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Friday, October 17, 1997

The 1998 Budget Speech

By Datuk Seri Anwar Ibrahim, the Finance Minister, introducing the Supply Bill (1998) at the Dewan Rakyat on Oct 17, 1997

Mr Speaker, Sir,

I beg to move that a Bill entitled "An Act to apply a sum from the Consolidated Fund for the service of the year 1998 and to appropriate that sum for the service of that year" be read a second time.


Mr Speaker, Sir,

Four years ago, when the Malaysian economy entered its sixth year of rapid growth, I reminded the House that we should not be complacent with our comfort and prosperity, that we should be mindful of the recurring cycles of economic prosperity and depression.

I suggested that lessons be drawn from the story of the Prophet Yusuf about the seven years of drought following seven years of fecundity, and about preparing for leaner times during the years of abundance.

He (Yusuf) said: Ye shall sow seven years as usual, but that which ye reap, leave it in the ear, all save a little which ye eat. Then after that will come seven hard years which will devour all that ye have prepared for them, save a little of that which ye have stored. (Quran, 12: 47-48)

On that occasion, it was stated that even though the cycles of prosperity and depression usually come in turns in any economy they can be avoided. Indeed, prosperity can turn into depression through man's own negligence, profligacy and poor planning. Like the Prophet Yusuf, we must exercise wisdom and prudence in expenditure to enhance our resilience to meet the challenges of the future.

In 1995, I again reminded the House of this advice from the Prophet Yusuf. I emphasised that economic planning and management in a strong economic situation should not make us complacent. It was explained that our development philosophy was growth and equity. Indeed, such a situation will enable us to implement more projects to assist the poor, build rural infrastructure, and low-cost housing as well as reduce the burden of taxes of the rakyat. We can take proactive measures and manage most problems as soon as they emerge. We need to maintain this state of readiness to face new and unexpected challenges.

Today, we are beset with new and tough challenges. Malaysia and other Asean countries are in the throes of a crisis affecting our currencies and stock markets. The Thai financial system which was quite fragile deteriorated even further after the baht came under severe attack by currency speculators. The value of the baht has declined by 29.3% against the US dollar as at Oct 15, compared with its value on July 1. During the same period, the Indonesian rupiah fell by 31.8%, the Philippine peso by 21.9% and the Singapore dollar by 7.6%. The ringgit fell by 20.1%.

The region's stock markets have become just as volatile. In the same period the stock exchange in Manila dropped by 27.5%, Jakarta by 29.1% and Kuala Lumpur by 25.7%. However, the share index of Bangkok declined 19.8% between December 1996 and July 1. The loss to the Malaysian stock market amounted to RM162.96bil or 21.9%.

It appears ironic that the currency crisis has hit the region at a time when the world economy in general is increasingly gaining strength. World trade grew by 7.7% this year. The growth rate of major industrial countries (G7) rose from 2.4% last year to 2.9% this year. The US economy entered its seventh year of growth. However, this development did not guarantee a strong international foreign exchange market.

In the early 1990s the yen appreciated strongly against the US dollar. Between May 1990 and April 1995, the yen's value rose 81% against the US dollar. This strengthening contributed to the vigorous growth of these South-East Asian economies as the high value of the yen caused many Japanese companies to become uncompetitive, forcing them to relocate their production units outside Japan, particularly to this region.

However, from April 1995, the tables turned. The yen plunged 30.4% against the US dollar, discouraging the Japanese from investing overseas. This resulted in a decline in Japanese investment in South-East Asia. This decline in capital inflows has compounded the problems in servicing the huge current account deficit in most of the countries in this region. Some of these countries increased their foreign borrowings to deal with the decline in capital inflows which were in the form of FDIs.

The bulk of such borrowings were denominated in US dollars to take advantage of interest rate differentials. As it turned out, the repayment of such loans became a major problem when the US dollar began to appreciate against the yen. Most of the currencies of these countries were linked to the US dollar. These initial difficulties developed into a crisis when borrowings in foreign currencies were used to finance share acquisition and property development. When the property sector softened, financial institutions which were overexposed to the sector found their stability undermined.

The strengthening of the US dollar since April 1995 also eroded the competitiveness of exports in the region because a large portion of the imports of intermediate goods were denominated in dollars. Financial institutions which were exposed to the non-productive sectors were put in a precarious position.

