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UPDATE 2-Malaysia bites bullet on consumption tax to curb rising debt

Al-Zaquan Amer Hamzah and Siva Sithraputhran
Friday, 25 Oct 2013 | 7:49 AM ET

(Recasts, adds details, quotes)

KUALA LUMPUR, Oct 25 (Reuters) - Malaysia's government moved to allay concerns over its fast-rising debt on Friday, announcing a new consumption tax at a surprisingly high rate, abolishing subsidies on sugar and hiking property taxes to dampen a surge in home prices.

Prime Minister Najib Razak, in his annual budget speech to parliament, announced his government would bring in a goods and services tax (GST) in 2015 at a rate of 6 percent, above market expectations of 4 or 5 percent.

The ringgit currency gained against the dollar in late trade as investors welcomed the tax, which is aimed at broadening the revenue base in a country where only about 10 percent of citizens pay income tax and most of the government's money comes from oil and gas.

Otherwise, Najib announced few major steps to cut subsidies that take up about a fifth of government spending, or deeper reforms such as reducing a bloated, but politically influential, civil service.

Once a high-flying "tiger" economy, Malaysia has become heavily dependent on commodity exports and struggled with low private investment since the 1997-98 Asian financial crisis, despite a partial revival in recent years.

"The government has decided to implement a fair and comprehensive tax system that benefits all Malaysians," Najib said. "The government believes that this is the best time to implement GST as the inflation rate is low and contained."

(For highlights of the budget speech, click on )

Najib was under pressure to take bold steps after Fitch ratings agency in July cut its outlook on Malaysia's sovereign debt to negative, citing poor prospects for reform following a divisive May election.

Malaysian markets suffered a bout of turmoil over the summer as the country's shrinking current account surplus left it vulnerable to fund outflows driven by an expected tightening of U.S. monetary policy.

Most economists said Najib's budget had gone some way to restoring confidence in the government's political will to improve its finances, which has been shaken by a rapid rise in debt in recent years.

"The fact that they took the bold step to introduce 6 percent at the start shows a lot of commitment in reining in the fiscal deficit," said Irvin Seah, DBS economist in Singapore.

"You won't see the full benefit of the GST on the fiscal position at the outset... But in the longer term it will help bolster the fiscal position."

Najib announced a raft of steps to offset the impact of the GST, including exemptions on basic food items and transport and one-off payments to poorer families. He also announced a cut in corporate tax of 1 percent to take effect in 2016.

Ratings agency Standard & Poor's called the budget "a step in the right direction" though it added that the budget proposals did not fully address the weaknesses of high subsidies and poor revenue structure.

"We would have preferred more clarity on say fuel subsidies such as details and timelines," said Selena Ling, head of treasury research at Overseas-Chinese Banking Corp in Singapore.

After securing his power base last weekend in ruling party elections, Najib had appeared to have a freer hand to tackle a high fiscal deficit with unpopular steps.

But having trimmed fuel subsidies by 3.3 billion ringgit ($1 billion) per year shortly the Fitch announcement, Najib only pledged to gradually restructure the subsidy policy.

COOLING PROPERTY BOOM

The government's economic report, released just ahead of the budget speech, said that spending on subsidies, including fuel, would total 39.3 billion ringgit next year, up slightly from 37.7 billion ringgit in 2013.

The abolition of the 0.34 ringgit per kg subsidy on sugar was justified as needed to combat rising rate of diabetes.

In the report, the government maintained its commitment to steadily cut the budget gap, from 4.5 percent in 2012 to 4.0 percent in 2013 and 3.5 percent in 2014.

"We believe that the government has paid heed to increasing criticism by markets and rating agencies, and has followed through after the aggressive fuel subsidy reduction in September," Barclays Capital economists wrote in a note.

The economic report forecast a slight pick-up in GDP growth to 5.0-5.5 percent in 2014 from 4.5-5.0 percent in 2013, underpinned by strong domestic demand. The government expects to narrowly stay within its self-imposed debt limit of 55 percent of GDP next year, forecasting a ratio of 54.7 percent.

To cool a surging property market, Najib announced that the country's property gains tax would be doubled to 30 percent for real estate sold within three years. The minimum value of a property for foreign buyers was doubled to 1 million ringgit.

Malaysian property prices have risen by about a third in the past three years, with even bigger rises in hot spots such as parts of southern Johor state.

The government forecast private investment would rise to 17.9 percent of GDP in 2014, with funds going into oil and gas, textiles, transport equipment and real estate development.

Private investment remains well below levels seen in the 1990s, when it averaged 22.9 percent of GDP annually, but it is recovering from an average of 11.8 percent between 2001-2011.

(Additional reporting by Anuradha Raghu and Niluksi Koswanage in Kuala Lumpur; Kevin Lim in Singapore. Writing by Stuart Grudgings; Editing by Simon Cameron-Moore)