Oil prices to put a strain on Malaysia’s fiscal deficit

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The contribution of oil revenue to Malaysia’s total revenue is projected at 20.7 per cent based on Budget 2020. — AFP photo

KUCHING: There are many ways the sharp drop in crude oil prices could impact Malaysia’s domestic economy as it is heavily reliant on oil revenue.

The research team at AmBank (M) Bhd noted that the contribution of oil revenue to Malaysia’s total revenue is projected at 20.7 per cent based on Budget 2020.

“The projected oil price, namely the Brent crude oil per barrel, was US$62 per barrel. On that account, the fiscal deficit to GGross Domestic Product (GDP) is expected to drop to 3.2 per cent in 2020 from 3.4 per cent in 2019,” it calculated in a note.

“Meanwhile, following the outbreak of the Coronavirus Disease 2019 (Covid-19), the government unveiled an additional RM20 billion stimulus package in a move to support the affected industries and the economic growth from sliding. As a result, the fiscal deficit/GDP was revised upwards to 3.4 per cent for 2020.

“However, the new challenge is the sharp drop in the oil prices. With the average Brent price per barrel for the first two months at US$60 per barrel, the oil price will have to average around US$64 per barrel for the remaining months of 2020 to US$62 per barrel.

“Now with the drop in oil price to US$35 per barrel, it heightens the risk on the ability to meet the new fiscal deficit/GDP of 3.4 per cent. With a US$27 per barrel fall from the government’s target of US$62, it should reduce the oil revenue by RM8.1 billion.”

This is based on the view that for every US$1 per barrel drop in oil price, it will reduce the oil revenue by RM300 million. Thus, AmBank Research said the oil revenue should drop from the Budget 2020’s projection of RM50.6 billion to RM42.5 billion.

“Assuming the total revenue drops to RM236.4 billion primarily due to lower oil revenue contribution and with no changes on total expenditure which is RM296.2 billion, the fiscal deficit/GDP for 2020 should reach 3.8 per cent from the new projection of 3.4 per cent as a result of the fiscal stimulus package,” it said.

However, if the drop in oil price results in the easing of fuel subsidy estimated at RM6 billion, that should provide comfort on the fiscal deficit position.

The drop in revenue due to the loss in oil revenue, added with lower expenditure as a result of no fuel subsidy, would result in a slightly higher fiscal deficit of around 3.6 per cent of GDP from the current 3.4 per cent of the GDP projection.”

Meanwhile, the risk for oil prices to go below US$30 per barrel remains high, with AmBank Research citing that the possibility for oil prices to drop to as low as US$20 to US$25 cannot be ruled out.

“Should oil prices reel to such low levels, the additional loss in oil revenue will be around RM11.1 to RM12.6 billion and will add strong upwards pressure on the fiscal deficit/GDP, surpassing four per cent levels,” it forewarned.

“While global central banks are still on a monetary easing pathway, such easing flexibility could soften in the case of Bank Negara Malaysia (BNM). The central bank has reduced in total 50bps from the start of 2020 to bring the OPR to 2.50%.

“There is now a challenge on the monetary policy. With the ringgit being on a more flexible exchange rate, any further easing of the policy rate could add pressure to the ringgit to weaken against the US dollar — in part because the ringgit is vulnerable to the movement of oil prices.

“Besides, a cheaper ringgit due to weaker oil prices compounded with any further monetary easing could pose potential inflationary pressure driven by higher import cost.

“Any potential rate cuts can be instituted modestly only if the global central banks continue to cut rates aggressively. BNM need to look at alternative mechanism like reducing the SRR and inject the addition fund into the Special Investment Fund to support SME businesses.

“With limited fiscal and monetary flexibility, added with ongoing external headwinds and domestic challenges, our base-case GDP growth projection for 2020 is between 2.5 and 3 per cent with an upside of 3.8 per cent.”

To support domestic economic activities, AmBank Research said it was important to revive both the consumer and business confidence, and address the tough job market by expediting policy implementation apart from having consistent policies.

“There is also a need for better engagement between the policymakers and businesses prior to instituting the policies.”