Targeted subsidies: Is the middle class ready?

The second quarter of 2015 will mark the entry of the much debated Goods and Services Tax (GST) which many economists agree will cause a spike in inflation. Based on the implementation of the GST or Value Added Tax ( VAT) in other countries, empirical studies have shown that there is an increase in inflation post the implementation of GST.

The government has made it clear that subsidies are unsustainable and it is serious about reducing the budget deficit to 3% in 2015. That means the days of heavily subsidised flour, gas, electricity and petrol are numbered.

The government is in the process of revamping its fuel subsidy mechanism and it wants to ensure that subsidies are more ‘targeted’ to the deserving group.

It is unclear what income bracket would entitle one to avail the subsidised fuel but many people currently enjoying the blanket subsidy would be paying more than RM2.30 per litre for their fuel come June 2015.

The subsidy saving would be channeled to the lower income group in the form of cash aid or better known as Bantuan Rakyat 1 Malaysia (BR1M). In Budget 2015, it was announced that households earning less than RM3,000 per month would be entitled to a one-off BR1M payment of RM950.

"The government has not defined what middle class is but going by the BR1M definition, middle class could be anything in excess of RM4,000 per month to RM10,000 per month," said Suhaimi Ilias, Group Chief Economist at Maybank Investment Bank Berhad.

The middle class category could be further separated to lower middle class and higher middle class.

Our current fuel consumption is around 24 billion litres per year. A 20 sen reduction in subsidy amounts to a “saving” of RM4.8 billion per year. BR1M 3.0 in February 2014 entailed total cash payment of RM4.6 billion to some seven million recipients. Quite clearly, the reduction in fuel subsidy can offset the cost of BR1M.

But the burning question is, what about the middle class? How are they going to face cost escalations i.e higher fuel prices? They are going to face a double whammy in the form of higher inflation thanks to GST and further subsidy rationalisation.

The argument for BR1M is that it is envisaged that the RM4.6 billion given to these households is actually being injected back into the local economy. What happens is that the recipients end up spending their money on local businesses, buying food, clothes and other household necessities from local traders.

So, the BR1M payments are supposed to act as economic enablers.

The International Monetary Funds (IMF) is a strong proponent of targeted subsidy but the argument about the middle class being the losers cannot be ignored. With more cuts in fuel subsidies which free up national cash flow, the Government can then consider other forms of targeted subsidies to those in need.