Under these circumstances, South-East Asian currencies were perceived to be overvalued. The baht came under selling pressure in May and June, a pressure so intense as to force its flotation on July 2. With that, its value in the foreign exchange market plunged. The same pressure was exerted on the Indonesian, Malaysian, Philippine and Singapore currencies.

Whilst it is true that the exchange rates of South-East Asian currencies needed correction, it is quite clear that there exist elements out to exploit the situation so as to depress the value of these currencies to artificially low levels.

The Thai financial crisis has spurred regional cooperation. In less than two weeks, a financial package for Thailand was put together on the initiative of the International Monetary Fund (IMF) amounting to US$17.2bil. This package was contributed by the IMF and several Asian countries. Malaysia contributed US$1bil. This package is to ensure that Thailand has sufficient financial resources to undertake a comprehensive programme to revive its economy and restore investor confidence.

And now, Indonesia has also requested for assistance from the IMF and World Bank (WB).

Despite our exposure to the global marketplace, we are confident that we can overcome its vagaries and challenges. We will continue to succeed because we were not complacent when our economy was doing well. Indeed, during these years of prosperity under the leadership of Datuk Seri Dr Mahathir Mohamed, we have been strengthening our economic fundamentals so that we would be resilient in times of trouble. When the economy showed signs of overheating from high growth, we implemented firm fiscal measures and tight monetary policies to control inflation. We spent prudently although Government revenue continued to increase.

The strength of economic fundamentals is reflected in the expansion of Gross Domestic Product (GDP) which is expected to grow for the 10th consecutive year, by 8%. The rate of inflation remains low at 3%. The rate of growth in national savings is among the highest in the world at 39.8% of Gross National Product (GNP).

Since 1993, Government finances have recorded surpluses and this has been maintained for five consecutive years, including a surplus of RM5.066bil or 1.9% of Gross National Product (GNP) for this year. The nation's reserves as at Sept 30 is still high at RM61.9bil, sufficient to finance 3.7 months of retained imports.

One important measure we took during the years of abundance was to settle our debts even before they were due for payment. Currently, our external debt is low and stands at RM10.4bil. The prudent steps we took in 1997 to curb extravagance and debt have saved us from a heavy debt repayment arising from the depreciation of the ringgit. The first prepayment began in 1997 financed by domestic borrowings. However, from 1992, the prepayments were paid from Government surpluses. The amount of prepayments between 1987 and 1997 is RM16.5 billion. As a result, the debt service ration (DSR) fell from 18.9% in 1986 to 6.8% this year. National debt also declined from 75.6 percent of GNP to 33.3 percent in the same period.

Current Challenges of the Malaysian Economy

The major challenge facing the economy is restoring economic stability and confidence in the economy. A major issue in addressing this challenge is the current account deficit of the balance of payments. Our deficit was significant at 10.5% of GNP in 1995 and this was reduced to 5.2% last year. This year the deficit is expected to decline to 5%. This deficit needs to be addressed with strong and bold measures. The problem of the balance of payments is the continuing deficit in the services account and significant increases in imports, primarily because of the overdependence of the manufacturing sector on imports of intermediate goods which account for 66% of total imports.

Imports of capital goods are also high at 19% of total imports. A large proportion of imports were bulky imports, including aeroplanes and ships to increase the capacity of the nation's services sector. In terms of exports, the slow expansion is due to the lower growth of manufactured exports resulting from the decline in international prices.

A deficit in the current account of the balance of payments of a country is a result of lesser earnings of foreign exchange compared with foreign payments. The deficit also reflects the existence of a savings-investment gap where domestic savings are insufficient to fully finance investment. This results in a country being dependent on foreign savings.

The banking system of this country continues to be sound. Profit before tax of the banking system increased by 27.5% in the last financial year. The average capital adequacy ratio for commercial banks exceeded 11.8%, merchant banks 13.3%, finance companies 10.6%, higher compared with the international standard of 8%. The ratio of non-performing loans (NPL) was reduced from 3.9% at end-1996 to 3.6% at end-June 1997. Return on assets by commercial banks was 1.8%, comparable to the returns received by other major international banks. Sufficient funds and strong reserves will ensure that our banking system remains sound.

