). (Scan QR Code 1 for the full article.)

Halting and reversing this downward spiral requires: (1) increasing revenue; and/or (2) reducing expenses. The current government’s move to tighten governance in managing public spending and awarding contracts based on open tenders should plug some wastage and leakage. The prime minister recently noted that up to RM10 billion could be saved from leakages in the government procurement system if corruption is eradicated at all levels. We will believe it when we see it. And this is reflective of what most Malaysians think, let’s be honest.

Clearly, more needs to be done to put Malaysia’s weakened fiscal position back onto the sustainability path.

Fact: Government revenue (primarily direct and indirect taxes) growth has lagged GDP growth from 2014 to 2019 (prior to the pandemic) — rising by only 3.8% per annum on average, compared with 7% nominal GDP growth.

This is due, in part, to years of flattish corporate taxes, as profits contracted-stagnated on the back of declining investments and productivity gains amid intensifying competition.

Meanwhile, according to the Ministry of Finance (MoF), only 16.5% of the country’s 15 million workforce pay income taxes — equivalent to just 2.5 million (or less than 8%) of the 32.7 million population. This is an exceedingly small tax base, primarily because the majority of workers earn incomes that are too low to qualify for taxes and for those who are, many pay only very little taxes. Case in point, the median monthly income for Malaysian salaried workers is RM2,250 while the minimum monthly income eligible for tax deductibility (for self) is RM3,111. Why is this the case?

We have, on many occasions, explained how and why persistent structural weakness has led to Malaysia increasingly losing competitiveness in attracting high-value investments. (Scan QR Codes 2 to 4 for the recent three-part series published on June 20 and 27, and July 4, 2022.)

Here is a brief recap. Our share of foreign direct investment (FDI) destined for Asean fell from 24% between 1977 and 1997 — prior to the Asian financial crisis (AFC) — to just 8% from 2000 to 2020 (see Chart 1). At the risk of sounding like a broken record, investment is the life blood of sustainable economic growth, job creation and raising the people’s income levels.

Fact: The 5-year moving average real GDP growth slowed from 6% in 2007 to 4.9% in 2019 while the decline in per capita income growth was even sharper, from 10.5% to 5.2% over the same period. The slowdown is worse in US dollar terms, no thanks to the weakening ringgit against the greenback (see Chart 2).

With falling investments, both foreign and domestic, Malaysia suffered premature deindustrialisation. Manufacturing as a percentage of GDP peaked at 30.9% in 1999, and has been falling steadily, to just 23.5% by 2021. Case in point, the ringgit is highly correlated to our main export commodities, especially oil — underscoring the fact that Malaysia is, increasingly, no longer seen as a manufacturing-driven economy (see Chart 3). We were, and still are, being displaced by China, and now Vietnam and Indonesia.

Instead of redoubling efforts to attract and promote investments, the then government encouraged domestic consumption to prop up faltering growth. Investment as a percentage of GDP fell sharply post-AFC while consumption as a percentage of GDP rose steadily (see Chart 4).

Thus, Malaysia pivoted to a consumption-driven economy before achieving high value-added manufacturing products and investments. That led to crippling household debts, currently among the highest in the region. Savings rates fell precipitously, resulting in a shrinking pool of funding that is so critical for domestic investments.

Low investments and the failure to move up the value chain meant that the majority of jobs created remained low-skilled, and as productivity gains lagged, so did wages growth. The average salary in Malaysia (in US$ terms) grew at a compound annual growth rate (CAGR) of only 1.9% from 2011 to 2020, which is among the slowest paces in the region (see Chart 5).

In short, wages were growing too slowly, and from a low base, thereby capping consumption and increasing private debts. Meanwhile, the weakening ringgit further ate into purchasing power and contributed to higher cost of living, which then fed back into even lower savings.

And before the bleeding-heart liberals and populist politicians start jumping on employers as “evil”, companies simply could not afford to pay more — when they failed to move up the value chain, intensifying competition eroded margins and profits. Chart 6 underscores the sad state of affairs for Malaysia’s largest listed companies. Returns on capital have been in decline year after year, from a peak of 8.9% in 2012 to 5.2% in 2019, prior to the pandemic. It is no wonder why the benchmark index, FBM KLCI, has performed terribly the past 10 years. Long-suffering Bursa Malaysia investors should be given a medal of honour — for their nationalistic zeal.

