Malaysia may raise fuel prices gradually to contain fiscal deficit - Hasan Jafri

Malaysia could lose its status as home of the second-cheapest gasoline in Southeast Asia as Prime Minister Abdullah Ahmad Badawi focuses his efforts to rein in the country's fiscal deficit on increasingly expensive fuel subsidies.

The prime minister, in his second full year in office, faces a tricky balancing act. He has successfully slashed the budget deficit to 3.8% of gross domestic product from 5.6% in 2002. But the energy-subsidy bill has emerged as a concern, and reducing it will be politically difficult.

Under Malaysia's 2006 budget, unveiled Sept. 30, the government will spend 15.7 billion ringgit ($4.17 billion) this year to cap retail fuel prices, up sharply from six billion ringgit two years ago. State-owned oil company Petroliam Nasional Bhd., or Petronas, will pay nine billion ringgit to subsidize natural gas sold to local utility companies.

The total energy bill of almost 25 billion ringgit is higher than the projected 18.44 billion ringgit fiscal deficit for 2006, twice as much as Malaysia's security spending and 6.4% more than what the government plans to spend on education.

Analysts expect that Malaysia will increase fuel prices at a gradual pace, unlike the Indonesian government, which this month increased retail prices by an average of more than 125%. Analysts say Malaysia is in a stronger financial position to bear the cost of the subsidies compared with Indonesia, which was under pressure from a sinking currency, to take tough action.

Malaysia's weaker economic performance this year, compared with last year, also argues for a more gradual approach. Economic growth is forecast by the government to slow to 5% in 2005 from 7.1% in 2004, partly because the rising cost of oil has increased the cost of doing business. Year-to-year inflation hit 3.7% in August, the highest rate since February 1999.

Malaysia exports high-quality sweet, light crude to the world and has gained enormously from the record crude prices. It doesn't have enough domestic refining capacity and is forced to import gasoline, kerosene oil and diesel fuel.

The government this year has increased gasoline prices by 6.6% and diesel prices by 45.6%. At 43 U.S. cents a liter, Malaysia has the region's second-lowest retail gasoline price after Brunei, where the price is 32 cents a liter.

Indonesia's recent fuel-price increases pushed the gasoline price there to 44 cents a liter. Thailand sells gasoline for 55 cents a liter, while in Singapore a liter of gasoline costs as much as a $1.

Mr. Abdullah isn't expected to follow Indonesian President Susilo Bambang Yudhoyono's lead and shock the economy with a massive one-time rise. Instead, he is more likely to continue to gradually raise prices after doing the same three times this year.

Officials argue that because of Malaysia's financial position is stronger than Indonesia's, Mr. Abdullah has more leeway in weaning the public off cheap gasoline. The incremental approach will also keep political pressure off Mr. Abdullah, as well as ensure that inflation doesn't spike and that economic growth doesn't falter.

"You need a period of adjustment and just can't go cold turkey," says a senior government official who doesn't want to be identified. Other government officials say that Mr. Abdullah's administration is treading carefully because of fears of a backlash, particularly from the politically dominant ethnic Malay community. "The whole issue is very political. There is a lot of opposition against removing subsidies from within government", says a Finance Ministry official.

The government has said it won't raise prices further this year but has stopped short of saying what it intends to do in 2006.

Assuming crude oil continues to trade above $60 a barrel, some economists expect Mr. Abdullah to raise retail gasoline prices by 12% to 25% next year. The higher prices would help the government reduce both its budget deficit and its subsidy bill, perhaps by as much as three billion ringgit.

Still, Raising fuel prices too sharply could lead to a backlash from consumers and from industries such as fishing in rural areas, which rely heavily on subsidies and are poorer than middle-class residents of Kuala Lumpur.

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