AsiaInt Focus
AsiaInt Focus Archive


This article was first published in the October 2002 issue of the AsiaInt Economic Intelligence Review.

On 20 September, Malaysia’s Prime Minister Mahathir Mohamad outlined details of what in all probability will be his last budget. As is perhaps fitting given the significance of the occasion, his package for 2003 is arguably the most ambitious of his 21-year premiership, not simply because of the targets he sets but also for what such a budget represents for the stature of Malaysia’s economy.
In essence, the 2003 budget is aimed at cutting Malaysia’s dependency on the external sector, whether exports or foreign direct investment (FDI), instead making domestic businesses and industry the main growth drivers. Mahathir believes that Malaysia can achieve 6.0%-6.5% growth next year under its own steam, and he is also determined that 2003 will witness a tightening of the purse strings as "the government cannot continuously implement expansionary fiscal policies". The idea cannot be faulted for a lack of ambition; strong, reliable growth combined with a low fiscal deficit has long been the dream of South-East Asia’s trade-dependent economies. However, whether such a plan is feasible is another matter.
Without doubt, the highlight of the 2003 budget was the omission of a widely expected cut in the corporate tax rate. In May, Singapore’s fiscal 2002 budget cut the corporate tax rate to 22%, partly to encourage business to drive the economic recovery and partly to ensure it kept up with its regional competitors. Of these, the most serious threat is posed by Thailand which, according to a survey published last month by management consultants A T Kearney, is South-East Asia’s most attractive FDI destination. In December 2001, Thailand stated its intent with an extensive package of FDI incentives which included a 10% corporate tax rate for regional headquarters opening in Bangkok.
Against this backdrop of a region upping the stakes in a desperate attempt to counter China’s apparent monopoly of foreign inflows, it was widely expected that Mahathir would follow suit and cut Malaysia’s corporate tax rate across the board from 28% to 20%. He resisted the temptation, saying: "It [the fall in FDI] is not because of the corporate tax rate. When the rate was 40%, foreign investors still invested in Malaysia but now at the rate of 28% FDI has declined." Mahathir conceded that China lay at the heart of the declining FDI inflows, but in a move that might set an interesting precedent for the rest of South-East Asia, he all but admitted defeat: "Even if we reduce the corporate tax rate, FDI will still go to China."
The Malaysian prime minister continued: "We have realized that we are overdependent on foreign investment, FDI, and external trade…That is why we want to increase the domestic industries and manufacturing sector’s contribution to the economic growth without reducing our trade with foreign countries." To this end, it was small to medium-sized enterprises (SMEs) that were the beneficiaries of the tax cut rather than the multinationals as Mahathir looks to bolster considerably competition in the domestic market. Indeed, in an attempt to reverse the outlook completely, the budget offers substantial cuts to Malaysian companies that penetrate new markets, with a 50% income tax exemption for such expansionary companies topping a 30% exemption for those which increase their exports.
It is hoped that such measures, combined with a modest increase in planned government expenditure (the 2003 budget is worth 110bn ringgit ($29bn), 9.2% above this year’s), will not only offset whatever should happen in an increasingly uncertain global export and investment market but will also serve to give Malaysia its strongest growth since the heady pre-crisis days of 1997. To make the 6.0%-6.5% growth a reality, manufacturing will rise 8.5% year-on-year against an estimated 5.1% growth this year, while private consumption will expand 7.6% and public consumption 8.5%.
And all this will come in a year when the fiscal deficit will be cut to 3.9% of GDP from an estimated 4.7% this year, which begs the question of where the money will come from. In some quarters it has been suggested that the plan is simply not feasible in isolation and that the government will have to resort to overseas borrowing, possibly to fund an extra budget in 2003 as it will not want to increase taxes with an election looming in 2004.
It is difficult not to concur. Indeed, for all Mahathir’s talk of Malaysia’s economy becoming insulated against external factors, the budget nonetheless works on the assumption that exports will expand 10.4% in 2003 against growth of 4.5% forecast for this year. Given that Malaysia’s exports in 2001 amounted to 101.2% of its GDP, a dependency on trade is not going to be easy to break. And actually, the assumption that the export market is going to pick up in the second half of this year into 2003 is nowhere near as widespread as previously. The recovery in the US is still at best stuttering, and with a war with Iraq looking increasingly likely, uncertainty abounds, with a double-dip recession still not discountable.
Malaysia’s August export figures showed the effect of a drop-off in orders from the US, which accounted for 21% of exports for the month. For no sooner is Malaysia registering growth of 13.8% year-on-year – its second consecutive month of double-digit growth – than economists are already warning of a slowdown, with exports up just 1.6% on the month, largely due to a 5.3% month-on-month fall in shipments to the US.
That said, exports to China, South Korea, and Japan took up the slack in the second quarter and should continue to grow in the future. But whether North Asia can support growth in excess of 10% next year without a fully functioning US economy is an entirely different matter. The early indications are not good; the 3.2% month-on-month fall in August’s industrial-production index (IPI) does not bode well.
It is likely, therefore, that something will have to give next year. Growth forecasts will either have to be cut, or the fiscal-deficit target will need to be revised. But this is no disaster for Malaysia. Mahathir’s ambition is as much as anything inspired by a surprisingly good 2002, which has been crowned in recent months by ratings upgrades by both Standard & Poor’s in August and Moody’s Investors Service in September.
According to Standard & Poor’s: "The affirmation reflects [the] expectation that the Malaysian government’s economic policies and its commitment to corporate restructuring will not falter as a result of the retirement of Prime Minister Mahathir and the transition to his successor." Moody’s meanwhile cited Malaysia’s demonstrated economic resilience in the face of volatile external conditions, and the implementation of domestic corporate and banking-sector reforms.
Both agencies referred specifically to the achievements of the Corporate Debt Restructuring Committee (CDRC) which was established in 1998 in the wake of the Asian financial crisis and which closed down on 15 August this year. Set up primarily to dispose of non-performing loans (NPLs) from the banking sector, the CDRC managed in under four years to reduce the NPL rate from 21.6% (on a three-month basis) to 11.2%, raising 43.9bn ringgit ($11.5bn) along the way. And it managed this without the legal powers to force lenders and borrowers into compromise.
The success of the CDRC is reflective of a change in the way Malaysia perceives itself and thus how it is perceived by others. Both Standard & Poor’s and Moody’s appreciated that Malaysia is committed to establishing an efficient and transparent economy that has the potential to dominate Asia in years to come. Mahathir’s 2003 budget is ambitious, perhaps overly so, but it demonstrates the intentions of his country. It might be too early to talk of independence from the global economy, but the markets are unanimous that Malaysia is headed in the right direction, and with sentiment counting for so much, a little bit of optimism never hurt anyone. It might even bring the FDI back; not that that will matter to Mahathir, of course.

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