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| WIKILEAKS: Malaysia's 2008 Budget: Pork Sold Separately Posted: 14 Oct 2011 01:00 AM PDT
The issue the Prime Minister isn't bringing up for this election-year budget is the problem of declining oil revenues. Petronas provides 35 to 40% of the GOM's budget. However, Malaysia is projected to be a net importer of oil within the next several years, based on a continued trajectory of 4% annual increases in domestic demand. This is a major problem because Petronas is obliged by the GOM to provide oil and gas for the domestic market at subsidized prices and it is responsible for covering the price gap between international and domestic prices. THE CORRIDORS OF POWER Raja Petra Kamarudin
1. Summary: On September 7, Prime Minister Abdullah Ahmad Badawi unveiled his 2008 budget proposal. Billed as a "fiscally responsible" budget, it projects a deficit of 3.1%, down from 3.2% in 2007. Although spending is up, the GOM projects higher GDP growth will generate more than adequate additional revenue flows to compensate for it. The Prime Minister (PM) also announced that he expects the private sector, including foreign investors, to help fund government-initiated development plans. While the budget contained some important new tax provisions including a welcomed decrease in corporate tax rates, simplified tax collection on dividends, and enactment of additional tax preferences for the Islamic financial sector, the most important tax reform measure, implementation of the new Goods and Services Tax (GST) proposed in 2004, was missing. In a panel discussion following the release of the budget, Ministry of Finance officials insisted it was still on the table. However, absent up-front support from the PM and with elections just around the corner, the GOM is unlikely to submit a GST proposal to Parliament in the coming year. This leaves the GOM without an answer to how it will reduce its dependence on revenues from the oil sector, even though depleting oil reserves imply this revenue stream will shrink in the near future. Absent tax broadening measures like the GST, the GOM, which currently gets 38 percent of its revenue from the national oil company, will find it increasingly difficult to maintain its fiscal deficit within manageable bounds over the next decade. End summary. First, what the budget didn't do: 3. For an election year budget, many Malaysians were surprised by what it did not do. A widely anticipated voter-friendly cut in the top individual income tax bracket did not materialize, but neither did any additional "sin" taxes (on tobacco or alcohol) which the GOM tends to increase every year. Consistent with its billing as a "fiscally responsible" budget, no large new development projects were announced as part of the budget. However, the Prime Minister already had announced plans to invest heavily in three regions on the peninsula, including the "Iskandar Development Region" bordering Singapore, plus Northern and Eastern Corridor Regional Development Plans. Similar regional development projects are rumored to be in the works for East Malaysia as well. The Prime Minister announced that he is relying in large part on the private sector to finance these government initiatives. Reducing the deficit? A closer look at the numbers: 4. A closer look at the numbers shows that the GOM's formula for lowering the deficit is a result of two underlying assumptions, both of which have been received with some skepticism by local analysts. The first assumption is that real GDP will grow by 6 percent to 6.5% - a projection that analysts find somewhat optimistic. (Currently GDP is growing at approximately 5.7%.) The second assumption is that the private sector - particularly foreign investors - will provide the lion's share of the funding needed for the three regional development plans laid out by the Prime Minister. Spending up 2.5% from last year 5. Total budget expenditures (operating and development) for 2008 are RM 168.8 billion ($ 48.2 billion) in 2008, up 2.5% from RM 164.7 billion ($ 47 .1 billion) in 2007. Operating expenses up: 6. Operating costs will grow 4% to RM 128.8 billion ($ 36.8 billion) in 2008. Salaries comprise 28.1% ($ 10.3 billion) of operating expenditures and fixed charges and grants 49.6% ($ 18.3 billion). $ 11.4 billion for development: 7. Gross development expenditure is budgeted at RM 40.0 billion ($ 11.4 billion), 2.1% lower than the revised allocation of RM 40.9 billion ($ 11.7 billion) in 2007 as the government intends to count on the private sector to drive economic growth. This 8% reduction came as a surprise to many analysts, some of whom had projected an allocation of RM 48 to 50 billion ($ 13.7 to 14.3 billion) for 2008. However, the Ministry of Finance also may tap into its supplementary allocation of US$ 2.35 billion when the government does a mid-term review of the Ninth Malaysian Plan in mid-2008. 8. The biggest slice of the $ 11.4 billion development budget will go to education and training with $ 2.1 billion (18.4%), transport $ 1.9 billion (16.9%) and security $1.4 billion (15.2%). Trade & Industry and agriculture will receive $ 1.1 billion (9.7%) and $ 1.05 billion (9.4%) respectively. Plans to cut subsidies? 