KUALA LUMPUR Malaysian Prime Minister Najib Razak will trim the government's hefty subsidy bill and likely announce a new consumption tax later this week as he delivers a budget seen as crucial to ward off a possible credit downgrade and reassure investors over the Southeast Asian country's fast-growing debt burden.
After securing his power base in ruling party elections over the weekend, Najib should have a freer hand to tackle a high fiscal deficit with unpopular steps to wean Malaysians off cheap fuel and food.
But the budget, to be unveiled in parliament on Friday, is unlikely to make drastic cuts to subsidies that take up about a fifth of government spending, or include deeper reforms such as reducing a bloated, but politically influential, civil service.
Any wavering over reforms the government has flagged, such the introduction of a Goods and Services Tax (GST), would disappoint investors, uneasy with Malaysia's shrinking current account surplus and a budget gap that is the second-biggest in emerging Asia.
"The government will have to show the political will to address the situation," said Chua Hak Bin, a Singapore-based economist at Bank of America Merrill Lynch.
In July, ratings agency Fitch cut its outlook on Malaysia's sovereign debt to negative, citing gloomier prospects for reforms in the wake of the ruling coalition's weak election result in May that appeared to undermine Najib's standing.
Slowing economic growth is weighing on Malaysia's efforts to improve its finances. Malaysia's central bank cut its forecast for full-year 2013 growth to 4.5-5.0 percent from 5-6 percent.
Years of heavy spending, including Najib's own pre-election giveaways and a fast-growing civil service wage bill, have hampered efforts to reduce the chronic budget deficit. Najib aims to trim the gap from 4.5 percent of GDP in 2012 to 4 percent in 2013 and 3.5 percent in 2014 before returning to a surplus by around 2020.
The deficit has pushed Malaysia's national debt to 53.5 percent of gross domestic product from 43 percent in 2008, close to a self-imposed limit of 55 percent.
TRIMMING, NOT SLASHING, SUBSIDIES
Najib, who trimmed fuel subsidies by 3.3 billion ringgit ($1 billion) per year shortly after the Fitch announcement, prepared the ground for further cuts in a blog post on Sunday.
"I believe we need to take long-term measures to reduce dependence on government subsidies at present so we will not burden future generations," he wrote.
Referring to fuel subsidies, he said: "the money can be channeled to other areas that are more important, such as education and infrastructure improvements."
The government has allocated 24.8 billion ringgit for fuel subsidies this year.
Rahul Bajoria, an economist at Barclays Capital in Singapore, said expectations among institutional investors were "quite low" for the budget, and that fuel subsidy cuts would likely be limited.
"There is some expectation he will follow through on the momentum. But he's not going to hike prices by 10 percent in the next three months or anything like that."
Najib said steps would be implemented gradually and that low-income groups would receive help to cope with price rises, signalling another likely round of cash handouts that totalled around 3 billion ringgit in last year's budget.
Malaysian consumers can expect another hit from the new consumption tax, although it is unlikely to be implemented until 2015, three years before the next election falls due. The long-delayed tax, seen as crucial to cut Malaysia's heavy dependence on oil revenues, would replace the current narrower sales and service taxes and apply to all stages of transactions. Currently, only about 10 percent of Malaysia's workforce pays income taxes.
The tax is likely to be introduced at a rate of at least 4 percent, which Bajoria of Barclays said would be revenue neutral. Bajoria said the government could opt for a 5 percent rate, which he said would be revenue positive to the tune of 5-6 billion ringgit.
"It makes sense for them to pull the trigger this time round," Bajoria said.
Najib could also opt to hike the property gains tax in a move to cool property prices, which have risen by about a third in the past three years, with even bigger rises in hot spots such as parts of southern Johor state.
Tough action against speculators could have a knock-on effect on shares in Malaysia-listed property firms such as SP Setia and Mah Sing Group.
(Writing by Stuart Grudgings; editing by Simon Cameron-Moore)