sensitivity analysis – the _

[2800] What is the fiscal deficit status now?

Back in January, the official deficit projection for 2015 was revised up by the government to 3.2% of GDP from 3.0% due to the falling energy prices. I concluded then the new target was achievable if government revenue would increase by at least 1.2% YoY. It was a reasonable target eight or nine months ago.

Unfortunately, a lot of things have happened since then and that 1.2% YoY revenue growth does not look easy anymore. That means, the current deficit target seems incredible now.

I have updated my sensitivity analysis. I think the fiscal deficit this year will likely be around 3.5%-3.9% of GDP. I did a tighter projection for work but I can afford to cast a wider net here.

Below is a table of deficit-to-GDP, dependent on revenue and NGDP changes this year. I have highlighted several cells in red corresponding to my expectations.

2015 Fiscal deficit sensitivity analysis

The assumptions (projections?) are:

0%-2% revenue contraction
4%-5% NGDP growth.
For government spending growth, I imputed 1.2% YoY into my model, which is the exact increase the government announced from its budget revision back in January. I do not expect any spending cut due to… hmm… some political imperatives and I suppose, Keynesian tendencies within the government. I am unsure how the Monday announcement would affect spending as details are scarce so far but my gut feeling says it will not matter.

The weaker revenue is mostly due to depressed petroleum tax collection, lower petroleum royalties and lower dividend. I am a bit unsure how other taxes, especially company and individual income taxes, will change. But what we do have is the first half data and individual income tax collection is already down by 33% YoY, partly, I guess, because of the earlier tax cuts. Company income tax collection rose strongly however, increasing 43% YoY but judging from earning reports so far, I think the second half will be very different.

The ~~1MDB Minister~~ ~~Prime Minister~~ Finance Minister will table the government budget on October 23. We will know more then.

Mohd Hafiz Noor Shams. Some rights reserved

p/s — It would be interesting to compare current assumptions with past ones:

My current expectation is based on 1.2% spending growth, 0%-2% revenue contraction and 4%-5% NGDP growth. These are part of the three assumptions listed above.
Back in January 2015 during the revised budget, the assumptions were 1.2% spending growth, 1%-2% revenue growth and 4%-5% NGDP growth.
The original 2015 official projection, shared in October 2014, was 3.2% spending growth, 4.5% revenue growth and 9% NGDP growth.

You can see the drastic change in projections and assumption since October 2014. Maybe a table will be clearer for comparison:

Malaysian deficit ratio target change

[2763] Is the new 3.2% deficit target achievable?

People are asking me if the Malaysian government’s new 3.2% deficit ratio target is achievable. I have read in the news that several politicians are skeptical about the target. I do not remember who said that but I feel the sentiment is shared by many.

But the only way to really answer this objectively is to run a sensitivity analysis.

It is relatively easy to do a sensitivity analysis and I have done one last week under the assumption of no expenditure cut. That one shows how the deficit ratio would react if the government had not changed its budget under a range of NGDP and revenue assumptions. I think it somewhat presents the realistic worst-case scenario. The government said its fiscal deficit would have gone up to 3.9% of GDP in 2015 without any expenditure cut. I think that would come close to my expectation (4.0%-4.1%), which is based on no revenue growth (not unreasonable) and at about 4%-5% NGDP growth. I am not reproducing the table here because I do not want to confuse the readers. If you are interested in that sensitivity analysis, you should revisit the post.

But that sensitivity analysis does not indicate whether the new 3.2% target is realistic. To answer that, it requires a bit more moving parts added into it. One additional dimension is required to be exact.

I am doing that here by showing 3 cases of revenue change under a range of NGDP and expenditure assumptions (note the not-so-small difference from the above model). To cut through the graphics, I think the 3.2% fiscal deficit ratio target is achievable if revenue grows by about 2% (I said about because I am too lazy to run a differential equation).

Before that, some legends for the three charts at the bottom. The yellow-highlighted cells describe the would-be situations if the expenditure was not cut (yes, it is a funny coincidence that the government had planned to increase its expenditure by 3.2% from 2014 in the original budget). The red-highlighted cells show the deficit ratio under the January 20 revised budget expenditure figures (Under revised budget, expenditure would still grow 1.2%. So, please do not call this austerity).

Here is the deficit ratio if 2015 revenue does not change from last year. Achieving 3.2% target seems impossible under this scenario (I wrote impossible because it would require a very strong NGDP growth at a time the GDP deflator appearing weak. If government revenue is flat this year, then my projection for the deficit would be about 3.6%):

Things would look a bit better if the government revenue would grow by 1% this year, but it would miss the deficit target still as 9% NGDP growth is beyond our reach, given current constraints:

Under 2% revenue growth case, the 3.2% deficit ratio looks achievable:

So, after reading through this, do you think the 3.2% deficit is achievable?

Ultimately, your answer must rely on revenue and NGDP growth. I think the reasonable NGDP growth assumption is about 4%-5%. As for revenue, I am unsure at the moment. There are just too many moving parts that require further investigation but the original budget had it grown at 4.5%. It will definitely be lower than that this year.