Malaysian Prime Minister Najib Razak took steps for a shift toward fiscal prudence, scrapping sugar subsidies and unveiling plans for a consumption tax in 2015 while softening the impact with handouts to the poor.

The government will implement a goods and services tax of 6 percent in April 2015, while corporate and personal income tax rates will be lowered after the new levy comes into force, Najib said in his 2014 budget speech yesterday.

The fiscal deficit will shrink to 3.5 percent of gross domestic product next year from 4 percent in 2013, meeting targets set previously, the finance ministry said in a report.

Having earlier given handouts and pay increases for civil servants to woo voters, Najib is adjusting his focus to improve government finances and avert a credit rating downgrade after cementing his leadership of the country in a May general election. The prime minister will give tax breaks to middle-income earners and spend 4.6 billion ringgit ($1.5 billion) on aid for the poor to reduce the impact on consumer spending.

“When you announce these kinds of tax changes you’ve got to provide certain offsets and we got that,” said Euben Paracuelles, a Singapore-based economist at Nomura Holdings Inc.

“Fiscal consolidation will obviously have an impact on growth but again this is a price that they are now willing to pay because the fiscal priorities are now more pressing.”

Growth Forecast GDP may expand 5 percent to 5.5 percent in 2014 from an estimated 4.5 percent to 5 percent this year, according to the Ministry of Finance’s 2013/2014 economic report released in conjunction with the budget speech.

Forward contracts in Malaysia’s ringgit climbed after Najib announced the GST plan, with one-month non-deliverable forwards rising 0.5 percent to 3.1357 per dollar as of 5:39 p.m. in Kuala Lumpur yesterday, the highest level since June 17, according to data compiled by Bloomberg.

Stocks, bonds and the ringgit had advanced this week on optimism the prime minister would follow through on politically unpopular revenue-generating measures after Fitch Ratings cut Malaysia’s credit outlook to negative in July, citing rising debt levels and a lack of budgetary reform.

The “budget will be an important input to Fitch’s ongoing assessment of Malaysia’s public finances and broader sovereign credit profile,” Andrew Colquhoun, head of Asia-Pacific Sovereigns at Fitch, said in an e-mailed comment after Najib announced his plans. “However, Fitch expects it will be important to monitor the implementation and execution of budget measures over time.”

Tapering Risk

The negative outlook partly reflects the risk that the broader public sector deficit beyond the federal government will drive the emergence of a current-account shortfall, which could potentially increase Malaysia’s vulnerability to renewed “market tensions” when an impending reduction in U.S. monetary stimulus once again becomes imminent, the ratings company said.

Najib, 60, announced upgrades to rural airports, broadband network expansions and agricultural subsidies, pledging to support the economy while keeping debt levels from breaching the government’s ceiling. He is also the finance minister.

“While supporting the growth momentum, we are fully aware of the need to be fiscally responsible,” Najib said in the finance ministry report. “We are also pursuing better targeted, efficient and effective government expenditure. One of the measures towards this goal is to gradually carry out subsidy rationalization, with complementary measures to assist the vulnerable groups.”

The administration will cap debt service charges at below 15 percent of revenue and total federal government debt within 55 percent of GDP to make sure its finances remain healthy, the finance ministry said in its report.

Government Debt

Total federal government debt is expected to climb to 541.3 billion ringgit or 54.8 percent of GDP this year, up from 53.3 percent in 2012, the report showed. The subsidy bill is projected to decline to 39.4 billion ringgit next year, from an estimated 46.7 billion ringgit this year. This includes the costs to keep prices artificially low for items such as fuel and cooking oil, incentives to boost food production, educational assistance and social welfare programs.

The government will abolish its sugar subsidy of 34 sen from today, Najib said, pointing to statistics that showed 2.6 million Malaysians under the age of 30 are diabetic. The real property gains tax will be raised to control excessive speculation, he said.

“On the surface, it does look like the government is focusing on deficit consolidation, with the GST rate of 6 percent coming in higher than expected,” said Saktiandi Supaat, Singapore-based head of foreign-exchange research at Malayan Banking Bhd. (MAY) “The issue is whether these intricacies are easily implementable or not.”

Tax Protests

Protests against the consumption tax were planned in several locations nationwide this week by a citizen group called Oppressed People Network, a sign of the resistance Najib faces in proceeding with the levy. About 50 people gathered outside Parliament yesterday before Najib began his speech, carrying banners to reject any GST.

The GST can be avoided by cutting wastage, Malaysian opposition leader Anwar Ibrahim told reporters in Kuala Lumpur yesterday, saying he’s against the plan.

“Our concern, other than the issue of good governance, is the issue of inequality,” he said. “The GST will cause a bigger burden, particularly to the lower-income and middle-income groups.”

Softening Impact

The current sales tax and service levy will be abolished in place of the GST, Najib said. Essential food items such as rice, sugar, salt and cooking oil will be zero-rated while services including public transport are exempted from the new tax, he said.

The corporate tax rate will be lowered to 24 percent from 25 percent after the GST is implemented, while personal income tax levels will be reduced by 1 percentage point to 3 percentage points to increase disposable income, Najib said. For small- and medium-sized companies, the tax rate will be cut to 19 percent from 20 percent, he said.

The income threshold for the top tax rate will be raised to 400,000 ringgit from 100,000 ringgit when the GST starts, while middle-income earners will get a 2,000 ringgit tax relief for this year, Najib said.

“With the removal of the current sales tax, lower corporate tax rates, and exemption of low income households from income tax, the overall impact of the GST could be revenue neutral in the early years of its implementation,” said YeeFarn Phua, an analyst at Standard & Poor’s in Singapore.

Surplus Narrows

Najib’s government is forecasting federal spending of 262.2 billion ringgit in 2014, according to the finance ministry’s report. Total expenditure for this year is estimated at 261.3 billion ringgit, 4.6 percent more than originally budgeted.

Malaysia’s current-account surplus is estimated to narrow to 26.6 billion ringgit this year from 57.3 billion ringgit in 2012, the report showed.

The FTSE Bursa Malaysia KLCI Index of shares climbed to a record close on Oct. 24. The ringgit gained this week after touching a four-month high of 3.1413 per dollar on Oct. 18. It has appreciated more than 3 percent in October, the second-best performance among Asia’s 11 most-traded currencies behind Indonesia’s rupiah.

“The government will do what is right for our economy,” Najib said in a statement on Oct. 24. “Some measures may not be popular now, but over the medium term what is good for the economy is also good for the people.”