Subsidies in Question


Economic News

22 Jul 2010
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Malaysia currently has some of Asia's lowest fuel prices, with the government fixing costs well below market rates and paying subsidies to fuel retailers as compensation. Prime Minister Abdullah Badawi, speaking at the annual assembly of the ruling United Malays National Organisation (UMNO) party in November, indicated that the government could no longer afford to spend such a significant amount on subventions and said the country would have to consider lowering them in the new year.

The government has also announced that it will be considering national oil firm Petronas' long-standing request to increase the price of the natural gas it sells to local industries, including power firms.

In February 2006, the government implemented its largest ever fuel price increase when it raised the price by 9 cents per barrel. At the time, oil was trading at $60 a barrel and fuel subsidies for the year cost the government $4.5bn. With global prices now edging towards $100 per barrel, the cost of the subsidy is expected to reach $6bn for 2007, an amount that comes out to 3.1% of GDP.

With the total budget deficit for 2007 estimated at 3.4% of GDP, it is clear that the fuel subsidy is a major contributor. Should the government wish to achieve its target deficit of 3.1% of GDP for 2008, officials are suggesting lowering the subsidy is a necessary course of action.

Pump prices for petrol in Malaysia, currently just above 50 US cents per litre, are approximately one half of the cost in neighbouring Singapore. In 2006, Malaysia consumed 500,000 barrels of oil per day (bpd) against its production of 747,000 bpd. With respect to natural gas, 69% of the daily 5.8bn cu ft produced in 2006 was consumed domestically.

While Malaysia, as a net exporter of oil and gas, benefits from the global rise in oil and gas prices, critics argue that below-market domestic selling prices lead to wastage and inefficient usage, ultimately depleting the supply base. In addition, as the government argued in June 2006 when it approved a 12% hike in the electricity tariff, the first in almost a decade, the cost savings from lowering subsidies can be re-allocated towards boosting the public transportation system and reducing the nation's energy dependency.

Tenaga Nasional, the state power company, has been given a verbal reassurance by the deputy prime minister that it will not be adversely affected if and when the government reviews gas prices. Tenaga currently purchases its gas from national petroleum company Petronas at a highly subsidised price of $1.93 per million British thermal units (BTUs) - significantly lower than the market price of $12. Nor Mohamed Yackop, Malaysia's second finance minister, said last week that Tenaga would be allowed to raise its power tariffs should the price it pays for sourcing natural gas be increased. Should Tenaga be permitted to raise its tariffs, it is expected that the brunt of the burden will fall on industrial and commercial users, as the government has pledged to protect households from a hike in power charges.

According to local research house Kenanga, a 10% reduction in subsidies would result in an estimated 11% drop in Tenaga Nasional's estimated 2008 net profit. Tenaga currently holds a top five position in terms of market capitalisation on the Bursa Stock Exchange.

Analysts agree that the construction and transportation sectors stand to be the most adversely affected by a rise in fuel prices. Malaysia's construction sector is already feeling the pinch from rising global steel and cement costs and insiders worry that an increase in fuel prices could add further burden. However, this could be offset should the reduction in subsidies free up additional savings that the government then chooses to allocate towards infrastructure spending.

Plus Expressways, Malaysia's largest toll operator, experienced a decline in traffic during the 2006 fuel price increase. The company has been contractually assured of a toll rate increase of between 10% and 50% in the new year, with some analysts questioning whether the government will intervene and prevent the hike. Should Plus Expressways not be permitted to increase its toll charges, the government will have to pay the company $115m in compensation.

It is estimated that for every 3 cent increase in fuel prices, inflation increases by an additional 0.5%. In February 2006, when the price was increased by 9 cents, inflation for March rose to 4.8%, up from 3.2% in February.

While inflation in Malaysia is reasonably low at 2%, these questions come just before an expected election year and a reduction in subsidies and any subsequent raise in inflation or prices may be contentious issues for voters. The timing of the election is thus expected to be linked to the subsidy cuts. A local newspaper recently reported that the fuel price increase will likely occur early in the year, with the elections called later in an effort to distance the candidates from a negative public reaction. However, the Malaysian Institute of Economic Research, which foresees the possibility of a 9 cent to 12 cent increase in fuel prices, believes the hike will only occur after elections that will take place at the beginning of the year.

Irrespective of when the announcement occurs, the Malaysian government will need to balance consumer and voter sentiment with a clear budget policy.

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