Malaysia: Cutting back on subsidies

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The Malaysian government is continuing its campaign to reform the nation’s economy, broadening its base and liberalising many previously restricted sectors. However, its most recent moves to rein in subsidies, which are designed to reduce the strain on the budget, may prove unpopular and could stoke inflationary fires in the short term.

Though the Malaysian economy has performed well in the aftermath of the global downturn, posting growth of 7.2% last year and with GDP forecast to expand by around 5.5% in 2011, at least some of this growth has been underpinned by increased state spending. To maintain the flow of new investments and meet the objective of reducing the budget deficit to 5.4%, cuts will need to be made in certain areas, with the growing subsidies bill an obvious target.

The government has long been aware of the need for a reduction in the subsidies regime and has already eased some of the price support for certain basic foodstuffs. Official estimates putting this year’s subsidies bill at more than $8bn. Though at least some of this increase is due to fluctuating international fuel prices, with oil subsidies tipped to double this year to almost $7bn, the government has made it clear that the Malaysian economy must learn to operate in a real market environment.

On June 1 tariffs came into force for electricity and natural gas, with power prices rising by an average of 7% while the charges for gas went up around $1 per million metric British thermal units (BTUs), a rise of 29% from the previous rate of $3.50 per million metric BTUs. Further gas price hikes are to follow every six months until the tariff reaches market level, probably in 2016. Though officials have said most of the burden of the increases will fall on commercial and industrial users, with 75% of citizens unlikely to be directly affected by the volume-based rise on electricity prices, it is expected that the impact of the hikes will still be passed on to the general public as production costs increase.

Speaking just days before the new tariffs came into force, Deputy Prime Minister Muhyiddin Yassin played down concerns that the reduced subsidies would result in a jump in inflation, though he called on the public to be more prudent in their utilities use. While maintaining the system of subsidies would be a politically popular move, Muhyiddin said it would have dire consequences down the line.

“We might be popular for a while if we do not do anything, but in the long term it will have adverse effects as the government would have to shoulder all burdens,” he said on May 31. “The people will be happy but it is they who would have to face the consequences as there will come a time when the economic situation would be so bad that it would be beyond the government’s control.”

Though he acknowledged that the scaling back of subsidies will prove unpopular with many, Prime Minister Najib Razak warned on June 4 that failing to do so would jeopardise the long-term future of the economy and undermine efforts to obtain “developed country” status.

“In the interest of the people and country, a responsible government will find solutions and make choices for the well-being of the people, not only in the short and medium terms but also in the long term,” he said.

It was important to avoid excessive expenditure while ensuring that spending on essential services such as health and education were maintained, Najib said. He added that the rationalisation of price support programmes was not intended to eliminate subsidies, but rather to provide reasonable amounts of assistance to the eligible and needy target groups and sectors.

While the prime minister has said he is prepared to make the tough decisions needed to reform the economy, the government did forgo a proposal to slash price support for petrol, choosing in late May to leave the existing levy in place for the time being. Though fuel subsidies come at significant cost to the government, low-cost petrol and diesel are popular among voters, as well as in the industrial sector. Amidst speculation that the prime minister may call an early general election later this year, the government may be more likely to adopt a gradual approach to subsidy reduction rather than send shocks through the economy with sudden cuts.

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