The budget gap may narrow to 7% of gross domestic product (GDP) in 2010, according to the median forecast of nine economists in a Bloomberg News survey. That compares with the government’s estimate for a shortfall of 7.6% of GDP this year, the biggest since 1987.

“The high budget deficit doesn’t just reflect cyclical factors but structural ones as well,” said Robert Prior-Wandesforde, an economist at HSBC Holdings Plc in Singapore.

“It’s important this structural deficit is brought down quickly. If no action is taken and the economy is hit by another big shock in the near future, there’ll be little or no room for the government to respond via a relaxation of the fiscal stance.”

Najib, who unveiled RM67 billion of stimulus initiatives, said last month the government will be more “prudent” in spending and make subsidies more “targeted” as the economy recovers.

Malaysia’s economy will probably expand 4.5% next year, after contracting about 2.9% in 2009, according to the median estimate of economists surveyed by Bloomberg. Najib will unveil the 2010 budget and growth forecast, along with a revised 2009 GDP estimate in parliament tomorrow.

The government, which subsidises products from gasoline to sugar to keep prices low, will revamp the system to ensure it benefits the most needy consumers next year, Second Finance Minister Datuk Seri Ahmad Husni Hanadzlah said on Oct 13.

The new subsidy mechanism will involve fuel, he said, predicting next year’s budget deficit will be smaller than this year’s 7.6% of GDP as operational spending is reduced.

“We expect subsidies to be the most flexible expenditure that the government may cut back on,” said Kit Wei Zheng, an economist at Citigroup Inc in Singapore. “Both fuel and food subsidies may be reformed to make them more targeted.”

Malaysia spent RM9 billion on fuel subsidies, and another RM4.7 billion on subsidies ranging from food to electricity and transport, Najib said last week, without specifying any time period. The Ministry of Finance last year said subsidies would account for about 16.4% or RM33.8 billion of the 2009 budget.

Malaysia’s total 2010 budget plan will be smaller than the RM196 billion allocated for this year, Ahmad Husni said on Oct 13. The government will also try to increase efficiency and curb ministers’ expenses on overseas trips to cut costs, he said.

Even as he tries to trim operational costs and subsidies, Najib will probably maintain development spending on transport, housing, education and security to support the nascent recovery and improve the nation’s competitiveness, analysts said.

Economists’ estimates for development spending next year range from RM55 billion to RM60.5 billion compared with about RM51.7 billion initially allotted for 2009.

“A premature exit from stimulus spending could stop the recovery in its tracks,” said Lee Heng Guie, chief economist at CIMB Investment Bank Bhd. “Policymakers have the unenviable task of spurring growth through continued stimulus spending while maintaining fiscal discipline.”

Projects that may be implemented include the extension of subway lines, the construction of a low-cost carrier airport and a sub-sea cable project to transmit power from Borneo to Peninsular Malaysia, Lee said.

The government may announce more measures to open up its services industry and further loosen rules on property sales to boost local and foreign investment, economists said.

Najib is also due to unveil a new national automotive policy this month that may allow greater foreign participation in the local industry, said Wong Ming Tek, head of research at HwangDBS Vickers Research.

The government needs to increase its sources of revenue to help reduce its budget deficit, and this may prompt Najib to raise taxes on alcohol and gaming, said Suhaimi Ilias, chief economist at Maybank Investment Bank Bhd. The tax on tobacco and cigarettes was raised on Oct 1. Najib will probably leave corporate and personal income taxes unchanged and unveil a timeframe for the implementation of a goods and services tax (GST) as early as 2011, economists predict.

“With Malaysia’s corporate and personal income taxes higher than regional competitors, a further cut would help attract much needed investment and talent,” Citigroup’s Kit said. “But with income taxes comprising a hefty 28% of revenues, the government’s hands are tied by the fiscal deficit. A cut in income taxes will likely take place when the GST is implemented, such that the net impact is revenue neutral.” — Bloomberg

This article appeared in The Edge Financial Daily, October 22, 2009.