The Edge Daily, June 10, 2008
By Choong Khuat Hock
Malaysia's 14-month high inflation rate at 3.0% in April 2008 has not fully reflected recent price rises. Food, which accounts for around 33% of the CPI weights, was the main contributor to the rise in April's inflation. Added to that now would be the inflationary contribution from the fuel, transport and communications which account for 15.9% of CPI weights. The petrol hike of 40.6% to RM2.70 per litre is the highest in Malaysia's history (see Table 1). This together with an 18-26% hike in electricity prices is likely to push inflation above 5% and curb consumer spending. We are likely to witness what transpired in 2006 when inflation rate averaged 3.6% following a hike in fuel and electricity prices. In 2006, the inflation rate peaked at 4.8% in March following the 18.5% hike in petrol price to RM1.92 per litre on 28 February 2006. As a result of the rising inflation then, consumer sentiments were negatively impacted. The impact will be worse this time as the quantum of the increase is greater.
With this price hike, Malaysians join the rest of the world in facing the unpleasant effects of higher energy costs which will translate to higher costs of goods and services. For example, cement prices will be raised as there is a cost pass through formula for energy costs. Transportation and distribution costs will increase and the cost of producing goods will also rise. The knock-on effects will lead to higher construction costs and property prices. Workers are also likely to demand for higher wages. Malaysia is increasingly dependent on private consumption for growth. Chart 1 shows that private consumption accounted for 52.9% of GDP in 1 Q 2008, a record high. Over 70% of Malaysia's 7.1 % 1 Q 2008 GDP growth came from private consumption which grew by 11.8%. With lower disposable incomes and a rising debt burden (consumer debt to GDP ratio in excess of 60% from only 44% in 1998), weaker private consumption growth is likely to result in GDP growth falling to around 3-5% in subsequent quarters.
Is this the right move? Yes, as Malaysia's budget deficit at 3.2% of GDP in 2007 is high among Asian countries and hence higher subsidies arising from rising food and energy costs cannot be sustained without compromising the financial well being of future generations. The subsidies, besides encouraging a subsidy mentality and economic complacency, have also led to smuggling resulting in exceptionally high per capita consumption of foodstuff at border states. Subsidies also lead to misallocation and distortions in the economy. One reason why oil prices have remained high is that countries like Malaysia and more importantly, China and India, keep fuel and energy prices artificially low and hence demand does not adequately respond to higher prices. A roll back of subsidies will hopefully impact demand growth and put a cap on the oil price.
Is it the right timing? Prices should have been allowed to move up in line with market prices much earlier as is the case in many other countries. This would have allowed consumers to adjust to higher prices in a more gradual fashion. The government could then have argued that the price rises were due to market forces. Instead a futile attempt to keep prices at unsustainable low levels has now led to the highest petrol price hike in Malaysian history. This is likely to provide fodder to the opposition in blaming the government for not keeping to its promises on not burdening the people. Thus, the timing should have been earlier and more gradual and may not be ideal from a political viewpoint. But then, there is never a good timing for bad news!
Now that subsidies have been reduced, more money can be allocated for developmental projects. Reviewing some of the major projects, it would seem that the Penang bridge would be sensible as there is already congestion on the existing bridge. The economics for the RM12.5bn Ipoh to Padang Besar double tracking railway and the RM3.5bn Seremban to Gemas double tracking railway do not appear sensible. The fast train from KL to Singapore costs less than the Ipoh to Padang Besar Railway as it is partially financed by the private sector and the economic benefits would have been far greater as it will link a metropolitan area of 11m comprising Singapore, KL and Johor. Many commuters are likely to take the fast train from KL to Singapore but it is difficult to imagine that many commuters taking the train from Ipoh to the Thai border. It can only be hoped that the RM13.7bn saved a year is not squandered on development projects with questionable economic returns.
With rising inflation, investors may have to make their assets work harder. Interest rates are likely to rise, otherwise, a negative interest rate environment would encourage people to switch into currencies or assets with better returns. The recent run on the Vietnamese Dong was because interest rates at 14% did not compensate for a 25% inflation rate. The Vietnamese authorities have since increased interest rates. Higher interest rates at a time when consumer debt to GDP ratio is at a record high will reduce increase consumers' debt burden and moderate loan growth of banks.
Many sectors will be adversely impacted. All consumer related sectors (including Media, Tobacco, Gaming, Brewery, Banking, Autos, Airlines) will be hit as consumers reel from lower disposable income and higher interest rates. Demand for cars will decline and lower road usage may reduce the revenues of toll operators (e.g. PLUS). Domestic tourism may also be a casualty while lower disposable income and higher airline surcharges are likely to curb air travel which is negative for Air Asia and MAS.
The margins of construction companies will be squeezed by higher building materials and transportation costs. Property companies will have to increase the selling price of new homes due to rising construction and land costs. This together with a decline in disposable income will reduce property transactions. A dip in property prices represents a good opportunity for long-term investors as when the next upswing starts, prices will be much higher. With much higher transportation costs, developers with land bank located far from the city will see demand falling. An inner city revival may be in the making, benefiting property companies with a good land bank near the city.
The windfall tax on plantations and IPPs are a form of market distortion. It makes stock picking trickier as one would have to factor in political interventions. The windfall tax on IPPs above 9% return on assets will impact profits but the impact is minimized as companies like Tanjong and in particular YTL Power derives the bulk of their earnings from other sources. The windfall tax of 15%o n CPO above RM2, 000 per tonne is higher in Peninsular Malaysia at 15% compared to only 7.5% for Sabah and Sarawak. The windfall tax will replace the Cooking Oil Subsidy Scheme (COSS) payable by plantations in Sabah. Therefore, plantation stocks with a large land bank in Peninsular Malaysia like KLK will be negatively impacted while those with a large land bank in Sabah like IOI may be a net beneficiary from the removal of COSS.
Tenaga is the beneficiary as it will be allowed to increase tariffs. Its margins were already being squeezed by an increase in coal prices. The oil & gas sector is unaffected and will continue to benefit from deep sea exploration activities. However, the margins of fabricators may be squeezed by higher raw material and energy costs.
The price hikes are inevitable and Malaysians will have to tighten their belts. Subsidies on many food items remain and will cushion the impact on the poor but like other market distortions, it leads to illegal activities like smuggling. It is hoped that money saved will be spent on developmental projects with justifiable economic returns. The drastic price hikes are likely to have political ramifications especially when the pain sets in. As the unsustainable subsidy shield is being removed, Malaysians are being increasingly exposed to the vagaries of the real world. It is a lesson in adaptability and like most lessons; there is no gain without pain.
Table 1: A History of petrol price hikes
before the 90's - RM 0.89
1990 - RM 1.10 (increased RM 0.21) + 23.596%
01/10/2000 - RM 1.20 (increased RM 0.10) + 9.091%
20/10/2001 - RM 1.30 (increased RM 0.10) + 8.333%
01/05/2002 - RM 1.32 (increased RM 0.02) + 1.538%
31/10/2002 - RM 1.33 (increased RM 0.01) + 0.758%
01/03/2003 - RM 1.35 (increased RM 0.02) + 1.504%
01/05/2004 - RM 1.37 (increased RM 0.02) + 1.481%
01/10/2004 - RM 1.42 (increased RM 0.05) + 3.650%
05/05/2005 - RM 1.52 (increased RM 0.10) + 7.042%
31/07/2005 - RM 1.62 (increased RM 0.10) + 6.579%
28/02/2006 - RM 1.92 (increased RM 0.30) + 18.519%
05/06/2008 - RM 2.70 (increased RM 0.78) + 40.625%
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