However, we cannot be complacent as regards the strength of the banking system. The system's overexposure to the property sector needs to be reduced so that the banking system is not threatened in the event of a price correction in the property market, in particular for commercial buildings where supply may exceed demand. The provision of loans for the purchase of shares and the use of shares as collateral for financing also needs to be closely monitored.

Malaysia's economy is entering a period of transition. The direction of the economy is currently fraught with uncertainties. The crisis in the financial markets that is being experienced is a test of economic resilience and the effectiveness of policies. While we need to adjust to changing external economic and financial developments, we also need to take concrete measures to strengthen economic fundamentals so that we can face external shocks and pressures. In addition, world growth is expected to be the fastest in this decade. The strengthening of economic growth in a number of industrial countries, in particular US and Europe, will provide an impetus to the region's economy.

We must be committed in facing this challenge. The responsibility to restore our economy to a stronger footing to achieve developed-nation status should be shared by all. If the burden is shared, it will be lighter. We will succeed if we are wise, good and brave. As Confucius says: the wise is not easily confused; the good is not easily moved; the brave does not fear.

Budget Strategy 1998

Our economy is at a crossroads. We must tread carefully. We cannot afford mistakes. Our resilience is being tested. But as our Prime Minister has said, we should not panic. What is required is discipline and resilience. Let us not give up. Leaders and rakyat and the public and private sectors should cooperate; as in the saying:

The Prophet is distinguished by miracles,
The believers by their consensus,
Water is shaped by its vessel,
Unity by consensus,
Water flows according to its course,
Truth emerges from consultation.

We must be aware that the Malaysian economy is changing and becoming more matured. Our approach and management of the economy should reflect this change. A mature economy does not need to grow at a high rate. Our task is to ensure macroeconomic stability, especially in the balance of payments, the rate of inflation as well as the strength of the Government and private sector's financial positions. This is the main objective of this Budget. When our economic fundamentals strengthen, we can move rapidly towards achieving Vision 2020. The 1998 Budget Strategy is:

(i) Strengthening economic fundamentals and stabilising financial markets;

(ii) Maintaining sustainable growth;

(iii) Continuing the process of deregulation and liberalisation of the economy; and

(iv) Continuing the social agenda for further overall development.

Strengthening Economic Fundamentals

Given the weak sentiments in the financial markets, economic management will give priority to efforts at rebuilding confidence. Measures will be directed at hastening the recovery of the foreign exchange and stock markets. The Government will continue to encourage foreign investors, in particular through smart partnerships with domestic investors.

Strengthening the balance of payments

The deficit in the current account will be reduced through reduced imports and increase in exports of goods and services. The use of local goods must be increased and all Government agencies and companies have been directed to do this. Domestic producers have been warned not to take this opportunity to increase prices of goods and services. Exporters will need to reduce the cost of production (without sacrificing quality) so that export competitiveness will be enhanced.

Increasing Export Competitiveness

Malaysia's exports, particularly manufactured exports, have begun to be adversely affected with the entry of more competitors in the international markets. We must be more aggressive in reducing the cost of doing business in this country to improve our competitiveness and encourage exports. We must compete aggressively with low-cost producers in countries like China and Vietnam. Wage increases exceeding that of productivity have to be contained. The Government is taking measures to ensure that the cost of doing business in this country does not affect export competitiveness and continues to attract investors to Malaysia.

The present economic situation warrants the private sector to take more proactive measures in order to increase exports of goods and services. Exporters must seize the opportunity to take advantage of the depreciation of the ringgit. To assist the private sector in these areas, I propose that companies in the manufacturing, agriculture and services sectors be given tax incentives based on the increase in export value:

(i) for the manufacturing sector, companies exporting goods having value-added of 30% be given exemption from income tax equivalent to 10% of the increase in export value, and companies exporting products having value-added of 50% be given exemption from income tax equivalent to 15% of the increase in export value; and

(ii) for the agriculture and services sectors, companies be given a one-tier income tax exemption equivalent to 10% of the increase in export value. For the agriculture sector, fresh fruits and cut flowers will qualify for this incentive. In the case of the services sector, the eligible services include health, education and professional services.

