Malaysia's upcoming GST poised to reform existing tax regime

However, inflationary impact is inevitable.

Malaysia's Goods and Services Tax (GST) will come into effect in April, with the 6% tax hike soon to replace the existing Sales and Services Tax (SST), and which is seen as a significant move in reforming the existing tax regime and a key milestone towards further fiscal consolidation and longer term debt sustainability.

According to a research note from DBS, however, its inflationary impact is inevitable.

While the introduction of the offset measures, an expanded exemption list and the abolishment of the SST may help to dilute the pass-through effect of the tax hike, inflation is still expected to spike up.

Here's more from DBS:

The direct inflation impact of the GST is about 1.5%-pt. This will lift Apr15 CPI inflation to 4.3% YoY, from an estimated 2.8% in Mar15.

Juxtaposed with the fuel price hikes that came into effect in Oct14, and factoring in a certain degree of second order price effect and pricing adjustments from retailers, headline CPI inflation is likely to approach the 5% level in the few months after the tax hike, before easing to 4.3% in 4Q15.

On average, full year inflation is expected to register 4.2% in 2015.

With inflation likely to be significantly higher than usual, monetary policy will remain on a tightening bias.

We expect Bank Negara to raise the Overnight Policy Rate by another 25bps to 3.50% in the first quarter next year.

This will be a pre-emptive move to anchor inflation expectation amid a still fairly sanguine growth outlook.