Development spending may be cut

KUALA LUMPUR: While a cut in development spending seems remote for now, a further fall in commodity prices could force the government to consider doing so, especially with a possible credit rating cut looming in the background.

“It all depends on commodity prices. If commodity prices fall further and Malaysia takes a proactive stance, the government may cut its development spending to protect the rating,” said Hong Leong Asset Management’s head of investment Lye Thim Loong at Hong Leong Bank’s 2015 market outlook talk “Seeking growth in the world of divergence” on Saturday.

While the government has tweaked Budget 2015 by trimming its operating expenditure by RM5.5 billion, international rating agency Fitch Ratings on Jan 21 said it would still maintain its ‘negative’ outlook on Malaysia’s long-term issuer default ratings, adding that it was more likely than not to downgrade the country’s ratings within the next 12 to 18 months.

Fitch also noted that the possibility of twin fiscal and current account deficits “will remain a rating sensitivity for Malaysia”. A rating downgrade typically results in a flight of capital from a country, which will then have a weakening effect on its currency.

However, Lye noted that the risk of a downgrade is minimal at this point, so long as the fiscal deficit is kept under the 3.5% of the gross domestic product (GDP) mark.

“I think Malaysia will still run a small current account surplus, provided that oil prices do not trade below US$50 on average for the whole year and crude palm oil (CPO) doesn’t drop below RM2,000 per tonne,” said Lye.

Eastspring Investments Bhd chief investment officer of equities Yvonne Tan warned that cutting development expenditure would be unwise due to its implications on economic growth.

“I don’t like the idea of cutting development expenditure. Unless the underlying growth and consumption are strong, doing so will result in a lower-than-expected GDP growth. If that risk [materialises], the percentage of budget deficit [target] will have to be reworked,” she said. 

According to the government, the RM5.5 billion savings would come from Budget 2015’s operational expenditure that was initially set at RM223.4 billion, while the RM48.5 billion for development spending would remain untouched.

Nevertheless, Tan was “quite cautious” on whether the government would successfully cut its operating expenditure as planned in the budget revisions announced by Prime Minister Datuk Seri Najib Razak.

Lye and Tan were among seven speakers at the talk on Saturday. The others were Hong Leong Bank Bhd global markets chief operating officer Hor Kwok Wai, Schroder Investment Management Ltd’s head of product for Asia Pacific Showbhik Kalra, Franklin Templeton Asset Management (M) Sdn Bhd country head Sandeep Singh, CIMB Principal Asset Management (S) Pte Ltd chief executive officer (CEO) for regional head of equities Ken Goh and Nikko Asset Management Co Ltd head of equity Takashi Maruyama. 

The session was moderated by The Edge Media Group publisher and group CEO Ho Kay Tat, who opined that the combination of high household debt, falling commodities prices, outflow of funds and a weakening ringgit has cast concerns over the ability of the central bank and the federal government to manoeuvre the country out of its current macroeconomic situation.

“We are caught between a rock and a hard place as both fiscal and monetary policies are facing constraints,” said Ho.

Hong Leong Bank’s Hor concurred with Ho’s sentiment.

“The government has a fiscal deficit target of 3.2% — they can’t spend too much more to pump prime the economy. A lot of the levers that are available to us are starting to come down,” he said, adding that Malaysians will need to adjust their mindset to a period of slower growth ahead.

“Many people think that [growth rates] are going to zoom back up to the 6%-7% levels, but many Asian economies are potentially heading towards 2%-4% growth, which, somehow in Malaysia, we don’t seem to be used to,” said Hor. 

He added that this was a “multi-year view” and that slower growth “isn’t necessarily a bad thing”.

Eastspring Investments’ Tan agreed that commodity prices are a key factor. “The impact is actually quite big if oil prices stay at the current level. If we don’t further cut our budget, the budget deficit will go to 3.4%, as there is a 0.2% change [in the budget deficit] for every US$5 per barrel drop in oil prices,” she said.

She noted that Malaysia’s dependency on the export of liquefied natural gas (LNG) was also a concern.

“If oil price continues to be weak for a prolonged period, there is a negative impact on LNG price and the LNG price will adjust. With all that supply coming out, I’m not optimistic about the scenario I’m looking at,” she further added.

On the expected interest rate hike in the US, Schroder Investment’s Kalra said the markets are “much better prepared” for the hike and that Asia is unlikely to experience a shock to its markets as seen in May 2013, when interest rates rose sharply and caused a panic in financial markets worldwide.

This article first appeared in The Edge Financial Daily, on January 26, 2015.