The availability of modern warehousing will assist the private sector in reducing their cost of exports. I propose that warehouses which are used for purposes of export and re-export be given a special building allowance of 10%. This proposal will enable warehouses to be fully depreciated over a period of 10 years instead of 45 years. In addition to this incentive, customs procedures related to exports will be simplified.

Reducing Imports

Imports of capital and intermediate goods as a percentage of GDP amount to 67.2%. This shows that economic activities in Malaysia especially in the manufacturing sector are overly dependent on imports of capital and intermediate goods. To reduce this dependence, the capacity of domestic production for import substitution has to be expanded. Indeed, as was emphasised in previous Budgets, there is a large number of useable machinery in the country which is neglected and not utilised because of the propensity of the private sector to import new machinery.

The Government has imposed import duties of between 5% and 20% on bulldozers, excavators and piledrivers in order to discourage unnecessary importation of heavy machinery. As a measure to curb imports and especially in the construction industry, I propose that:

(i) all imports of heavy machinery for the construction sector be required to obtain approval to import from the Ministry of International Trade and Industry (MITI) and the approval will only be given if this machinery is not available locally;

(ii) import duty on construction materials such as tiles, marble, iron and steel be increased from between 5% and 25% to between 10% and 30%;

(iii) import duty of 55 be imposed on heavy machinery and equipment such as tower cranes, forklifts and escalators;

(iv) import duty on dumpers and multi-purpose vehicles be increased from between zero and 30% to 50%;

(v) import duty on special purpose vehicles such as crane lorries and concrete mixer lorries be increased from 35% to 50%;


(vi)the rate of initial capital allowance for imported heavy machinery be reduced from 20% to 10%, and the annual allowance be reduced from between 12% and 20% to 10%.

At the same time, the private sector is reminded to reduce purchases of imports and utilise more domestic inputs. The banking sector is requested to be more careful in granting loans for financing less productive projects. Investment activities are encouraged in the more productive sectors which:

* Generate foreign exchange earnings;

* Improve productivity and competitiveness;

* Increase the use of automation and higher technology.

In addition, the private sector should also support the policy of reducing imports and encourage the use of domestic inputs; and reduce overlapping investments through consolidation and mergers, for example in the telecommunications sector.

Imports of consumer goods, which amount to 12% of total imports, are still high and must be reduced. Efforts to encourage the consumption of quality local products that have succeeded in penetrating the export market must be increased. In relation to this, I propose that import duties on a number of consumer durables be increased from 25% to 30% because most of these items are manufactured locally. Among these are refrigerators, vacuum cleaners, microwave ovens and floor polishers.

Local Brand Names

Besides curbing imports, there must be greater efforts to promote the use of local branded products as some of these products have successfully penetrated the export market. In order to expand the markets for these products, I propose that the expenditure incurred on advertising locally be given double deduction for income tax purposes, in addition to the existing incentives. Expenditure incurred on advertising these products overseas has already been given the double deduction incentive.

Tax on Motor Vehicles

It would appear that the rich cannot be persuaded to buy local goods. They are of the opinion that local goods are inferior. They like to show off with luxurious cars. As such, imports of luxurious cars are on the increase. There is no alternative but to increase the import duty. Therefore, I propose that import duties on motor vehicles especially in luxury categories namely, cars, vans, 4-wheel drives and motorcycles, whether they are completely built-up (CBU) or completely knocked-down (CKD) be increased as follows:

(i) import duty on CBU cars be increased from between 140% and 200%, to between 140% and 300%, while import duty on CKD be increased from 42% to a maximum of 80%;

(ii) import duty on CBU vans be increased from 35% to between 42% and 140%, while import duty on CKD be increased from 5% to a maximum of 40%;

(iii) import duty on CBU 4-wheel drives and multipurpose vehicles be increased from 50% to between 60% and 200%; while import duty on CKD be increased from 5% to a maximum of 40%; and

(iv) import duty on CBU motorcycles be increased from 60% to between 80% and 120%, while import duty on CKD be increased from 5% to a maximum of 30%. Excise duty will also be increased from a maximum of 20% to a maximum of 50%. In addition, a sales tax of 105 is imposed on motorcycles with an engine capacity of more than 200cc. Finally, road tax for motorcycles of engine capacity of 200cc and above be increased from between RM100 and RM130 to between RM150 and RM400 per annum.

