Immediate risks to the stability of Malaysia’s coalition government have eased in the wake of local elections in six states, says Fitch Ratings. However, the results could add to strains within the ruling alliance over the longer term, as well as complicating fiscal consolidation efforts.
The elections saw the coalition between Pakatan Harapan (PH) and Barisan Nasional (BN) retain power in three states, while the opposition Perikatan Nasional (PN) kept control of the other three states with more than two-thirds majorities. PN gained seats in the three PH strongholds and prevented the PH-BN coalition from retaining a two-thirds majority in Selangor.
The rating agency believes this outcome will be sufficient to ensure the continuity of the coalition in the near term, but BN’s losses may aggravate underlying tensions between the coalition partners over the longer term. Fitch expects the result to add to the pressures on the BN Chairman, Ahmad Zahid bin Hamidi, who also serves as Deputy Prime Minister but faces corruption charges.
The results may also further complicate the government’s fiscal consolidation efforts. Prime Minister Anwar Ibrahim, in his EKONOMI MADANI Framework, has targeted a deficit of 3% of GDP or lower within 10 years, and the government has given many indications that it is looking to reform subsidy regimes to target them more efficiently.
The agency also believes the 2024 budget, due on 13 October, will advance subsidy rationalisation, likely to focus initially on electricity and diesel subsidies. The unity government has already taken some steps to reduce the electricity subsidies for non-domestic users and high-voltage users while leaving the majority of households unaffected. Most food subsidies and the costly fuel subsidies have been maintained in 2023.
Broad removal of subsidies is likely to be unpopular, especially as it may put upward pressure on inflation in the near term. Inflation, while low compared with many countries in the region at an average of 3.2% yoy in 1H23, was a source of public discontent ahead of the state elections. The election outcomes could encourage the government to prioritise other aspects of the MADANI agenda, such as those focused on containing living costs, raising wage growth, and improving welfare. It has, for example, recently discussed plans to introduce guidelines for wage increases, albeit only on a voluntary and productivity-linked basis.
Even if the authorities move ahead with some subsidy reforms as we anticipate, officials may be more generous with the offsetting assistance. The government has some headroom to accommodate such spending. Revenue grew strongly over 1-6M23, rising 19.4% yoy, while expenditure rose by only 10.6%. We believe the federal government deficit target of 5% of GDP for 2023 should be achievable even with modest additional spending. Moreover, when we affirmed Malaysia’s rating at ‘BBB+’/Stable in February 2023 Fitch says it assumed that the authorities would reduce federal government deficits gradually, to an average of around 4.5% of GDP in 2023-2025. Fitch has since revised this to 4.3%, but our forecast is still wider than the 4.1% target that the government has laid out for the period in its Medium-Term Fiscal Framework for 2023-2025.
Nonetheless, the electoral pressure on the authorities is likely to limit the potential for upside surprises on fiscal consolidation, making it more likely that Malaysia’s debt levels will remain high. Fitch expects the country’s general government debt/GDP to stand at around 72% in 2023, compared with a median of 56% for the ‘BBB’ category. This includes guarantees on loans by government-linked companies and 1Malaysia Development Berhad’s (1MDB) net debt, which collectively totalled 12.5% of GDP in 2022. Fitch sees debt/GDP falling only slowly, to 70% by 2025.
