Crude oil prices fall: subsidy needless, ringgit weaken, fiscal health affected

Malaysia's iconic Twin Towers are seen in the background of the Malaysian oil and gas company Petronas logo at a petrol station in Kuala Lumpur

DESPITE the geopolitical uncertainties in recent months – Islamic State of Iraq terrorism, Russian-Ukraine tension,Israel-Gaza conflict – Brent crude oil price has fallen to a new four-year low on Nov 13 at US$77.9 per barrel.

This is a significant drop from the average price of US$112 per barrel in June 2014. The floor price support is still not yet in sight and the downward spiral of prices seems likely to persist into 2015.

The key factors contributing to the recent drop in prices are large crude oil supply from American shale oil production, weakening demand from a subdued global economic growth outlook and also a stronger US dollar in the recent months.

Malaysia’s economy is very much dependent on the oil and gas sector. From the federal government budget revenue to the country’s exports of crude oil and petroleum products, the issue of falling crude oil prices warrants a closer inspection.

Government estimates gone awry

The Government’s projection of its fiscal position and overall economy in Budget 2015 is based on the assumption that the average Brent crude oil price would be US$105 per barrel in 2014 and US$100 per barrel in 2015. Given the substantial differences from the current market prices, the Government’s projections may no longer be in sync with the economic reality.

Budget net loss from oil prices downtrend

One notable impact of falling crude oil prices is on the government’s budget finances. On one hand, the oil and gas sector has been contributing a third to the government’s budget revenue since 2005. At the same time, the Government spends a substantial amount of its operating expenditure on fuel subsidies – an estimated of 8.5% of budget operating expenditure in 2014. Therefore, sliding crude oil prices is a double-edge sword to the country’s fiscal health.

To put the issue in perspective, the estimated budget revenue contribution from the oil and gas sector is around 6% of gross domestic product (GDP)in recent years while fuel subsidy costs the government around 1.7% of GDP in 2014. As such, the impact of lower budget revenue will outweigh expenditure savings from lower fuel subsidy cost.

Therefore, if the current blanket fuel subsidy mechanism is left status quo in light of falling crude oil prices, the circumstances would risk our nation’s fiscal deficit targets. Keep in mind that the government has committed to reduce the current fiscal deficit to GDP estimate of 3.5% in 2014 to 3% in 2015 and ultimately achieve a balanced budget by 2020.

Timely goods and services tax

No doubt the heavy dependency on the volatile oil and gas sector for budget revenue is beginning to show signs of cracks. The issue is even more pressing now that budget revenue is squeezed from falling crude oil prices.

Therefore, the broad-based goods and services tax (GST), which will enhance tax revenue collection, is considered timely at this juncture. However, the implementation of GST is only part of the long term solution to fiscal sustainability. The government must also look into the expenditure side of the budget finance to manage its fiscal prudence.

New subsidy mechanism or market prices?

Based on the current crude oil prices, the government is only subsidising RM0.13 per litre for RON95 and RM0.12 per litre for diesel in November, compared to RM0.47 per litre subsidy for RON95 and RM0.59 per litre subsidy for diesel in September – before the October RM0.20 per litre fuel price hike.

According to the Finance Ministry, if global crude oil prices fall to a low of between US$70 and US$75 per barrel, the Government would not be providing any subsidy for fuel at the current fixed price of RM2.30 per litre for RON95 and RM2.20 per litre for diesel.

Since the market pump prices are approaching a level that would require no subsidy at all, there is an urgent concern to review the sustainability of the current blanket fuel subsidy approach.Although the government has proposed to initiate a new targeted fuel subsidy rationalisation programme based on individual income thresholds, the circumstances demand a review of subsidy provisions.

Ultimately, fuel subsidy is not sustainable in the long run. Whether the government initiates a tiered fuel subsidy provision or not, the reality is that fuel subsidy should not be entrenched indefinitely.

To plan ahead for fiscal prudence, the government’s initiative to move towards a managed float pump prices is appropriate at this juncture.

