CIMB Research expects pro-business and investment growth budget

BUDGET 2008’s theme is Enhancing Competitiveness and Sharing Economic Prosperity – a continuation of previous policies aimed at sharpening the nation’s competitive edge while creating a favourable investment climate for companies to realise their potential and venture into new growth areas and innovate.

We expect the broad budget measures to continue with the emphasis on strengthening the economy’s competitiveness and resilience to external risks.

The immediate challenge is to stimulate domestic and foreign investments. Private investment grew by 7% in 2006 and is estimated to expand by 8.5% in 2007 and 10.5% in 2008, falling short of the Ninth Malaysia Plan (9MP) target growth of 11.2% per annum during 2006-2010.

Although foreign direct investment (FDI) into Malaysia has improved since 2001, it is still lagging behind regional peers. Malaysia attracted US$6bil FDI in 2006, low compared with China (US$78.1bil), Singapore (US$24.2bil), Indonesia (US$7.5bil) and Thailand(US$9.8bil).

Higher fiscal spending to carry the day

The Finance Ministry is expected to maintain 2007’s gross domestic product (GDP) growth estimate at 6% and 6%-6.5% growth for 2008. This will be underpinned by stronger domestic demand, higher private and public investments as well as a steady recovery of exports. We are looking at 5.6% this year and 6.3% in 2008.

The Federal Government is expected to budget for a sizeable development spending of RM50bil or 7.4% of GDP in 2008, given the projected revenue growth of 6%-6.5%. This represents a rise of 12.4% over 2007’s budgeted expenditure of RM44.5bil or 7.2% of GDP.

With the mid-term review of the 9MP due in 2008, it is of outmost priority that all the ministries and agencies implement and execute the projects expeditiously, without any leakages or wastage. Budget 2008 is crucial as it comes midway through the 9MP.

We expect the budget deficit to amount to RM23.4bil or 3.5% of GDP in 2008, compared with an estimated RM21.4bil or 3.4% of GDP in 2007.

Revenue collection is expected to remain strong, underpinned by

(i) still strong economic growth;

(ii) average crude oil prices of US$65 per barrel (bbl) in 2006, US$65-70/bbl in 2007 and US$65/bbl in 2008,

(iii) handsome petroleum income tax, dividends, royalties and export duty contributions from Petronas (RM49.4bil or 40.9% of total revenue in 2006); and

(iv) higher contributions from investment income.

The balance of the funding needs will be largely sourced from domestic borrowings through the issuance of Malaysian Government Securities. Federal Government debt (comprising domestic and foreign borrowings) stood at US$72.3bil or 42.4% of GDP as at end-March. Total national debt to GDP has stayed below 50% since 1999 and stood at 32% as at end-2006.

Where will the development allocation go?

Reflecting the development thrusts of raising overall economic efficiency and productive capacity, the economic and social services sectors will get a whopping 80% of the total development expenditure allocation for 2008. This is in line with the 9MP objectives of nurturing new sources of growth, strengthening infrastructural support, improving the public delivery system, developing human resources, providing affordable housing and efficient public transport, and narrowing the regional income disparity.

Over the past six to eight months, news flow on 9MP construction-related projects remained strong and investors continue to expect more announcements of projects, especially water and sewerage projects.

The Federal Government has announced some high-impact projects, including the northern stretch of the double-tracking project, West Coast Highway, second Penang bridge and the Eastern Dispersal link. Besides that, the Government has also launched the Iskandar Development Region (IDR) and Northern Corridor Economic Region (NCER). It is expected to unveil the Eastern Corridor Economic Region – covering Kelantan, Pahang and Terengganu – by year-end.

Possible fiscal and non-fiscal incentives

Overall, the policy pronouncements will centre on the premise that the private sector will be the real engine of growth, supported by an expansionary fiscal policy targeting priority sectors. To sustain domestic demand in the face of higher living expenses, the Government could provide some relief to households and leave more disposable income.

We expect fiscal and non-fiscal incentives aimed at developing value-added industries with high-growth potential such as information and communications technology, biotechnology, modern agriculture, halal food industry, tourism, small and medium-scale enterprises and capital market development, including Islamic finance. The Government has rolled out specific investment incentives to draw investments into IDR and NCER.