9. Subsidies will constitute 7.9% ($ 2.9 billion) of operating expenditures, declining 15.8% from 9.8% ($ 3.5 billion) of operating expenditure in 2007, indicating the government will possibly reduce fuel subsidies (perhaps on gas) in 2008. Fuel subsidies are about three quarters of the total subsidy payment. So far, the government has kept its promise not to raise domestic fuel prices this year as crude oil prices continue to rise. High oil prices to keep a lid on deficit, for now: 10. Despite the increase in public spending, the government announced that it expected the fiscal deficit to remain under control at RM 20.9 billion ($ 6.0 billion) or 3.1% of GDP in 2008, down from an estimated RM 19.9 billion ($ 5.7 billion) or 3.2% of GDP in 2007. The government projected revenue to increase 3.7% to RM 147.1 billion ($ 42 billion) in 2008 from RM 141.8 billion ($ 40.5 billion) in 2007, based on an assumption that oil prices will average $ 74 per barrel in 2007 and $ 75 per barrel in 2008. Oil-related revenues are expected to contribute $ 15.9 billion or 38% of total revenue in 2008, up marginally from $ 15.3 billion or 37.9% of total revenue in 2007. (Comment: As the petroleum income tax collection is based on preceding year's income, the government can be confident of its oil revenue in 2008. National oil company Petronas' dividend payment to the government will accelerate to $ 6.9 billion in 2007 from $ 5.1 billion in 2006.) New tax provisions: 11. Following are the most significant changes to the tax code proposed in the 2008 budget: -- Corporate tax, reduced from 28% in 2006 to 27% in 2007, will be reduced further to 26% in 2008 and 25% in 2009. This compares favorably to most countries in the region, with the exception of Singapore (18%) and Hong Kong (17.5%). Vietnam, China, Thailand, India, Indonesia and the Philippines all have higher corporate tax rates, ranging from 28% to 35%. (Taiwan's corporate tax rate is also 25%, but there is an additional 20% withholding tax on dividends.) -- Tax on dividends will no longer be adjusted to meet the recipient's tax rate. Currently, taxpayers in brackets above the corporate rate are required to pay the difference; taxpayers in brackets below the corporate rate are eligible for a refund. (Dividend payments are not subject to double taxation in Malaysia.) Companies may opt for a six-year phase-in of this new provision. -- Small and Medium-sized Enterprises (SMEs) will be exempt from filing monthly tax estimates and paying monthly installments for the first two years of operations. Tax for the full two years will be liable upon filing at the end of the two years. A SME is defined as a company with ordinary paid-up share capital of less than RM 2.5 million (US$ 727,000). -- Information & Communication Technology (ICT) companies will be required to locate within specified geographic areas to retain current tax incentives. ICT companies will qualify for an exemption of import duties and sales tax for broadband equipment not produced in Malaysia. -- Income derived from trading of Certified Emission Reduction (CER) certificates will be tax exempt. -- Tax relief will be provided for post-graduate studies, sports and exercise equipment, children's educational accounts, computers, broadband subscription fees, and some retirement benefits. -- Expatriate income tax will be calculated according to the number of days physically present in Malaysia. -- A 7% cap on deductions for approved charitable contributions will be extended to individual taxpayers as well as companies. (Currently only companies are subject to the cap.) -- Companies located in the Labuan Offshore Financial Center can make an irrevocable election to be taxed at the regular Malaysian rate, allowing them to benefit from bilateral tax treaties that otherwise would exclude them. -- Taxpayers will be permitted to make mortgage payments out of their retirement savings accounts. -- A number of new incentives will be enacted for companies engaged in Islamic finance, including Islamic insurance (reftel). Comment: 12. The issue the Prime Minister isn't bringing up for this election-year budget is the problem of declining oil revenues. Petronas provides 35 to 40% of the GOM's budget. However, Malaysia is projected to be a net importer of oil within the next several years, based on a continued trajectory of 4% annual increases in domestic demand. This is a major problem because Petronas is obliged by the GOM to provide oil and gas for the domestic market at subsidized prices and it is responsible for covering the price gap between international and domestic prices. This of course eats away at its profits and its taxable income which is so essential to government revenue flows. While Petronas increasingly expands its operations overseas, it is unlikely to be able to do so rapidly enough to compensate for lost revenue when oil imports exceed exports. The problem of preventing a ballooning fiscal deficit when that happens is the elephant that everyone pretends not to see. KEITH (September 2007)
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| WIKILEAKS: Islamic Finance in Malaysia Part 2: Obstacles and Opportunities Posted: 13 Oct 2011 01:00 AM PDT
The concept of the time value of money is ignored, and the difference between the purchase and resale price is attributed solely to risk. A blind eye is turned to the fact that compensation for "risk" is equal to what a conventional bank would charge in interest, and this "risk" even can be compounded daily. Practitioners acknowledge this and other "impurities" in how Islamic finance is carried out, but hope that someday the industry will grow big enough to establish its own benchmarks. THE CORRIDORS OF POWER Raja Petra Kamarudin
1. (U) Summary: Malaysia is determined to become a global hub for Islamic Finance, and already accounts for two thirds of outstanding Islamic bond issuances (reftel). However, at a recent conference in KL, financial experts discussed a number of obstacles holding back development of this niche market. Chief among them was the inadequacy of the secondary market and the lack of Islamic derivative products. Higher legal fees and complications arising out of the need for Sharia compliance were a burden as well. Nevertheless, the Malaysian government remains optimistic and content to have a pragmatic approach to development rather than get hung up on the need for a "purist" approach to Sharia compliance. End summary. Central Bank Governor Claims 40% Annual Growth in Islamic Bonds 2. (U) At the 2nd Malaysian Islamic Finance Conference in Kuala Lumpur last month, Central Bank Governor Dr. Zeti Akhtar Aziz announced that Malaysia