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Utilities

SCENARIOS-Malaysia's options for subsidy cuts

KUALA LUMPUR, May 26 (Reuters) - Malaysia’s government is to meet on Wednesday to discuss politically unpopular changes to its subsidy regime for petrol, natural gas, food and road tolls.

It is unlikely to take a final decision on implementing any changes to the costly regime that chewed up 15.3 percent of Malaysia’s federal government operating spending in 2009, according to official figures.

Subsidies cost 24.5 billion Malaysian ringgit ($7.49 billion) in 2009, pushing Malaysia’s budget deficit to 7 percent of gross domestic product, its highest in more than 20 years.

Plans to cut subsidy spending to 20.9 billion ringgit this year were dealt a blow by the government’s failure to implement planned petrol price hikes in May. [ID:nSGE62307]

If you add in other spending in areas such as education grants and health, total transfer spending is around three times the declared subsidy bill at 74 billion ringgit, an amount used in a campaign to convince the public to accept the changes.

Following are the options the government may consider.

(See related analysis [ID:nSGE64O03F] )

CUTTING SUBSIDIES OVER 5 YEARS

It would reassure markets fearful of budget indiscipline and limit political damage for Prime Minister Najib Razak who must call a general election by 2013. Najib also faces polls this year or next in Sarawak, a state that provides over a fifth of government MPs.

A proposed start date of June 1 already seems to have slipped in the same way as a May deadline for petrol subsidy cuts.

A small initial hike in petrol prices by say 15 cents a litre would not immediately hit wallets or derail economic recovery, while producing savings of as much as 1.4 billion ringgit in 2010. Prices could then be hiked over a period of years on a regular basis. The timeframe for price hikes would have to be credible.

To assist the poor -- mainly Malays who make up much of the National Front government’s voter base -- the government could pay cash benefits to owners of smaller cars or motorcycles.

The risk is that regular semi-annual or annual price hikes could cause a continued drip of discontent with the government. For markets, the risk would be that the government would lose heart in the face of public opposition, as it did under Najib’s predecessor.

Electricity price hikes could be mitigated by putting a base consumption level under which people would not pay extra charges.

If electricity was hiked by 2.4 Malaysian cents per kilowatt-hour, that could save 800 million ringgit in 2010.

There would be a spike in annual inflation MYCPI=ECI as a result of the start of the subsidy regime changes, although the base effect would diminish their effect over time. Inflation could spike up to 4.5 percent at the start of 2011 if petrol, gas, electricity and toll road prices were hiked on June 1.

* Probability: Most likely option

* Market impact: It would be bullish for bonds if implemented, as little reform has been priced in by investors. It could boost electricity company Tenaga's TENA.KL stock price and its bonds.

DELAY, JUST MAKE MINOR CHANGES OR DO NOTHING

Tempting for a government that has already deferred planned price hikes due to fear of a voter backlash. While Najib has generally talked a good game on economic reform, a year in office has seen little of substance delivered, undermining investor confidence in his ability to overcome political obstacles.

The fact that Najib has outsourced all of his economic reforms to independent bodies shows little support within the government for painful decisions. Failure to implement electricity and petrol price hikes has already hit its credibility.

With Malaysia’s economy rebounding strongly, tax receipts will grow and there will be less need for government stimulus so the budget gap will narrow faster than the government’s forecast of 5.6 percent of GDP this year.

Najib, however, is committed to economic reform and has frequently pledged to tackle subsidies. If he fails, it will underline his political weakness.

* Probability: Less likely

* Market impact: Investors have limited their exposure to Malaysian assets, so another disappointment is unlikely to trigger an immediate selloff.

COMPLETE WITHDRAWAL OF SUBSIDIES IN ONE GO

A big bang approach would impress investors in Malaysian bonds but would be unpopular with voters as it would likely involve petrol prices, for example, rising by 1.15 ringgit per litre from their current 1.80 ringgit.

* Probability: The least likely option

* Market impact: The big bang would produce a bond and stock market rally for companies such as electricity company Tenaga. (Editing by Tomasz Janowski) ($1=3.273 Malaysian Ringgit)

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