Economic Impact of Removing Energy Subsidies in Malaysia

Abstract

The petroleum subsidy alone was over RM20 billion, which corresponds to around 10 percent of the total government expenditure. Malaysia’s fiscal deficit was 4.5 percent of the gross domestic product (GDP) in 2012, and the government aims to reduce it to 3 percent by 2015 and to 0 percent by 2020. The country has already started implementing policies to phase out the fuel subsidies. In December 2014, the government of Malaysia officially removed subsidy for fuels and introduced the “managed float system.” The Special Industrial Tariff for electricity will also be abolished by 2020. If the subsidy in natural gas being sold to electricity companies is removed, electricity price could increase to almost double. However, the Automatic Price Mechanism on transport fuel, such as gasoline, has shifted to the flotation method per 1 December 2014. Currently, the retail price of gasoline and diesel are influenced by market price. Consequently, the price hike in transport fuel after the removal of energy subsidies turned out to be overestimated. According to this study using the 2010 Malaysian Input-Output (I-O) Table, any increase prices in electricity and transport fuel leads to a serious price impacts to other sectors in Malaysia. Looking at other price changes historically, the rise of Production Price Index in Malaysia, such as wholesale price index and consumer price index was around 9 percent and 4.9 percent, respectively, from 2000 to 2012. When compared to these numbers, the price impact of a subsidy removal ranges from 5 percent to 6 percent is considered significant and hence mitigation measures such as phasing out subsidies particularly for the highly impacted sectors are increasingly important. Electricity price hikes largely affect the hotel and restaurant sector relative to other sectors. On the other hand, a transport fuel price hike affects several sectors widely. Our study shows the overall effects of subsidy removal and accordingly we propose two options on the usage of the subsidy budget. First, the Malaysian government can use its energy subsidy budget to reduce the fiscal deficit. This option can lower GDP (1.5 percent lower compared with the reference case), with deficit improvement of 0.9 percentage.