However, I would like to emphasise that the Government is mindful of the needs of the lower income groups and the small businessmen. For this reason, taxes on motor vehicles that are usually owned by these groups, namely vans of engine capacity less than 1800cc, motorcycles of engine capacity less than 200cc-and motorcars of engine capacity less than 2000cc are not increased.

Developing the Services Sector

Measures introduced in past years have successfully reduced the deficit in the services account of the balance of payments. In 1997, exports of services increased at a rate of 13.3%, higher than the increase in imports of services of 9.4%. However, efforts at further upgrading the capacity of the nation to export and substitute for imported services need to be intensified. I urge that priority be given to the use of domestic services, particularly, ports, shipping and air services and professional and consultancy services.

Life Reinsurance Companies

The insurance industry has great potential to contribute towards strengthening the services account of the balance of payments. In order to encourage the growth of the life reinsurance industry especially to underwrite foreign inward life reinsurance, I propose that a concessionary tax rate of 5% be imposed on income derived from this business.

Travel Documents

The number of Malaysians travelling abroad has increased and in 1996 the number of travellers amounted to 23 million. Although our policy is liberal, this figure is significantly large and has resulted in an outflow of RM6.5bil. Malaysians must reduce their overseas travel and take the opportunity to visit various attractive tourist spots in the country. As a measure to discourage overseas travel, I propose that the fees for an international travel document be increased from RM145 and RM265 to RM300 and RM600, and the fees for restricted travel document be increased from RM60 to RM150.

Relief for Children Studying Overseas

Currently parents who send their children to study abroad have been given tax relief of twice the amount of the child relief. In order to reduce the outflows, I propose to withdraw the additional relief given for children studying abroad in institutions of higher learning. However, students who have commenced their studies with institutions of higher learning by today, will continue to be eligible for this relief until the completion of their studies. This proposal will not jeopardise the opportunity of our children to pursue higher education. I am confident that they will be able to secure a place in local institutions of higher learning since there is a deliberate move by the government to increase the number of these institutions. Parents who send their children to study at local institutions of higher learning will continue to be given tax relief of four times the amount of child relief.

Reducing The Savings-Investment Gap

Although the nation's savings rate continues to be high at 39.8% of GNP, the investment rate has also been high at 44.8% of GNP. This has resulted in a savings-investment gap of 5%. The resource gap is the result of the higher investment over savings in the private sector which amounts to 10% of GNP. Given the high private sector resource gap, private Sector savings need to be further increased. In addition, private investors need to reduce investment in the less productive sectors of the economy. On the other hand, the public sector registered a resource surplus of 5% of GNP, reflecting the Government's prudent fiscal policies.

Increasing Domestic Savings

Sufficient domestic resources are important to finance investment projects and reduce the nation's dependence on foreign financing. To further increase savings, the Government has launched a campaign to encourage savings in addition to making available more instruments for saving. Aside from that, the Government has also increased the maximum limit for investment in Amanah Saham Nasional and Amanah Sahara Bumiputra to RM200,000. Up to Oct 15, Amanah Saham Wawasan 2020 has succeeded in mobilising capital amounting to RM1.726bil involving a total of 822,041 investors.

Tax Deductions on Contributions to Approved Schemes

The Employees Provident Fund (EPF) is recognised as a strong fund. It will continue to make investments governed by strict and prudent rules. At present, contributions made by employers to the EPF and approved schemes are allowed as a deduction for purposes of income tax up to a maximum amount of 17%. Of this amount, 12% is for mandatory contribution and the remaining 5% is for voluntary contribution. As a measure to increase national savings, I propose that the tax deduction on the voluntary contribution be increased from 5% to 7% increasing the total allowable deduction to be 19%.

Monetary Policy

Bank Negara Malaysia (BNM) will supervise and be vigilant to ensure that banking institutions continue to be strong. Prudential standards governing the domestic financial market will be improved to ensure that they are comparable with the standards observed in the international financial markets. To further strengthen the banking system, BNM will take the following measures:

(i) the rules on classification of non-performing loans will be tightened.

