Identifier
Created
Classification
Origin
06KUALALUMPUR1832
2006-09-29 09:38:00
UNCLASSIFIED
Embassy Kuala Lumpur
Cable title:  

THE 2007 BUDGET: LET THE GOOD TIMES ROLL FOR NOW

Tags:  ECON EFIN EPET EINV MY 
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RR RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHKL #1832/01 2720938
ZNR UUUUU ZZH
R 290938Z SEP 06
FM AMEMBASSY KUALA LUMPUR
TO RUEHC/SECSTATE WASHDC 7632
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHGV/USMISSION GENEVA 1428
RUCNASE/ASEAN MEMBER COLLECTIVE
UNCLAS SECTION 01 OF 03 KUALA LUMPUR 001832 

SIPDIS

STATE PASS USTR - WEISEL AND JENSEN
STATE PASS FEDERAL RESERVE AND EXIMBANK
STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN
USDOC FOR 4430/MAC/EAP/J.BAKER
TREASURY FOR OASIA AND IRS
TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN
GENEVA FOR USTR

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EPET EINV MY
SUBJECT: THE 2007 BUDGET: LET THE GOOD TIMES ROLL FOR NOW

REF: Kuala Lumpur 003906

UNCLAS SECTION 01 OF 03 KUALA LUMPUR 001832

SIPDIS

STATE PASS USTR - WEISEL AND JENSEN
STATE PASS FEDERAL RESERVE AND EXIMBANK
STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN
USDOC FOR 4430/MAC/EAP/J.BAKER
TREASURY FOR OASIA AND IRS
TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN
GENEVA FOR USTR

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EPET EINV MY
SUBJECT: THE 2007 BUDGET: LET THE GOOD TIMES ROLL FOR NOW

REF: Kuala Lumpur 003906


1. Summary: Savoring the blessings of higher oil prices, Prime
Minister Abdullah announced his first expansionary budget after two
years of fiscal tightening. Higher public spending is expected to
fuel domestic demand and provide a jumpstart for the Ninth Malaysian
Plan. The 2007 budget builds on initiatives in the two previous
budgets designed to enhance Malaysia's long-term competitiveness.
The government hopes to improve public service delivery, increase
the development of human capital, and address socioeconomic
imbalances. It also offers targeted assistance for favored sectors
such as biotechnology, information technology, communications,
agriculture and Islamic finance. Business received a pleasant
surprise in the form of a reduction in the corporate tax rate from
28% to 27% in 2007, and to 26% in 2008. However, despite tax cuts
and higher expenditures, the budget deficit will remain comfortable
at 3.4% of GDP thanks to the windfall revenue from higher oil
prices. The government remains optimistic that the economy will
grow 5.8% in 2006 and 6.0% in 2007. But there are clouds on the
horizon in the form of softening oil prices and a weakening global
economy that may have government forecasters reaching for their
umbrellas.
End Summary.

Higher Fiscal Spending to Fuel Growth
--------------


2. Prime Minister (and Finance Minister) Abdullah presented
Malaysia's 2007 budget to Parliament on September 1. Total budget
expenditures for 2007 are RM 157.5 billion ($42.6 billion),up 11.6%
from RM 141.2 billion ($38.2 billion) in 2006. The budget aims to
sustain Malaysia's economic growth through higher fiscal spending,
which is expected to boost domestic demand. More importantly, the
budget provides for a substantial 24.3% increase in development
expenditure to RM 44.5 billion ($12 billion) to jump start the Ninth
Malaysian Plan (9MP). (Comment: The allocation for development was

higher than expected. Some outside analysts believe the government
is concerned about sustaining growth in a weakening external
economic environment. Others perceive a political motivation,
citing the importance to Abdullah's administration of a making a
fast start to 9MP.)


3. The budget also calls for an increase in operating expenditures,
but by a slower rate of 7.2%. Operating costs will grow to RM 113
billion ($30.5 billion) in 2007. Subsidies alone constitute 10.5%
($3.2 billion) of operating expenditures. In 2006, about three
quarters of the total subsidy payment of $3.05 billion was spent on
fuel subsidies, despite an RM0.30 ($0.08) per liter hike in the
price of gasoline in early 2006.

Fiscal Deficit Under Control
--------------


4. Despite the increase in public spending, the government expects
the fiscal deficit to remain under control at RM 20.2 billion ($5.4
billion) or 3.4% of GDP in 2007. This compares to an estimated RM
19.3 billion ($5.2 billion) or 3.5% of GDP in 2006. The main reason
is windfall revenues from higher oil prices. The government
projects revenue to increase 11.8% to RM 134.8 billion ($36.4
billion) in 2007 from RM 120.6 billion ($32.6 billion) in 2006,
based on an assumption that oil prices will average $70 per barrel
in both 2006 and 2007. On this basis, oil-related revenues would
contribute $14.4 billion or 39.9% of total revenue in 2007, up from
$12.2 billion or 37.3% of total revenue in 2006. (Comment: As the
petroleum income tax collection is based on preceding year's income,
the government can be relatively confident of its oil revenue in

2007. National oil company Petronas' dividend payment to the
government will balloon to $4.3 billion in 2006 from $2.9 billion in

2005. The dividend alone is sufficient to cover the cost of the
fuel subsidies the government provides to Malaysian consumers.)
Private analysts estimate that every $1 per barrel increase in crude
oil prices would increase government revenue by RM 500 million ($
135 million) over two years.

