VZCZCXRO2502
RR RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHKL #1452/01 2680208
ZNR UUUUU ZZH
R 250208Z SEP 07
FM AMEMBASSY KUALA LUMPUR
TO RUEHC/SECSTATE WASHDC 0014
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHGV/USMISSION GENEVA 1509
RUCNASE/ASEAN MEMBER COLLECTIVE

UNCLAS SECTION 01 OF 03 KUALA LUMPUR 001452 
 
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 
GENEVA FOR USTR 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV MY
SUBJECT:  Malaysia's 2008 Budget: Pork Sold Separately 
 
REF:  KUALA LUMPUR 1429 
 
KUALA LUMP 00001452  001.2 OF 003 
 
 
¶1.  Summary:  On September 7, Prime Minister Abdullah Ahmad Badawi 
unveiled his 2008 budget proposal. Billed as a "fiscally 
responsible" budget, it projects a deficit of 3.1%, down from 3.2% 
in 2007.   Although spending is up, the GOM projects higher GDP 
growth will generate more than adequate additional revenue flows to 
compensate for it.  The Prime Minister (PM) also announced that he 
expects the private sector, including foreign investors, to help 
fund government-initiated development plans.  While the budget 
contained some important new tax provisions including a welcomed 
decrease in corporate tax rates, simplified tax collection on 
dividends, and enactment of additional tax preferences for the 
Islamic financial sector, the most important tax reform measure, 
implementation of the new Goods and Services Tax (GST) proposed in 
2004, was missing.  In a panel discussion following the release of 
the budget, Ministry of Finance officials insisted it was still on 
the table.  However, absent up-front support from the PM and with 
elections just around the corner, the GOM is unlikely to submit a 
GST proposal to Parliament in the coming year.  This leaves the GOM 
without an answer to how it will reduce its dependence on revenues 
from the oil sector, even though depleting oil reserves imply this 
revenue stream will shrink in the near future.  Absent tax 
broadening measures like the GST, the GOM, which currently gets 38 
percent of its revenue from the national oil company, will find it 
increasingly difficult to maintain its fiscal deficit within 
manageable bounds over the next decade.  End summary. 
 
First, what the budget didn't do: 
--------------------------------- 
 
¶3.  For an election year budget, many Malaysians were surprised by 
what it did not do.  A widely anticipated voter-friendly cut in the 
top individual income tax bracket did not materialize, but neither 
did any additional "sin" taxes (on tobacco or alcohol) which the GOM 
tends to increase every year.  Consistent with its billing as a 
"fiscally responsible" budget, no large new development projects 
were announced as part of the budget.  However, the Prime Minister 
already had announced plans to invest heavily in three regions on 
the peninsula, including the "Iskandar Development Region" bordering 
Singapore, plus Northern and Eastern Corridor Regional Development 
Plans. Similar regional development projects are rumored to be in 
the works for East Malaysia as well.  The Prime Minister announced 
that he is relying in large part on the private sector to finance 
these government initiatives. 
 
 
Reducing the deficit?  A closer look at the numbers: 
--------------------------------------------- ------- 
 
¶4.  A closer look at the numbers shows that the GOM's formula for 
lowering the deficit is a result of two underlying assumptions, both 
of which have been received with some skepticism by local analysts. 
The first assumption is that real GDP will grow by 6 percent to 6.5% 
- a projection that analysts find somewhat optimistic. (Currently 
GDP is growing at approximately 5.7%.)  The second assumption is 
that the private sector - particularly foreign investors - will 
provide the lion's share of the funding needed for the three 
regional development plans laid out by the Prime Minister. 
 
Spending up 2.5% from last year 
------------------------------- 
 
¶5.  Total budget expenditures (operating and development) for 2008 
are RM 168.8 billion ($ 48.2 billion) in 2008, up 2.5% from RM 164.7 
billion ($ 47 .1 billion) in 2007. 
 
Operating expenses up: 
---------------------- 
 
¶6.  Operating costs will grow 4% to RM 128.8 billion 
($ 36.8 billion) in 2008.  Salaries comprise 28.1% 
($ 10.3 billion) of operating expenditures and fixed charges and 
grants 49.6% ($ 18.3 billion). 
 
 
$ 11.4 billion for development: 
------------------------------- 
 
¶7.  Gross development expenditure is budgeted at RM 40.0 billion ($ 
11.4 billion), 2.1% lower than the revised allocation of RM 40.9 
billion ($ 11.7 billion) in 2007 as the government intends to count 
on the private sector to drive economic growth. This 8% reduction 
 
KUALA LUMP 00001452  002.2 OF 003 
 
 
came as a surprise to many analysts, some of whom had projected an 
allocation of RM 48 to 50 billion ($13.7 to 14.3 billion) for 2008. 
However, the Ministry of Finance also may tap into its supplementary 
allocation of US$ 2.35 billion when the government does a mid-term 
review of the Ninth Malaysian Plan in mid-2008. 
 
¶8.  The biggest slice of the $ 11.4 billion development budget will 
go to education and training with $ 2.1 billion (18.4%), transport $ 
1.9 billion (16.9%) and security $1.4 billion (15.2%).  Trade & 
Industry and agriculture will receive $ 1.1 billion (9.7%) and $ 
1.05 billion (9.4%) respectively. 
 
