Bangkok--8 Sep--Standard & Poor's A steep rise in Malaysia's fiscal deficit for 2008 could be a one-off fiscal slippage, or it may point to a deteriorating trend that will continue for the next few years. The jury is still out, given the government's projections of a much-reduced deficit in 2009 but the growing risks from external and internal factors that may push up budgeted expenditure. Standard & Poor's Ratings Services maintains its stable outlook on the ratings on Malaysia (foreign currency: A-/A-2; local currency: A+/A-1). "If the government successfully restores fiscal discipline, despite the uncertain global economic conditions and political pressure, the ratings and outlook will remain unchanged. But if the expected fiscal consolidation is further delayed, the local-currency ratings could come under increasing pressure. The foreign-currency rating should, however, remain stable over the next two years. That's because Malaysia has a strong external position for the rating category, despite an expected increase in public-sector debt and short-term external debt in 2008," said Standard & Poor's credit analyst Takahira Ogawa. In his August 2008 budget, Prime Minster and Finance Minister Abdullah Badawi announced that the fiscal deficit in 2008 will increase to 4.8% of GDP, from the 3.1% in the original budget a year ago and up from 3.2% in 2007. Although Mr. Badawi says revenue should be 9.8% higher than the original budget estimated, he warns that expenditure will soar by 16.7% in 2008. The significant increases are mainly attributable to higher spending on oil and food subsidies, and additional expenditure on infrastructure projects as the coalition government attempts to keep domestic demand strong enough to regain the nation's support after recent electoral setbacks. Subsidies are likely to surge to Malaysian ringgit (MYR) 34.1 billion, more than triple the 2007 level. Despite a restructuring of the fuel-subsidy system in June 2008 aimed at reining back the rapid rise in fuel subsidies, a 40%-60% increase in fuel prices has once again forced the government to push up expenditure targets. To reduce the impact of the high fuel prices on low-income groups and to maintain domestic demand, the government has introduced subsidies for low-income families, provided support for car and motorcycle owners, and allocated an additional MYR3.6 billion in food subsidies. The government estimates that gross spending on development projects will top MYR46.3 billion in 2008. That's a hefty 14% higher than in 2007, despite the government's original plan to reduce infrastructure spending by 2.1% year-on-year. "While the government expects the deficit to slide back to 3.6% in 2009, the eventual outturn could be much higher because of uncertain global macroeconomic conditions, a difficult political situation, and the size of the development budget," said Mr. Ogawa. For Malaysia, the uncertain global macroeconomic environment is being compounded by a challenging political situation, with the opposition parties stepping up their campaign to assume power. As a result, the government may feel compelled to increase public spending to maintain or boost domestic consumption. In addition, expenditure on development is slated to increase by 11.8% year-on-year in 2009, but could rocket if weaker-than-expected domestic demand persuades the government to increase spending on public projects. A strong rebound in oil prices could undermine the government's fiscal position, as it may need to increase subsidies to minimize the damage on domestic consumption. Although the 2009 budget maintains almost the same level of subsidies as in 2008 and the fuel subsidy is set at MYR0.30 per liter, the government could be propelled to increase the size of subsidies if oil prices rebound sharply. On the other hand, should oil prices slump, the national coffers would suffer, as the government has become increasingly dependent on oil-related revenue in recent years, with oil now accounting for about 40% of its total revenue. High oil prices present a significant medium-term risk. Despite increasing petroleum-related revenues, Malaysia's fiscal position has not been improving, mainly because of domestic fuel subsidies. The restructuring of the fuel-subsidy system in June 2008 could reduce future fiscal burdens, but a substantial chunk of the savings is being swallowed up by other forms of subsidies. "If global oil prices decline, depleting government revenue, and it proves difficult to reduce all subsidies, the government will struggle to curtail expenditure and avoid a significant slippage in its overall fiscal position," said Mr. Ogawa. For the Malaysian government, the issue will be how best to take advantage of the currently higher oil-related revenues, while keeping the budget's total outlays in check. This will mean managing public expectations about cheaper fuel prices and the levels of government support. Media Contact: David Wargin, New York (1) 212-438-1579, [email protected] Analyst Contact: Takahira Ogawa, Singapore (65) 6239-6342