Subsidy restructuring? Reality bites.....

Oleh lipantata

"Restructured fuel subsidy system. The revamped subsidy system will be effective on 5 June 2008. Petrol price was raised by 78 sen or 40.6% to RM2.70/litre (RM1.92 previously) and diesel price by RM1 or 63.3% to RM2.58/litre (RM1.58 previously).

The fuel prices will be reviewed every month in line with global oil prices. The full-fledge implementation of the subsidy system would eventually lead to market pricing of fuel prices in August. The electricity tariffs will be raised by 18% for households and 26% for the commercial and industry users w.e.f 1 July 2008.

Overall impact is negative. The economy will go through a period of adjustments depending on the size and duration of the shock. Given the convergence of external risks and domestic-induced risks, the adjustment will be significant. It is short-term pain but long-term gain for the economy. We cut our real GDP estimates to 5.3% (from 5.8% previously) for 2008 and 5.0% (from 5.5% previously) for 2009. Impact on domestic demand. As fuel and food are core elements in Malaysian household budgets, higher fuel prices along with other price increases will reduce disposable income and demand. Increased cost of doing business and margin compression would erode producers’ profits and may cause them to cut back on output. We revise lower our estimates for private consumption growth to 6.3% in 2008 (from 7.0% previously) and 5.5% in 2009 (10.8% in 2007). Likewise for private investment growth to 6.5% in 2008 (from 7.1% previously) and 6.6% in 2009 (12.3% in 2007).

Impact on sectors. There will be some measurable impacts on the broad sectors of the economy (transportation and logistic industry, food retailers, petty traders, auto, construction, consumer, media, property and toll operators).

Impact on fiscal deficit. It is estimated that the reduction in subsidy will result in a saving of RM13.7bn and hence, will help to reduce the fiscal deficits over time. The savings from the removal of subsidies will be channelled towards stabilising food prices. The removal of subsidies reflects the government’s commitment to fiscal consolidation and hence, is positive for the country’s sovereign debt ratings.

Impact on inflation. We estimate the headline inflation to rise sharply to 6.4% in June this year and will remain elevated between 5.6% and 6.1% in 2H08. On a full-year basis, we revise this year’s CPI growth estimate to 4.7% from 3.0% previously. For 2009, we project the average CPI growth will moderate to 3.0% as the impact of the fuel price hikes lapse.

Interest rates – to raise or not to raise? Bank Negara Malaysia(BNM) has to confront the opposing forces - the upside risks to inflation (largely cost-driven and global factors) and the downside risks to growth (anticipated in 2H08). Tinkering interest rates to alleviate the cost-driven inflation may not be the appropriate strategy. We expect BNM to keep the OPR steady at 3.50% for now though the risk of tightening bias has risen materially. The future monetary policy decision will be highly data dependent.



Regards,
AFM
"