Global Trends by Martin
Monday 4 September 2006
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
factor enabling the expansionary Budget, while the state of the
US economy may affect the next few years’ economic performance.
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
The government’s total spending
in 2006 (RM141 billion) is in turn 10% more than the 2005 level (RM128
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
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
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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