Mahathir Must Temper His Contempt for Markets
Malaysia’s prime minister has made an ill-timed gamble by scrapping the goods and services tax.
Mahathir Mohamad blamed everyone except himself and his policies for his country’s entanglement in the 1997 Asian crisis. It appears two decades haven’t been enough to mellow the Malaysian leader.
The 92-year-old prime minister has won an unexpected second shot at a job he retired from in 2003. But his contempt for markets is still intact.
No, he hasn't returned to calling George Soros a “moron” for betting against the ringgit back then. Nor has he reimposed capital controls. But he’s surely tempting fate by playing ducks and drakes with his country's tax policies so soon after last week's election result.
The decision to reduce the 6 percent goods-and-services tax to zero next month amounts to abolishing the levy. Granted, that was one of Mahathir’s promises to voters who were angry over their rising cost of living. However, by forsaking almost a fifth of the government’s revenue without a concrete plan to recoup the loss, Mahathir has gambled.
Go back to October 2013, when previous Prime Minister Najib Razak announced the plan to introduce the GST starting in 2015. The currency was weakening amid fears over the impending tightening of U.S. monetary policy – the so-called taper tantrum. Malaysian borrowing costs were rising. Things would get worse after oil prices – on which the petroleum-exporting nation is overly dependent – started falling in 2014. By July of the following year, the simmering 1MDB corruption scandal would erupt, and embroil Najib.
If it weren't for the GST becoming a steady source of government revenue, the almost $9 billion of global investors’ money that went into Malaysian bonds in 2012 – and which has kept falling since with the exception of 2015 – would by now have turned into a stampede for the exit. Local interest rates would have had to rise appreciably.
That hasn't happened. The 10-year Malaysian bond pays 110 basis points more than U.S. debt of similar maturity. The spread, the lowest since 2013, has shown no sign of hardening. Even as investors fret about leaving their money in India and Indonesia, the ringgit has been the best-performing Asian currency over the past six months, rising 5 percent against the dollar.
Why risk this stability? An easier solution would have been to lower the GST rate to, say, 4 percent. Before the tax was levied, the International Monetary Fund expected it to fetch between 1.9 percent and 2.6 percent of GDP. Last year’s take was 3 percent.
If that was a bit too much, abolishing the GST is too big a sacrifice. Reviving sales and services taxes would compensate for only half the loss, according to Capital Economics. More importantly, investors would worry about a credibility deficit. Rating companies would wonder whether Malaysia intends to ever balance its books.
GST is nowhere a popular tax. Once removed, it's impossible to restore. Slashing the rate to a more appropriate level would have been a decent compromise. With oil prices about 50 percent higher than what the government assumed in its annual budget, Mahathir could have been seen to be giving immediate relief to people without having to worry about losing revenue should energy prices weaken again.
Before the Asian crisis, fiscal stimulus in Malaysia – usually in the form of higher government spending – tended to lead to a large surge in output, whose effect would linger for years. That doesn't happen any longer. So don’t expect the tax rebate to lead to a significant pickup in GDP growth, which slowed in the first quarter to 5.4 percent. This fiscal adventurism was both unnecessary and – in an environment of rising global interest rates – ill-timed.
Now, if investors start to lose confidence in Malaysia, Mahathir should know whom to blame. Not Soros, of course.
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