When global crude oil prices are depressed, consumers would certainly rejoice. However, when there is a reversal of crude oil prices, the government could then step in to provide targeted assistance to the low-income households. As the government would be sensitive to the impact of rising cost to the low-income group, savings from fuel subsidy expenditure could be channelled to the targeted needy households.

The Bantuan Rakyat 1Malaysia (BR1M) provisions for eligible households and single individuals amount to around RM4.9bil in 2015, benefitting around 7 million recipients. Therefore, the low-income group has already been identified through the BR1M database. The government can consider to top up on BR1M with a supplementary monetary provisions equivalent to a cost of living allowance to compensate for the upside volatility of market fuel prices.

If the government would consider providing an additional RM250 to its BR1M provision for each eligible households and single individuals as the supplementary allowance, total BR1M payment for eligible recipients in 2015 would amount to around RM6.7bil.

Therefore, from the perspective of fiscal management, doing away with fuel subsidies would greatly assist the government to meet its fiscal objectives. From Budget 2015, the Government has allocated around RM37.7bil for subsidy expenditures. Based on historical trend, around 55% of total subsidy allocated is for fuel subsidies.

If the government considers abolishing subsidies for fuel in 2015, it could save up to RM20.7bil from the operating expenditure. Given that the projected fiscal deficit is around RM35.7bil for 2015, the savings from fuel subsidy will assist the government to meet its fiscal deficit targets. Furthermore, the government can also save billions of ringgit for money not spent on upgrading petrol pumps to accommodate the proposed tiered fuel subsidy mechanism.

As long as the provision for the additional supplementary allowance to BR1M does not exceed the savings from fuel subsidy expenditure, subsidies would be channelled to the targeted group while narrowing the fiscal deficit along the way.The cost of living allowance can be claimed through the BR1M distribution channel. This will assist the government to meet its fiscal deficit to GDP targets.

One way or another, it is still monetary subsidy provisions by the government. However, a more targeted approach to distributing provisions and also doing away with the heavy dependency on subsidies are the right approach moving forward not only for the fiscal health but also to the fundamental competitiveness of the economy.

By Manokaran Mottain, chief economist at Alliance Bank Malaysia Bhd.

Ringgit Falls for Sixth Week in Longest Stretch This Year on Oil

Malaysia’s ringgit fell for a sixth week, the longest losing streak this year, as a slump in crude oil prices threatens to crimp government revenue in a nation that’s a net exporter of the fuel.

The ringgit is Southeast Asia’s worst-performing currency in the second half as Brent crude lost 29 percent since the end of June. Oil-related industries account for 30 percent of government revenue. While a weaker exchange rate helps lower export prices it makes imports more expensive. A report today showed inflation quickened to 2.8 percent in October from a year earlier, compared with 2.6 percent the previous month.

“The drop in commodity prices, especially crude oil, is to be blamed for the ringgit weakness,” said Wong Chee Seng, a foreign-exchange strategist at AmBank Group in Kuala Lumpur. “The fact that the ringgit is a high-beta currency also didn’t help,” he said, referring to a measure of volatility.

The ringgit depreciated 0.3 percent from Nov. 14 to 3.3555 per dollar in Kuala Lumpur, according to data compiled by Bloomberg. It touched 3.3681 yesterday, the weakest level since March 2010, and has lost 4.3 percent since June 30.

One-month implied volatility, a measure of expected moves in the exchange rate used to price options and a gauge of risk, increased 16 basis points, or 0.16 percentage point, to 7.15 percent this week.

Subsidy Announcement

The ringgit led gains among Asian currencies today, rising 0.3 percent, after the government said in a statement that it will remove subsidies for fuel and diesel from Dec. 1 and as Brent rebounded.

“The ringgit strengthened today because of the increase in crude oil prices,” said Saktiandi Supaat, the Singapore-based head of foreign-exchange research at Malayan Banking Bhd. “The announcement on the subsidy removal gave further support.”