  • A cut in personal tax rate to boost consumer spending Budget 2007 announced a two-stage reduction in corporate tax rate by one percentage point each to 27% for year of assessment (YA) 2007 and 26% for YA2008. However, the corporate tax cut was not accompanied by a corresponding reduction in personal income tax, a disparity that we think will encourage tax avoidance.But it is not altogether surprising as it is not a norm for the Government to reduce personal and company tax rates simultaneously. As Figure 1 shows, there has always been a gap of one to two years before personal tax rates are realigned with corporate rate. This suggests that the harmonisation of the maximum individual income tax rate with corporate tax rate may be in store in Budget 2008.
  • Streamlining of existing personal income tax band Alternatively, the Government could consider raising the threshold taxable income brackets. Such a move would reward greater work efforts, which theoretically should boost productivity growth. Another option is higher personal tax relief and relief for spouses.
  • Separate the relief for insurance premiums and EPF contributions The combined premiums/contributions are currently subject to a limit of RM6,000. For many years, the insurance industry has been pushing for separate relief for insurance premiums and contributions to the Employees Provident Fund (EPF). We think it is time to allow for a separate deduction of say, RM5,000 each for insurance premiums and EPF contributions.
  • Up to RM5,000 relief for premiums paid on medical insurance for parents
  • Measures to stimulate the property market We expect the Government to initiate demand-side policies to boost the growth of the property sector as it is estimated to have a multiplier effect of at least two times on the economy. The authorities have announced several measures to help the property market including:(a) the relaxation of Foreign Investment Committee (FIC) regulations on foreign purchases of residential property priced above RM250,000;

    (b) removal of the limit of three residential or commercial property loans extended to non-residents; and

    (c) scrapping of real property gains tax (RPGT) on April 1.

    To further stimulate the property sector and house ownership, the Government could consider the following measures:

    (i) stamp duty exemption for the purchase of residential houses costing not more than RM250,000 on the condition that the sales and purchase agreement is executed within a one-year period;

    (ii) providing relief on interest expense incurred on a housing loan not more than RM250,000 taken to acquire an owner-occupied home (for first-time home buyers); and

    (iii) allowing EPF contributors to withdraw from Account II for the purchase of residential houses provided that the housing loan for the first property has been fully settled.

  • Relaxation of rules to promote real estate investment trusts (REITs) Since the launch of Malaysia’s first REIT in August 2005, the number of REITs has risen to 11, with a combined market capitalisation of about RM5bil. However, the size of the local REIT market is still small compared with those in Japan, Singapore and Hong Kong. Singapore’s REIT industry is said to be about 16 times larger than Malaysia’s.To encourage domestic investors’ participation and attract foreign investors, we see the need to streamline the tax treatment on dividends received from REITs:

    (a) exempt resident and non-resident individuals from the 15% withholding tax on dividends, and

    (b) reduce the withholding tax for non-resident institutional investors from 20% to 10%.

    To spur development of the REIT market, the Government should look into further relaxation of equity participation by foreigners. Currently, foreign shareholding is capped at 49% and bumiputra shareholding must be at least 30%.

  • Promote house ownership and affordable housing The budget is expected to unveil a new initiative or an “innovative” home financing scheme to encourage wider house ownership, especially among the lower-income group or the self-employed.The targeted group refers to households that are having difficulties getting housing loans due to inadequate financial records or lack of a strong credit history. The modus operandi may involve the setting up a revolving housing loans fund with contributions from both the Government and financial institutions.
  • Measures to encourage energy efficiency and reduce greenhouse effect Global warming is an issue of concern in the context of sustainable economic development. The World Bank has said climate change is likely to affect economies in the Asia-Pacific region significantly and these countries need to promote energy efficiency and cut greenhouse gas emissions.Malaysia is a signatory to the United Nations’ Kyoto Protocol but is not obliged to reduce carbon dioxide emission as it is still classified as a developing country. We expect some package of tax incentives to encourage energy efficiency, reduce greenhouse gas emissions and develop renewable energy resources.

    The proposed tax incentives could cover buildings and homes, vehicles, renewable energy and industrial equipment and may take the form of tax credit and capital expenditure allowances for investment in highly energy-efficient building equipment and the purchase of energy-efficient equipment and solar energy systems.

  • National car-scrapping policy to drive the domestic automotive market It is believed that the proposed voluntary scrapping of cars above 15 years and older will be announced on Budget Day. As a start, a cash subsidy will be offered to those purchasing new Proton cars.
  • Encouraging domestic and overseas investment In line with the Government’s objective of encouraging domestic banks to expand regionally, it is proposed that the existing overseas branches of banks should be eligible for income tax exemption for five years.In Budget 2007, only the profits of newly established overseas branches or remittance of profits of overseas subsidiaries are eligible for the tax exemption.

    To encourage mergers and acquisitions, it is proposed that full tax deductions be granted for the cost of goodwill, intangible assets and other merger related expenses incurred. This will significantly reduce the overall cost of mergers and acquisitions.

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