Optimistic Growth Forecast
--------------


5. The Treasury projects 5.8% real growth in GDP in 2006 and 6.0%
growth in 2007. Although this represents a downward revision in the
government's growth forecast for 2006, some private analysts think
it is optimistic. In September, the Asian Development Bank (ADB)
lowered its forecast for Malaysia, from 5.5% to 5.2% in 2006 and

KUALA LUMP 00001832 002 OF 003


from 5.8% to 5.0% in 2007. In making the change the ADB cited
expectations of slowing growth in the U.S. economy and softening
world demand for IT products. In July, the Malaysian Institute of
Economic Research (MIER) forecast that the Malaysian economy would
grow 5.2% in 2006 and 4.8% in 2007. Finance Minister II Mohamed Nor
Yakcop insisted that the government's growth targets could be
achieved as its forecasters had already factored in the chances of a
weakening external environment. Most local private forecasters are
projecting growth of around 5.6% at most in 2006, but there are a
few who share the government's view that real GDP growth could hit
6% next year.

The Budget Goals
--------------


6. The 2007 budget is the first to address the implementation of
the Ninth Malaysian Plan (9MP),the government's 5-year development
plan. Like its predecessors, it also aims to support Malaysia's
national objective of achieving developed country status by 2020.
The budget features five key "thrusts":
-- Moving the economy up the value chain;
-- Raising the capacity for knowledge and innovation;
-- Addressing persistent socioeconomic inequalities;
-- Improving the standard and sustainability of quality of life;
and
-- Strengthening institutional implementation and capacity.

Where Does the Money Go?
--------------


7. Practically all sectors will receive more government support
because of the increased development expenditure allocation ($12
billion) for 2007. Education and training receive the largest
share: $2.1 billion or 17.8% of development expenditure. Transport
receives $1.97 billion or 16.4%, security $1.8 billion or 15.3%,
trade and industry $1.4 billion or 11.5% and agriculture $1.1
billion or 9.3%.


8. The budget allocates RM 27.5 billion ($7.4 billion) to the
construction sector for roads, public housing and other
infrastructure. In particular, the Klang Valley area that includes
Kuala Lumpur will receive RM10 billion ($2.7 billion) for new light
railway links. This injection of funds is expected to revive the
politically-connected construction industry, which experienced two
years of contraction in 2004-05 and is projected to increase only
0.3% in 2006.

More Goodies for Favored Parties
--------------


9. Business was pleased by an unexpected cut in corporate tax rates
from 28% to 27% in 2007 and 26% in 2008. The government clearly was
concerned to bring Malaysia's tax rates closer to regional
competitors Hong Kong (17.5%),Singapore (corporate tax 20% and VAT
5%) and Taiwan (corporate tax 25% and VAT 5%). Following widespread
protest by businesses, who wanted more time to prepare, the
government delayed the planned introduction of a VAT in 2007 until
possibly 2009. To further promote Islamic financial services, the
budget allows full tax exemption for 10 years for income derived
from Islamic banking and takaful businesses conducted in
international currencies. Currently, the majority of Islamic
banking and takaful businesses are transacted in ringgit.
Foreigners are exempted from paying tax for profit and interest
income derived from Islamic financial institutions. In addition,
the government lowered the withholding tax for returns from Real
Estate Investment Trusts (REIT) from 28% to 15% for individuals and
20% for institutions for 5 years. REITs also are exempted from
income tax payment if they distribute 90% of their earnings to
investors. (Comment: REITs are relatively new in Malaysia with
only five REITS, including one Islamic REIT. The government is
fostering the development of more REITs, especially those that
comply with Shariah principles, to attract more Middle Eastern
investors.)


10. The government specifically allocated $57 million to support
the development of biotechnology. The government also plans to
provide venture capital for new technology-intensive agriculture
projects, and integrated agriculture and livestock projects. There
also are targeted expenditures to support information and
communications technologies, research and development, and small and
medium sized enterprises (SMEs). Individuals will now be able to
claim tax relief of RM3000 ($811) every three years for the purchase

KUALA LUMP 00001832 003 OF 003


of a personal computer, improving on the current tax rebate of RM500
($135) every five years. The government has been proclaiming 2007
as "Visit Malaysia Year," and to achieve its target of 20.1 million
tourists it is providing more tax breaks for tour operators and for
employers who provide sponsored local trips to their employees.


11. Civil servants were not left empty handed. Government
employees will get a bonus of one to two months' wages and lower
income employees will also receive an increase in their benefits
allowances. Government employees also will be able to seek a 20%
increase in housing loans from the government. Government retirees
will receive a one time payment of RM200 ($54) or RM400 ($108)
depending on their pension. For students from poor families
attending government schools, the government will increase the
monthly allowance from RM30 to RM50 for primary school children and
RM50 to RM70 for secondary school students.

The Only Pain: Higher Sin Taxes
--------------


12. The government increased the excise duties on tobacco products
by 7% to 8% on September 1, raising the duty by one Malaysian cent
per cigarette. This is low compared to previous hikes, but comes on
top of four consecutive years of increases. Likewise, the
government raised the excise duty for liquor with more than 40%
alcohol content by RM5 ($1.35) per liter. Beer drinkers were
relieved that the duty on their beverage of choice remained
unchanged.

Let the Good Times Roll - For Now
--------------


13. Comment: Thanks to the oil price windfall, PM Abdullah has
been able to shift from his previously tight fiscal policy to
generous development spending and moderate growth in other
expenditures, while still keeping the deficit under control.
However, there are clouds on the horizon that could rain on the
party: 1) oil prices could stay below $70 a barrel (they already
are trending downward from that peak); and 2) the increased
development funds may not have the long-term impact the government
desires if they are not spent wisely. If the global economy also
starts to slow, even government economists may start reaching for
their umbrellas.

LAFLEUR