Malaysia’s 10-year government notes fell for a second week. The yield on the 4.181 percent securities maturing in July 2024 rose three basis points to 3.9 percent, data compiled by Bloomberg show. The yield dropped three basis points today. - Bloomberg

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Timing of latest fuel subsidy cut a surprise

PETALING JAYA - The latest round of fuel subsidy rationalisation came as a surprise to researchers and analysts who, nevertheless, are positive on the implications of the move, which could translate into savings of an estimated RM1 billion for the government.

Effective today, retail prices of RON95 petrol and diesel are up 20 sen each to RM2.30 per litre and RM2.20 per litre, respectively. This translates into a 9.5% increase for RON95 and 10% for diesel.

"We estimate that this fuel subsidy cut will save the government around RM1.1 billion in 2014, thus helping to achieve fiscal deficit target of 3% by 2015 and a balanced budget by 2020," AllianceDBS Research economist Manokaran Mottain said in a note today.

Currently, the market price for RON95 is RM2.58 per litre and for diesel RM2.52 a litre.

Manokaran said the move to cut the fuel subsidy further came as a surprise ahead of the tabling of Budget 2015 on Oct 10 and amid the recent decline in global crude oil prices.

"Following the recent announcement of a delay in the introduction of a multi-tiered mechanism for fuel, we had expected something like this to come on Budget Day," he said.

Manokaran said the reduction in fuel subsidy was necessary as the government had committed to bringing down the budget deficit to gross domestic product ratio from an estimated 3.5% this year to 3% in 2015, and to achieve a balanced budget by 2020.

However, in light of the latest fuel subsidy cut, Manokaran is now expecting a delay in the announcement of a multi-tiered pricing mechanism.

"We maintain our view that the current blanket subsidy mechanism has to be changed to a multi-tiered subsidy structure based on household income level.

"This is to ensure that subsidies are only channelled to the lower-income group. We hope that the government will have strong willpower to initiate the fuel subsidy reforms soon in order to ensure the economy is more competitive," he said.

Manokaran expects inflation to spike again in the last quarter of this year following the hike in fuel prices. "We maintain our view that 2014 full-year inflation will be 3.5% and inflation to hit 4% in 2015 on the back of the Goods and Services Tax implementation," he said.

Meanwhile, HongLeong Investment Bank Research said that with the 20 sen fuel price increase, it sees no rush for the government to implement the multi-tiered subsidy scheme, which has high complexity in implementation.

"In line with the latest comments by the Ministry of Domestic Trade, Cooperatives and Consumerism, we now expect the new fuel scheme to be rolled out in early 2015," its economist Sia Ket Ee said.

Coupled with the recent weakening of crude oil prices, he said, the government's fuel subsidy per litre is now as low as 28 sen to 32 sen per litre.

"As we expect crude oil prices to remain weak in the near term, the government's subsidy bill is expected to be well contained," Sia said.

He said savings from the subsidy cuts will likely be channelled to other economic services and social spending, expecting an additional RM150 in BR1M payment for 2015, or an extra RM1.2 billion.

The BR1M payout announced in Budget 2014 was RM650 for households and RM300 for singles. A BR1M payment of RM450 was also given to households with a monthly income of between RM3,000 and RM4,000.

RHB Research said the hike in fuel prices will likely hurt consumer and business spending somewhat but it will likely be manageable.

It expects inflation pressure to hold up in the fourth quarter following the fuel prices hike today, which will spill-over into other end-product and service prices gradually.

"Given that the weights for petrol and diesel account for about 7.5% and 0.2% respectively of the Consumer Price Index, the hikes in retail petrol and diesel prices are expected to add 0.7 percentage point to the inflation rate in October.

"However, the impact on inflation will likely be more muted due to the higher base effect in the 4Q of 2013," it said.

In light of the fuel price hike, RHB Research now expects inflation to come in at the higher end of its forecast of 3% to 3.4% in 2014, compared with 2.1% in 2013.

While inflation is expected to hold up in the fourth quarter due to the higher fuel prices, it opined that the country will likely experience a more moderate pace of economic growth in the second half of this year. -Sundaily

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