Global Insight Perspective | |
Significance | Unlike other Asian nations, Malaysia is embarking on a wholesale restructuring of its energy pricing system, with the aim of saving upwards of US$4 billion per year and putting a cap on demand. |
Implications | Although the move is prudent in the interests of long-term fiscal stability, a political backlash is expected against the already-weakened Abdullah Ahmad Badawi government. |
Outlook | Malaysia has stated its intent to move to full market pricing over the near term. Although progressive dismantlement of fuel subsidies will exacerbate short-term inflationary pressures the long-term fiscal gains will be substantial. However, as political tensions increase, the government's will to implement further reforms will be the key variable. |
Market Realities
Any remaining doubts that political will was lacking for a radical restructuring in energy prices in Malaysia were set aside yesterday, as Abdullah Ahmad Badawi's government raised prices for transportation fuels by 41–63% as part of a raft of measures to take pricing to international levels by August.
Panic buying followed the announcement, but with prices active from midnight last night there was limited time for this to distort the demand picture. As of now, premium leaded gasoline (petrol) has been increased by 41% to 2.70 ringgit (US$0.83) per litre, while diesel will stand 63% higher at 2.58 ringgit. By August, the government intends to make the remaining jump to international pricing where crude oil trades at upwards of US$120 per barrel.
Under the energy reforms, 1 July will also see electricity prices rise as power companies, led by Tenaga Nasional, are allowed to pass on increases of up to 18% for residential users and 26% for companies to reflect higher gas feedstock prices. Under the reforms, state oil and gas company Petronas will be able to charge power companies more than double the price for its natural gas, at 14.31 ringgit/Mbtu from 6.40 ringgit/Mbtu, according to local newspaper The Star.
Together, the government estimates that the measures will save 13.7 billion ringgit—around 4 billion ringgit on fuel and double that for natural gas sales. Along with a new 30% windfall profit tax on palm oil producers and independent power producers, this will provide the government with significant additional resources. It had previously been mulling setting aside one-third of its expenditure (56 billion ringgit) on fuel subsidies based on current international prices, according to figures from the domestic trade minister, Shahrir Samad.
Fiscally Responsibly But Politically Risky
As expected, there has been a significant public backlash to the increase in fuel prices, with opposition groups holding protests in the capital, Kuala Lumpur, and northern city of Ipoh. Queues were also reported at filling stations yesterday as motorists attempted to fill up before the new fuel prices took effect from midnight. Meanwhile, the government rescinded a ban on the sale of gasoline to Singaporeans and Thais purchasing fuel at the border that was issued on Monday (2 June), which affected 296 filling stations in the northern states bordering Thailand and 197 in southern Johor state, which borders Singapore.
Despite being a political gamble, the tenability of subsidies is increasingly in question following the marked elevation in the global oil price floor. Counter-cyclical spending by the government—typically through large-scale public projects—has resulted in an average budget deficit of around 4–5% of GDP in recent years. Fuel subsidies currently account for around one-third of the total national budget. The encroachment of the subsidy burden is reducing resources for more productive long-term investment in human and physical capital. Longer-term concerns over the fiscal sustainability of fuel subsidies are increasingly outweighing short-term inflation risks generated by abrupt increases in administered prices. India, encumbered with a traditionally weak fiscal position, raised administered prices yesterday, while Indonesia reduced its subsidies in late May. Authorities in Malaysia appear to have judged the timing of an increase as apposite. First-quarter growth proved robust, fuelled by robust consumer spending and resilient export growth. The economy expanded by 7.1% in annual terms in the three months through March, treading close to the 7.3% gain recorded in the fourth quarter of 2007. Concurrently, inflation remains comparatively subdued, with core inflation remaining relatively dormant. Although standing as a 15-month high, annual inflation stood at just 3.0% in April. Any spike subsequent to today's adjustment should therefore remain relatively contained.
Outlook and Implications
Malaysia has been one of the first subsidising states to brave comprehensive reform at current oil price levels, despite the inevitable negative immediate impact on inflation and popular sentiment. The move is even more remarkable given the country's status as a net oil exporter. The move highlights the shift among Asian governments to prioritising long-term fiscal sustainability over short-term concerns and inflation risks, with authorities banking on the relative buoyancy and resilience of growth to absorb any shock. The government projected that the move may take some momentum out of domestic growth, raising their average annual inflation forecast to 4–5%. The central Bank Negara also retains latitude to increase interest rates without dealing a major blow to domestic demand, with the leading rate standing at just 3.5%.
However, the political risks may be less benign. The removal of the fuel price controls is likely to put further strain on Prime Minister Abdullah Ahmad Badawi’s political future, following the poor performance of his ruling United Malays National Organisation (UMNO)-led Barisan Nasional (BN) coalition government in March's parliamentary election, in which it recorded its worst results since its inception. Despite pledges to improve the accountability and transparency of the government, Abdullah remains under pressure to resign, fuelled by former prime minister Mahathir Mohammed's withdrawal from the party last month. It also comes amid a strengthening of the opposition three-party coalition led by Anwar Ibrahim, which is in control of five states and one-third of parliamentary seats.