Hence, what we would most like to see in Budget 2023 are concrete, transparent and CONSISTENT measures to encourage and attract investments and, in particular, high-value investments. The most important and crucial catalyst would be the speed of Malaysia’s digital transformation — to make up for lost time and allow the country to catch up in the new digital global economy.

In effect, we see digitalisation as the key to reboot the virtuous cycle of investments, growth and higher income levels, which was interrupted by the AFC and our own response to the crisis, the most damaging of which were capital controls. Over the medium-longer term, successful digitalisation and investment drive will broaden the tax base and raise government revenue through higher corporate profits and individual incomes.

For a start, we would like to see policy continuity. Measures to ensure the accelerated digital infrastructure — 5G and mobile, fiberisation, local and international connectivity, cloud and data centres and such — should remain in place and to lay the building blocks for the ecosystem — including legislative, regulatory and monitoring frameworks and availability of talent pool — as well as tax and other incentives for businesses, for faster adoption of digitalisation.

The Malaysia Digital Economy Blueprint, launched in February 2021 by the then prime minister Tan Sri Muhyiddin Yassin, kick-started this process. It foresees RM70 billion investments in the following five years — create 500,000 new job opportunities and contribute 22.6% of Malaysia’s GDP by 2030. It will also help 875,000 MSMEs (micro, small and medium enterprises) and SMEs. By 2030, companies in Malaysia will realise a productivity gain of 30%.

The “out of the box” solution to bring 5G faster and a lot cheaper to all Malaysians via a single wholesale network (SWN) — through Digital Nasional Bhd (DNB) — lays a crucial path that will enable Malaysia to become a global leader in 5G innovation and applications, and all without government funding. (Scan QR Code 5 on next page for a related article, penned by Amit Mital, former special assistant to the president and senior director at the National Security Council, the White House, published in Malay Mail on Jan 18.) Existing telco cartels will cease to be able to extract high prices for low-quality connectivity, making billions of ringgit each year from the rakyat.

It is important to understand that, unlike previous generations of mobile networks that were mostly driven by end-consumer demand — hence, we can “afford” to wait as telcos slowly build the economic case for gradual rollout — 5G is critical “build and they will come” infrastructure, driven by enterprise use cases and is one of the key factors to attract investments in the digital world.

This fact is acknowledged by leading global experts, including Intel CEO Pat Gelsinger. The company has committed to investing RM30 billion in Malaysia over the next 10 years (scan QR Code 6 for the full article).

With these foundational blocks in place, the private sector could then drive the next leg of the digital economy, expanding the ecosystem through innovations and new business applications and opportunities — which will create more jobs and generate multiplier effects through the economy.

Studies estimate that the adoption of high-speed, low-latency and large number of devices connectivity for massive data transmission can create use cases worth some US$620 billion by 2026, across multiple industries including transportation, retail, financial services, media and entertainment, smart manufacturing, energy and public facilities, public security and healthcare. This digital transformation comes at a particularly critical juncture for the country — as the next driver for broader-based growth in the economy.

Over the past few decades, Malaysia’s manufacturing sector has relied heavily on the electrical and electronics (E&E) sector as the principal growth driver. However, this segment is now under threat, because of the fragmentation of the global chips industry (tech war between the US-led West and China), strategic shift towards onshoring and near-shoring to replace the current globalised supply chain, as well as the fact that Malaysia lies at the lower end of this value chain.

Apart from digital, the government has also indicated that development spending will focus on high-impact projects related to food security, food value chain, renewables and green technology.

The agriculture-fisheries sector, we think, holds much promise, especially with the application of modern farming technologies to increase productivity. Malaysia’s primary food imports have risen steadily over the past 20 years, from 0.7% of gross imports in 2000 to 1.2% in 2021. Boosting local food production would not only improve self-sufficiency (and national security) but also reduce foreign currency outflows and strengthen the ringgit. It will also create sustainable jobs.

A stable supply of domestically produced food may also be cheaper, or at least less prone to global price fluctuations. In addition to direct subsidies to farmers and fishermen, the government could allocate additional funding for R&D grants, training and education, tax incentives, market development and so on.

Government support measures should extend to the downstream value-added chain as Malaysia also spends substantial amounts importing processed food, which have risen from 1.3% of gross imports to 2.5% between 2000 and 2021. Processed food could be exported to earn foreign currencies as well — indeed, there are domestic companies that are already enjoying some success in this area.

A more robust agriculture-fisheries-processed food sector could make more significant contributions to the economy and employment. Thailand is a very successful example we should learn from.