 
Plans to cut subsidies? 
----------------------- 
 
¶9.  Subsidies will constitute 7.9% ($ 2.9 billion) of operating 
expenditures, declining 15.8% from 9.8% ($ 3.5 billion) of operating 
expenditure in 2007, indicating the government will possibly reduce 
fuel subsidies (perhaps on gas) in 2008.  Fuel subsidies are about 
three quarters of the total subsidy payment.  So far, the government 
has kept its promise not to raise domestic fuel prices this year as 
crude oil prices continue to rise. 
 
High oil prices to keep a lid on deficit, for now: 
--------------------------------------------- ----- 
 
¶10.  Despite the increase in public spending, the government 
announced that it expected the fiscal deficit to remain under 
control at RM 20.9 billion ($ 6.0 billion) or 3.1% of GDP in 2008, 
down from an estimated RM 19.9 billion ($ 5.7 billion) or 3.2% of 
GDP in 2007.  The government projected revenue to increase 3.7% to 
RM 147.1 billion ($ 42 billion) in 2008 from RM 141.8 billion ($ 
40.5 billion) in 2007, based on an assumption that oil prices will 
average $ 74 per barrel in 2007 and $ 75 per barrel in 2008. 
Oil-related revenues are expected to contribute $ 15.9 billion or 
38% of total revenue in 2008, up marginally from $ 15.3 billion or 
37.9% of total revenue in 2007. (Comment: As the petroleum income 
tax collection is based on preceding year's income, the government 
can be confident of its oil revenue in 2008.  National oil company 
Petronas' dividend payment to the government will accelerate to $ 
6.9 billion in 2007 from $ 5.1 billion in 2006.) 
 
 
New tax provisions: 
------------------- 
 
¶11.  Following are the most significant changes to the tax code 
proposed in the 2008 budget: 
 
--  Corporate tax, reduced from 28% in 2006 to 27% in 2007, will be 
reduced further to 26% in 2008 and 25% in 2009. This compares 
favorably to most countries in the region, with the exception of 
Singapore (18%) and Hong Kong (17.5%).  Vietnam, China, Thailand, 
India, Indonesia and the Philippines all have higher corporate tax 
rates, ranging from 28% to 35%.  (Taiwan's corporate tax rate is 
also 25%, but there is an additional 20% withholding tax on 
dividends.) 
 
--  Tax on dividends will no longer be adjusted to meet the 
recipient's tax rate.  Currently, taxpayers in brackets above the 
corporate rate are required to pay the difference; taxpayers in 
brackets below the corporate rate are eligible for a refund. 
(Dividend payments are not subject to double taxation in Malaysia.) 
Companies may opt for a six-year phase-in of this new provision. 
 
-- Small and Medium-sized Enterprises (SMEs) will be exempt from 
filing monthly tax estimates and paying monthly installments for the 
first two years of operations.  Tax for the full two years will be 
liable upon filing at the end of the two years.  A SME is defined as 
a company with ordinary paid-up share capital of less than RM 2.5 
million (US$ 727,000). 
 
--  Information & Communication Technology (ICT) companies will be 
required to locate within specified geographic areas to retain 
current tax incentives.  ICT companies will qualify for an exemption 
of import duties and sales tax for broadband equipment not produced 
in Malaysia. 
 
--  Income derived from trading of Certified Emission Reduction 
(CER) certificates will be tax exempt. 
 
--  Tax relief will be provided for post-graduate studies, sports 
 
KUALA LUMP 00001452  003.2 OF 003 
 
 
and exercise equipment, children's educational accounts, computers, 
broadband subscription fees, and some retirement benefits. 
 
-- Expatriate income tax will be calculated according to the number 
of days physically present in Malaysia. 
 
--  A 7% cap on deductions for approved charitable contributions 
will be extended to individual taxpayers as well as companies. 
(Currently only companies are subject to the cap.) 
 
--  Companies located in the Labuan Offshore Financial Center can 
make an irrevocable election to be taxed at the regular Malaysian 
rate, allowing them to benefit from bilateral tax treaties that 
otherwise would exclude them. 
 
--  Taxpayers will be permitted to make mortgage payments out of 
their retirement savings accounts. 
 
--  A number of new incentives will be enacted for companies engaged 
in Islamic finance, including Islamic insurance (reftel). 
 
 
Comment: 
-------- 
 
¶12.  The issue the Prime Minister isn't bringing up for this 
election-year budget is the problem of declining oil revenues. 
Petronas provides 35 to 40% of the GOM's budget.  However, Malaysia 
is projected to be a net importer of oil within the next several 
years, based on a continued trajectory of 4% annual increases in 
domestic demand.  This is a major problem because Petronas is 
obliged by the GOM to provide oil and gas for the domestic market at 
subsidized prices and it is responsible for covering the price gap 
between international and domestic prices. This of course eats away 
at its profits and its taxable income which is so essential to 
government revenue flows.  While Petronas increasingly expands its 
operations overseas, it is unlikely to be able to do so rapidly 
enough to compensate for lost revenue when oil imports exceed 
exports.  The problem of preventing a ballooning fiscal deficit when 
that happens is the elephant that everyone pretends not to see. 
 
 
KEITH