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Stakes are high for Mahathir in first budget back as Malaysian PM

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Less than six months in office, Malaysian Prime Minister Mahathir Mohamad is staring down a possible credit rating downgrade in his government's first budget.

[KUALA LUMPUR] Less than six months in office, Malaysian Prime Minister Mahathir Mohamad is staring down a possible credit rating downgrade in his government's first budget.

Economists and market watchers are bracing for bigger deficit targets, higher debt and slower economic growth when Finance Minister Lim Guan Eng delivers his budget speech on Friday. Moody's Investors Service has already flagged threats to Malaysia's A3 rating, while credit-default swaps have risen.

The budget will be a tough balancing act for 93-year-old Dr Mahathir: he needs to find more revenue and keep debt under control, without angering voters and stalling the economy with higher taxes and severe spending cuts.

The ousting of Najib Razak's government "was very much triggered by economic discontents," said Wong Chin Huat, a political analyst at the Penang Institute. Dr Mahathir's ruling Pakatan Harapan coalition, "which won only 48 per cent of popular votes, must tread very carefully between competing demands between fiscal discipline and avoiding a popular backlash."

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Part of the deficit problem is due to Dr Mahathir's own doing. Shortly after winning the May 9 election, he scrapped a consumption tax to fulfill a key campaign pledge, which Mr Lim has said leaves a RM23 billion (S$7.59 billion) revenue shortfall. The government has also fixated on contingent liabilities - such as guarantees for public companies - which if included in the state's overall debt figures would push up the ratio to above a self-imposed threshold of 55 per cent of gross domestic product.

Here's a snapshot of what economists are expecting:

BUDGET DEFICIT

The previous government had an optimistic target of 2.8 per cent of GDP for the budget deficit for this year, which it planned to slowly narrow over time. Mahathir's move to scrap the goods-and-services tax and replace it with a sales tax makes that goal unlikely.

The median forecast of nine economists surveyed by Bloomberg is for the deficit to reach 3.2 per cent of GDP in 2018 and remain at that level next year. The government has already abandoned a plan by the previous administration to balance the budget in two years time, forecasting instead a shortfall of 3 per cent of GDP in 2020.

Mohamed Faiz Nagutha, an economist at Bank of America Merrill Lynch in Singapore, said a key question for investors relates to the medium-term fiscal plan. Even though authorities may commit to reducing the deficit over time "details are going to be important in convincing investors," he said in a note.

GDP GROWTH

The economy was one of the growth stars in Asia last year, expanding almost 6 per cent on the back of an export boom, strong public infrastructure spending and cash handouts by the previous government. Growth has eased this year amid rising trade risks and after the political transition led to a slump in public spending.

Economists in a Bloomberg survey forecast growth of 4.8 per cent this year and 4.5 per cent next year. According to a mid-term review, the government is projecting expansion of 4.5 per cent to 5.5 per cent in 2018 to 2020.

Mahathir's focus in his first few months in office has been to root out corruption, reform key institutions and reprioritize some spending. That's made businesses cautious to invest, and the "private sector is looking towards the coming 2019 budget for new policies, growth catalysts, and fiscal clarity," said Julia Goh, an economist at United Overseas Bank Ltd. in Kuala Lumpur.

NEW TAXES

The government may make some key tax changes to help boost revenue. These are some of the measures it could adopt:

Digital tax: Like other South-east Asian nations, Malaysia may look to tap the fast-growing e-commerce world with new levies, according to Mohd Afzanizam Abdul Rashid, chief economist at Bank Islam Malaysia Bhd. in Kuala Lumpur

Sugar tax: To help promote healthy living, a tax on sugar or soda consumption could be imposed

Logging and carbon tax: To improve and protect the environment, the government could consider green taxes. Neighboring Singapore plans to introduce a carbon tax from 2020

Others: Bloomberg Economics' Tamara Henderson said she doesn't expect the government to invoke a capital gains tax. A levy like that would be a disadvantage to Malaysia relative to peers, she said. New taxes on inheritance or online transactions are unlikely to be rolled out until 2020, she added.

BLOOMBERG