Elsewhere, the previous budget included import and excise duties exemptions for imported and locally assembled electric vehicles (EV). We think that more efforts could be focused on attracting investments in the sector, beyond simply tax exemption for car buyers.

For instance, more incentives are needed for global automakers to set up plants to manufacture parts and systems needed for EV-AV (autonomous vehicles) in the region. Demand is just taking off and there are massive investing dollars to be had. Malaysia’s auto industry, we believe, have the talent pool, the accumulated skillset from 40 years of experience. We have good logistics infrastructure and 5G infrastructure. We just need more supportive government policies, like that of China, Thailand and Indonesia.

Addressing the rising cost of living is a priority and one of the most immediate concerns. Some possible measures include further deregulation of the economy, removal of all approved permits (AP) and reduce/remove licensing requirements to boost business efficiency and competitiveness. Many, if not all, of these are effectively rent-seekers, or as the prime minister describes it, “cartels”. So yes, please go ahead and remove these cartels, whether for food, cars or telcos.

For instance, Padiberas Nasional holds the monopoly to import rice in Malaysia and has profited immensely over the years. In the last 10 years (2012-2021), the company reported net profits totalling nearly RM1.3 billion. In FY2020, it paid a whopping RM670 million in dividends to shareholders. One would presume that if not for this monopolistic outsized profit, rice prices in the country would be lower.

Anecdotal evidence: According to data provider Global Product Prices, the price of rice in Malaysia is the highest among the major Asean countries (see Chart 7).

A speedy and transparent approval process for foreign worker permits will alleviate the current production bottleneck. All of the above will reduce the cost of doing business and help ease price inflation.

Last but not least, the cost of living has also been driven up by the sustained and predictable decline in the value of the ringgit, given that we are a very open economy (see Chart 8). Measures to strengthen the ringgit could be a good start.

No discussion of the budget is complete without mentioning the option of re-introducing the much-vilified goods and services tax (GST). The beauty of GST (also known as value-added tax or VAT in parts of the world) is that it is a broad-based, multi-level tax system — taxes are levied on the value added at each stage of production and covers all final consumption.

Fact: GST/VAT is widely employed around the world in more than 160 countries, and its share of tax revenue has risen in recent decades. According to the International Monetary Fund (IMF), GST/VAT accounts for over 30%, on average, of those countries’ total tax revenues.

Malaysia first implemented a 6% GST in April 2015 and tax collection peaked at RM44.3 billion in 2017, making up about 25% of total direct and indirect taxes. However, the tax raised consumer prices and became a huge contentious issue during the 2018 general election (GE14). It was eventually scrapped in June 2018, after the change in government, and replaced by a narrower sales and services tax (SST).

We understand that a re-introduction of GST may not be politically palatable. But in truth, the difference in tax collections between the GST and SST — and therefore the impact on consumers — is not as significant as one would assume. Case in point, total SST collection was estimated at roughly RM32 billion in the original Budget 2023. A back-of-the-envelope calculation shows that the current SST regime collects about two-thirds what would be collected from GST at 6%. In other words, we are already paying “GST” — just in another name. Why not be honest about it and choose the better tax regime?

GST is broader-based and more revenue-efficient, and is proven to be more tax evasion-avoidance-proof compared with SST because it is easier to track through every step of the production and there is greater accountability given the many parties involved along the supply chain. The impact of GST on low-income households can be mitigated with additional direct cash transfers.

Perhaps a more politically-viable option is to raise the SST rates on goods and services that cater primarily to the rich, or higher taxes levied on assets (such as properties and cars) above a certain value threshold.

There is the option of excess profit tax, though it is difficult to pin the appropriate threshold rate of return and certainly extremely difficult to account for, monitor and enforce. Case in point, privatisations in the 1990s came with the stated objective of allowing a fixed return on investments for projects — no more, no less. In reality, what happened was that the project costs were inflated — the concessionaires still made huge profits based on the stated fixed returns. We call it “stealing upfront”. Even if it can be executed perfectly, an excess profit tax will surely make Malaysia less attractive to investors. That would be self-defeating.

As we have said before, higher taxes lead to a less competitive business environment — and do not promote investments or savings. The better option would be to reduce operating expenses. Unfortunately, this is far easier said than done, particularly for democratically elected governments. Few, if any, populist governments — including this current Malaysian government — have the political will to make the hard decisions that inflict pain on voters. That is why it is so difficult to wean governments the world over off their penchant for spending largess and addiction to debts. Populist policies, on the other hand, are often short-term solutions that are not beneficial to the country in the long run. (Scan QR Code 7.)

