The recent budget 2025 sent a clear message - the government is determined to narrow the fiscal deficit and boost its fiscal coffers.

While indicating a desire to return to the pre-pandemic fiscal trajectory, the approach taken was balanced. The magnitude of the spending was the largest ever, exceeding MYR400bn, with a strong emphasis on growth through a broad-based series of measures.

Let's start with the maths. The government aims to reduce its 2025 fiscal deficit to 3.8% of GDP, down from 4.3% in 2024. While this is above our original forecast of 3.5%, it is the fourth consecutive year that the government has aimed to shrink its fiscal deficit, paving the way to achieve 3% in 3-5 years as outlined by the Financial Responsibility Act, which was passed in October 2023.

Before looking ahead to 2025, a quick takeaway from the 2024 budget revisions is warranted. The current balance has been lowered to MYR0.6bn, as opposed to the budgeted MYR3.8bn. Both subsidies and emoluments have been revised higher but, fortunately, better-than-expected sales and service tax (SST) collection has come to the rescue, at least partially.

Now fast forward to 2025: the overall fiscal deficit is budgeted to fall to MYR80bn for the first time since 2019. However, current expenditure remains elevated, at a record high of MYR335bn, resulting in a minimal current balance of only 0.2% of GDP in 2025. Meanwhile, net development expenditure is budgeted to be almost flat at MYR84.7bn.

On the expenditure side, spending will rise 4% in 2025. The lion's share will come from emoluments alongside associated higher pension spending. This is not surprising as a 7-15% rise in civil servant salaries was announced earlier under the revised and phased Public Service Remuneration System (SSPA), effective from December 2024. This will be partly funded by more revenue and savings from subsidies.

However, nuances matter. Based on the revised 2024 budget, the subsidy bill will be MYR61.4bn this year, 14% higher than what was budgeted for. In 2025, subsidies of MYR52.6bn have been allocated, a 14% decline from the 2024 revised level. This will put 2025 subsidies back to roughly the same level as the original 2024 budget.

Now, the billion-ringgit question: what about the RON95 subsidy? This is one of the top three questions asked by investors we meet. The good news is that the government is committed to delivering its promises by announcing RON95 subsidy rationalisation in mid-2025. The goal is to cut RON95 subsidies for the top 15%, while maintaining the petrol price at MYR2.05/litre for the rest of the population.

Based on the budget speech, RON95 subsidies are expected to cost MYR20bn, representing almost a third of total subsidies in 2023. That said, details will be unveiled only in mid-2025, creating some uncertainty as the inflation trajectory will largely depend on the magnitude of the removal of subsidies. Even more important is the mitigation mechanism. This is why the government will likely take the next eight months to finetune the details of this mechanism, which is widely believed to be harder to implement than the one for diesel, given its far-reaching impact.

Despite the focus on "raising the floor", the budget is also about how to "lift the ceiling". For one, a New Investment Incentive Framework (NIIF) has been announced to attract more investment to boost Malaysia's competitiveness. Aimed to be launched in 3Q25, the NIIF focuses on providing incentives and encouraging development in strategic areas of growth. Separately, special incentives to attract quality foreign direct investment in the Johor-Singapore Special Economic Zone (JS-SEZ) will be announced by end-2024.

Given the still-sizeable spending plans for 2025, questions remain about funding. In particular, Petronas dividends are allocated to be flat at MYR32bn, the same level as this year. As in 2024, the 2025 budget is based on two assumptions as the government bids to diversify away from energy-related revenue: higher GDP growth and a broadening tax base.

First, there is the estimated 8% increase in corporate and individual income tax revenue. Second, in the absence of reintroducing the GST, broadening the SST is seen as an alternative. Indeed, this is what was delivered in the budget. Key measures include expanding the SST base to non-essential goods and additional services from May 2025 and the introduction of a 2% tax on dividend income over MYR100,000 for individuals.

Overall, Malaysia's continued progress in fiscal consolidation is a real positive. But the budget aims to strike a balance by addressing a range of issues - from easing the cost of living to raising Malaysia's growth potential. The plan is clear - now all eyes are on how it will be implemented next year.