Tuesday, July 20, 2010

Is Malaysia's Subsidy Rationalisation Program Justified?

The long awaited subsidy-rationalisation programme in Malaysia has finally kicked in on 16th July after several years of empty words. Although painful and of course an unpopular move, it is deemed as necessary since Malaysia has been facing the worst ever fiscal deficit in 22 years. It was standing at 7% of GDP last year. The no-nonsense Datuk Seri Najib, revealed recently in its ambitious plan of reducing the current budget deficit to 5.3% this year, before halving it by 2015

Although this move has began to attract political football, survey shows that most Malaysians welcome such policy with open arms. The announced decision is an increase in price of essential items like sugar by 25 cents (5 pence), petrol and diesel by 5 cents (1 pence) and LPG (liquefied petroleum gas) by 10 cents (2 pence)

It is applauded since the people are insignificantly affected, unlike the previous hike of 50 cents in petrol (10 pence per litre) few years ago. On top of that the Cabinet promises to monitor the prices of all related items

Why subsidy rationalisation is justified?

(1) Improve government finances. Malaysia has one of the largest ratios in the world in terms of subsidies to government spending. This explains why the nation’s balance sheet has deteriorated significantly in recent years. With rising budget deficit (G>T) hence growing national debt, it is of no surprise international rating agency like Fitch Ratings downgraded us from ‘A plus’ to ‘A’. It may affect Malaysia’s ability to raise funds from overseas shall the need arises

(2) Improve development. So far we have been doing fine. Malaysia is classified as a country with high HDI of 0.829. To improve the ranking much more need to be done. We must further improve our education system. More schools need to be built especially in rural areas. Healthcare is equally important too. With the savings of subsidies by an estimated amount of RM750 million (£ 150 million) from now to end of year, number of hospitals in most needed areas in Sabah and Sarawak (East Malaysia) can be doubled. With ease of access to healthcare, gradual increase in life expectancy should materialise. Others like infrastructures, roads and bridges can be constructed to smoothen and increase the efficiency of business transaction by reducing time of travelling. These are the benefits that will last permanently

(3) Low inflation. Most of the research house has predicted a fairly low level of inflation in Malaysia. The CPI forecast for June 2010 is all below 2%, showing that rise in prices of goods and services are within the reasonable range. Although the rise in oil price might cause cost-push inflation (with AS shifting backward) due to higher cost of transportation, it is expected to have a negligible effect onto the growth in third quarter and throughout the year. Furthermore we have registered a robust 10.1% in the first quarter

(4) Not effective in distributing income. By definition, subsidy means reduction in price so that certain quarters can benefit from the low price, in this case the lower income group. In Malaysian context, government intervention to close income gap through such measure has shown an ‘epic failure’. An owner with garage-full of Ferraris gets equal price of petrol as someone who rides a motorcycle. The rich benefit since their expenditure onto petrol as a percentage of total income is so insignificant. This holds true even for some low-profile millionaires or billionaires who drive an average car

(5) Further discourage smuggling. It happens due to large price differential between countries. As such it creates the incentive for profiteers to practice arbitrage. In Thailand, the price of sugar is RM2.60 (52 pence) while in Malaysia RM1.90 (38 pence). In Singapore, price of sugar is RM3.70 (74 pence). As the price of sugar is expected to increase gradually in Malaysia, arguably smuggling activities will reduce since there will be lesser profits. Don’t forget they still have to bribe officers to get their goods through

(6) Reduce chronic disease. It is an established fact that Malaysians craze for sweetness in their daily diet. We normally have everything coated with sugar, from a simple doughnut to ‘teh tarik’ (name for tea in Malaysia). No wonder we have one of the highest diabetes case in the world. The number has doubled ever since 2000. Also sugar leads to other problems like overweight and this may subsequently develop related illnesses like heart attack

(7) Increase efficiency. Bus operators and cabs will have to be more efficient in order to maintain their profits. To bus firms, certain trips may need to be created while some others slashed. Salary to bus drivers and other maintenance charges will also need to be adjusted. To owners of private vehicle, they may need to plan their journey ahead to avoid travelling unnecessarily and caught in congestion which should cost them more

Why Inflation In UK Is Still High Despite Its Weak Economy?

The British economy is currently suffering from a period of high inflation, something which is usually against the norm especially when the economy is still in a dire state, with unemployment at record level of 8% and house prices on average are 10% below the level last seen in summer 2007

The present inflation rate is lingering around 3.1%-3.5%, much higher than both US and Eurozone of 0.9%. Given the high level of spare capacity due to rising unemployment and unutilised machineries, shouldn’t the inflation fall?

Here are some possible explanations:

(a) Weakening currency. The pound has weakened against major currencies like the dollar and euro in the recent few months. Since these two economies are major trading partners of UK, any changes in the direction will therefore have a significant impact towards the level of inflation. A weaker pound means finished and semi-finished goods from Germany and US will be artificially more expensive. To stay profitable and preserve company’s balance sheet during stormy days, inevitably some of these costs will have to be passed on to consumers in the form of higher price, hence inflation

(b) Higher price of energy. Although the Western economies slow down markedly, this isn’t the case for many Asian economies. Malaysian economic growth is vibrant somewhere close to 10%, Singapore’s growth soared to an unprecedented level of 19.3% in second quarter of 2010 (July 14th 2010) and China despite slowing down is still able to retain double digit growth of 10.3%. The rapid growth rate in Asia explains why oil prices remain obstinately high at more than $80 a barrel as it is widely used to fuel economic activities like shipping, more cars and trucks on the road, more business flights etc. Higher oil price coupled by weakening currency explain why petrol price is high in UK. It will feed through the entire chain of production process as businesses trying to protect themselves

(c) VAT (Value Added Tax). This is similar to sales tax. It was raised to 17.5% early this year, and there it has been confirmed that will be further increased to 20% from 4th January 2011. Although it is a painful measure, it is viewed as necessary to pay off the deficits that Labour government ran up. It is estimated that VAT alone will help to raise £13 billion a year under the Coalition’s ambitious plan to eradicate deficit in five years time. This will cause price of cars, flat screen TVs and many other goods to increase in price

(d) Firms shielding themselves. Another possible explanation for the high inflation is that businesses are trying to protect their own profitability. Since the financial institutions are still surrounded by pessimism, many firm still find it difficult to get the needed financing for their operations. With rising excess capacity hence a fall in demand for goods, these firms will have to raise some of their prices to stay profitable as before especially in segment of goods where demand is still inelastic. Therefore prices are still high