 One area to reduce expenses is cutting back on the bloated civil service. Emoluments have been increasing over the years. In the original Budget 2023, salaries and wages accounted for 40% of total operating expenses, excluding debt service charges. We spend more on emoluments as a percentage of GDP than South Korea, Thailand, Indonesia, Japan and Singapore — not because we pay better but because of the sheer number of civil servants on the payroll. The Malaysian government employs 16.3% of all workers in the country, disproportionately higher than that in most countries (see table below).

In fact, we think this may be yet another symptom of years of declining investments, resulting in lesser jobs creation for the people — the government has to pick up the slack to keep unemployment low. Right-sizing the civil service will reduce expenses. But, as in the case of GST, we know politicians do not possess the political will or bravery to do the deed.

Another much-talked about option is to cut back on fuel subsidies — from the current blanket subsidy to the targeted subsidy scheme. Fuel subsidies ballooned last year with higher global oil prices and accounted for 45% of total subsidy and social assistance expenses in 2022. According to the previous government, only 20% of this fuel subsidy accrued to the B40 low-income households.

We have reservations in cutting fuel subsidy to the remaining 60% of the population. This may be controversial, but the B40 already gets substantial cash transfers and aid-benefits from various assistance programmes. We would argue that it is the middle-income households in cities that are struggling — and too often neglected.

Additionally, allowing petrol prices to rise will be inflationary. We have no doubt it will trigger cascading price increases across the board — that will only worsen cost-of-living pressures for everyone. Ultimately, it will be the poor and middle-income households that will suffer the most.

In short, we think the amount of fuel subsidy is not a high price to pay, from the larger-scheme-of-things perspective, at least at this point in time. We also note that the low-middle income households constitute the majority of voters.

Therefore, in reality, there are severe limitations to raising taxes or cutting expenses. This means that higher government borrowings are inevitable. Public debt including liabilities has reached RM1.5 trillion or 80% of GDP. We may be nearing the upper limits of borrowings before investors start demanding larger premium on interest costs to compensate for the higher risks. Our greatest fear is that Bank Negara Malaysia may be asked to monetise future government debts. That would be catastrophic for investor confidence, the ringgit and the economy.

What the government can — and must — do is reinvigorate investments. Create a business-friendly environment that promotes innovations and productivity. Remove rent-seeking activities (do it — not just say it for political mileage). Change the perception of our public service to one that is transparent, streamlined, efficient and absent of systemic corruption. The education and training system must be able to provide the necessary talent pool to attract investors. The brain drain must be stopped and talents must be recruited from abroad.

There are two other critical areas we will come back to in future articles — education and affordable housing. This article is already way too long.

But be honest, these are great sound bites. Are they achievable? Will the end result take so long that the country and the politicians will run out of patience? So, the bottom line is — get digital transformation right. It guarantees to bring investments, create jobs and lower the cost of living. It has already started. Just don’t drop the ball with political posturing and small-minded envy and pride.

A successful digitalisation and investment drive will ultimately broaden the tax base and raise government revenue — through higher corporate profits and individual incomes — and put Malaysia back onto the sustainable path towards high-income nation status.

The Global Portfolio gained 1.1% for the week ended Jan 25, with stocks generally doing better than bonds. The top gainers included GoTo Gojek Tokopedia (+3.8%), Tencent Holdings (+3.1%) and Global X China Electric Vehicle and Battery ETF (+2%) while the notable losers were iShares 20+ Year Treasury Bond ETF (-1.1%), Grab Holdings (-0.8%) and NEXT Funds Japan Bond ETF (-0.1%). Total portfolio returns since inception now stand at 33.7%, trailing the MSCI World Net Return Index’s gain of 42.8% over the same period.

Meanwhile, the Malaysian Portfolio was up by more than 3% for the week, outperforming the benchmark FBM KLCI’s 0.3% gain. All five stocks in the portfolio ended higher. The best-performing stock was Velesto Energy, whose shares gained a whopping 18.9%. Other notable gainers included CCK Consolidated Holdings (+2.0%), RCE Capital (+1.1%) and Deleum (+1.1%). Last week’s gains boosted total portfolio returns to 154.8% since inception. This portfolio is outperforming the benchmark FBM KLCI, which is down 18.1%, by a long, long way.

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views  to influence readers to buy/sell stocks. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.

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