Beginning with financial year 1998, a loan which has been in arrears for three months will be classified as non-performing, compared with the present rule of six months in arrears;

(ii) banking institutions will now be required to provide greater disclosure of their financial position to enable the market to make well-informed decisions. With immediate effect, banking institutions will have to provide information on non-performing loans, exposure by sector, and movements in their provisions for bad and doubtful debts, including interest-in-suspense;

(iii) the real-time gross settlement (RTGS) system for large value interbank funds transfers will be launched on Jan 1. This will reduce the risks associated with large value payment systems and promote financial stability;

(iv) the banking institutions are currently required to maintain general provisions equivalent to 1% of total outstanding loans net of interest-in-suspense and specific provisions. This minimum requirement will be increased to 1.5% with effect from financial year 1998; and

(v) requests for foreign borrowing to finance domestic projects will be scrutinised carefully to ensure that such financing is only for productive purposes. Furthermore, the Government may consider tax related measures to limit resort to short-term borrowing.

Given that the high growth in credit of about 29% may cause an increase in the rate of inflation, monetary policy will be tight. The high growth in credit has caused interest rates to increase. The three-month inter-bank rate is currently 8.2%. Interest rates will remain firm, consistent with the current economic situation. BNM will also rely on other instruments to moderate the rapid increase in credit and ensure that its growth is reduced to around 20% at the end of 1998. Resources will be channelled to the more productive sectors including manufacturing, small and medium industries, export and low-cost housing. BNM will also be stringent in approving private debt issues to ensure that resources are channelled to these productive sectors. This would help to ensure that funds raised through the capital market would not be channelled for speculative activities, excessive consumption and other less productive activities.

In introducing these instruments and measures, we will ensure that economic growth is not excessively affected and that investors are not driven to relocate their economic activities off-shore.

Besides the high growth of credit, the ratio of passenger cars to the population is 1:9 which is among the highest in the developing world. Therefore in line with the control of excessive credit and the need to discourage excessive spending, especially among those who love to change cars, the credit ceiling for hire purchase of passenger cars will be reduced to 70% from 75% and the period for repayment will not exceed five years.

The nation can be expected to experience inflationary pressures resulting from the increase in the prices of imports following the depreciation of the ringgit compared with the currencies of major suppliers. Therefore, the strategy to control inflation needs to be strengthened. Immediate action by traders to import supplies from low-cost producers will mitigate price pressures. Wholesalers and retailers are reminded not to take advantage of the decline in the ringgit to increase prices and reap excessive profits. The Government has collected information on prices for almost all goods and will closely monitor changes by increasing enforcement. However, the effectiveness of these measures will also be determined by consumers who should be more conscious of price and quality, especially during festive seasons like Hari Raya, Chinese New Year and Deepavail.

Given the current turmoil in the financial markets, policies and measures to further upgrade prudential standards and financial policies are a bitter pill that we have to swallow.

Maintaining Sustainable Growth

Economic growth must come not only from capital and labour inputs but increases in productivity. In this context, the nation's factors of production, in particular capital and labour, must be used optimally to produce high output. Given that the country has achieved full employment and the Government's policy is to reduce the use of foreign labour, the nation must shift to labour-saving and automated production processes. The manufacturing sector in particular, is urged to hasten this shift to the use of robotics in their production processes.

Corporate Tax

The private sector is the engine of growth. The depreciation of the ringgit has caused an increase in the cost of operation and per unit cost of production which had eroded the competitiveness of Malaysian manufactured products in the international market. We should assist the private sector to reduce the burden of price increases due to the depreciation of the ringgit against the US dollar. We need to increase investment, productivity and export competitiveness. I propose that the company income tax rate be reduced by 2% from 30% to 28%. What is more important is the private sector will be able to absorb the increase in costs and not pass them on to the consumer. Entrepreneurs should not burden consumers with price increases.

The petroleum industry including its downstream activities has been an important source of revenue to the government. In order to encourage oil companies to develop the marginal fields and to increase exploration of new fields, I propose that the petroleum income tax be reduced from 40% to 38% and the export duty on crude oil be reduced from 20% to 10%.

In line with the decision to reduce income tax, the tax administration particularly the Inland Revenue Board and the Royal Customs and Excise Department would be made more efficient and transparent. Reformation and the level of integrity of the administration would assist in preventing tax evasion and revenue loss.

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