VZCZCXRO4523
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 
 
¶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