accounted for about two-thirds of outstanding Islamic bonds throughout the world, amounting to roughly US$47 billion in 2007. High savings rates in Asia and the Middle East were driving demand, she said, resulting in an average growth rate of 40% per year in the scale of the Islamic bond market. How to Build the Industry 3. (U) While Governor Zeti focused largely on Malaysia's success with Islamic bonds, other speakers at the conference focused on what needed to be done to build the industry. Malaysia's RHB Islamic Bank chairman Vaseehar Hassan urged Malaysian Islamic banks to venture overseas and establish links with Middle Eastern markets, while also calling for non-Malaysian banks to issue Islamic bonds in Malaysia. Still a Developing Capital Market 4. (U) Investors at the conference complained that the Islamic derivative market was inadequate, and that there was almost no secondary domestic market for Islamic products. There are simply too few players and intermediaries, they commented, so most investors prefer holding their investments. Moreover, few Islamic derivative products exist. Some investors also accused banks of not being transparent in risk management due to the lack of Islamic derivatives for hedging purposes. Similarly, international rating agencies have noted the difficulty in rating Islamic products as there are few products for benchmarking. In the case of Islamic REITs (Real Estate Investment Trust), Moody's Representative Director Christina Maynes said it was very much a conventional REIT in Malaysia's case. However, she commented that Middle Eastern investors generally preferred to invest in real estate directly. Double the Legal Fees 5. (U) Issuers complained about the difficulty and higher cost in coming up with Sharia-compliant products. Legal fees essentially double with the added layer of a board of Islamic scholars who must adjudicate Sharia-compliance. Sharia-compliance a high bar to meet 6. (SBU) In addition, Sharia compliance is stringent: in addition to the basic prohibitions, like alcohol, gambling, etc., income from interest and debt to asset ratios must be below certain thresholds. Ed Teather, Executive Director and Senior Economist for ASEAN Research, told ECONOFF that these kinds of requirements made Islamic finance theoretically viable for refinancing existing assets, but nearly impossible to finance a new initiative that exists only as a blueprint or a business plan. In addition, he pointed out that with the current excess liquidity in the market it simply did not make economic sense for corporations to go to the added trouble and extra expense of issuing Islamic products. Shortage of experts 7. (U) Yet another barrier is a lack of skilled Islamic finance professionals. Banking professionals are seldom proficient in Sharia, while Islamic scholars are seldom proficient in finance. The GOM is providing scholarships to Malays who want to study Islamic finance and has established a training entity funded and coordinated through the Central Bank. The 2008 budget proposes to exempt expatriate Islamic finance professionals from paying income tax in an effort to attract more talent from the Middle East. Working Towards Becoming "Purely Islamic" 8. (U) Islamic finance, as it is currently practiced, is not regarded as "pure" by many practitioners and scholars. However, there is a general consensus among these experts on the need to build the industry until it can become independent of the global conventional finance system. Until then, interest rates remain the fundamental benchmark for pricing and the mingling of Islamic and conventional assets will continue. 9. (U) Islamic finance, which forbids charging interest, uses an underlying asset to structure a "trade" as a substitute for a loan. For example, a contract is written to buy a specific amount of wheat and then re-sell the wheat at a specified later date at a different price. The price difference can be used to finance an entirely unrelated transaction. The concept of the time value of money is ignored, and the difference between the purchase and resale price is attributed solely to risk. A blind eye is turned to the fact that compensation for "risk" is equal to what a conventional bank would charge in interest, and this "risk" even can be compounded daily. Practitioners acknowledge this and other "impurities" in how Islamic finance is carried out, but hope that someday the industry will grow big enough to establish its own benchmarks. 10. (SBU) The concerns of some practitioners go further. Rafe Haneef, Citibank's Head of Islamic Finance for Asia, told ECONOFF that in order to truly practice Islamic finance, one had to be concerned about what the next customer did with the wheat even after the Islamic bank no longer held title to it. The wheat could be sold for consumption, but once it had been used in an Islamic transaction, it should not be used in any interest-bearing transaction. He said this would be "like selling grapes to a winemaker." 11. (SBU) Because the market for Islamic finance remains small, some mingling of funds is inevitable, as there simply are not enough Islamic financial products available. "All roads lead to U.S. Treasury bonds eventually," explained David "Daud Abdullah" Vichary, a longtime Islamic finance practitioner and British national. As the same money gets circulated, it is impossible to shelter it from conventional finance, he told ECONOFF. Comment 12. (U) Whether or not Islamic finance will overcome its obstacles and become a major global industry remains an open question. The vision of its promoters is to tolerate a bit of un-Islamic "impurity" for now out of necessity, but to gradually move toward a "purer" form as the industry grows. In Malaysia, with the government in an activist mode, the approach to Islamic finance is more pragmatic than pure, and it appears to be a growing reality. KEITH (September 2007)
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