This article first appeared in Forum, The Edge Malaysia Weekly on March 31, 2025 - April 6, 2025

The Budget 2025 announcement that RON95 fuel subsidies would be removed for the top 15% of income earners starting mid-2025 marks a significant step towards the country’s subsidy reforms, following the decision to float diesel prices in mid-2024. The authorities have decided to implement a two-tiered pricing system to distinguish eligible recipients from those who are not. While subsidy rationalisation is commendable, the proposed approach may fall short of delivering its intended objective.

While the primary objective of subsidy rationalisation is to improve public finances, targeting only the top 15% of income earners offers relatively modest fiscal savings. After accounting for the expanded cash transfers announced in the budget, the net savings of the latest subsidy reform shrink to RM5 billion annually, or 0.3% of gross domestic product (GDP), from an estimated gross savings of RM8 billion annually. Moreover, the decision to target the top 15% of income earners lacks clarity, raising questions about the arbitrariness of this threshold and whether it adequately reflects income disparities among households.

The proposed two-tiered pricing system also presents significant implementation challenges. Determining subsidy eligibility would require extensive data collection, verification and income classification. Implementing differential pricing at petrol stations presents another layer of complexity. International experience shows that operators of fuel stations often lack the necessary incentive, capacity and infrastructure to enforce such measures. In addition, monitoring and enforcing compliance would demand significant resources and oversights, further stretching administrative capacity. These challenges not only threaten to dilute the policy’s effectiveness but also risk eroding public confidence in the government.

The concerns surrounding the potential impact of RON95 subsidy rationalisation are valid, as reforms of this scale are naturally prone to political and social resistance. If poorly managed, they risk being undermined or entirely withdrawn. A well-thought-out strategy is therefore crucial to ensure the successful implementation of subsidy rationalisation and the rebuilding of fiscal buffers.

In this context, we would recommend a staggered, two-phased elimination of petrol subsidies over a 12-month period as proposed in Amro’s 2024 Annual Consultation Report for Malaysia. Amro is the Asean+3 Macroeconomic Research Office. The first phase could involve an adjustment from the current RM2.05/litre to RM2.40/litre in the first six months, followed by floating the RON95 price to market rates (estimated at RM2.90/litre based on a Brent crude price of US$76/barrel) by the end of the 12th month.

International experience shows that a phased approach allows households and businesses to adjust to the higher market price gradually, mitigating the full impact of subsidy removal on the cost of living. It also provides time for governments to gain public acceptance for the measure by demonstrating that subsidy savings are being reinvested in public welfare. Namibia, for instance, successfully removed subsidies through a three-year reform plan, while Iran and Egypt adopted a five-year gradual reduction of energy subsidies. All complemented their reforms with expanded social assistance programmes to cushion the impact on vulnerable populations, ensuring a smoother transition. In the region, Indonesia took a different approach in its 2014 energy subsidy reform by implementing a one-off 34% price increase on gasoline and diesel prices and adopting a semi-automatic fuel pricing mechanism (though the effort was stalled later). That said, Indonesia’s drastic approach was facilitated by the low oil prices at the time, which provided policymakers with more policy room. Given the current oil price level, a gradual and phased approach may be more suitable for Malaysia, as it minimises economic disruptions and increases the likelihood of success for a sustained reform.

A phased approach also lowers administrative complexity and improves compliance. Unlike tiered pricing mechanisms, floating prices with direct cash transfers simplify the reform process. Cash transfer programmes can leverage existing databases, such as eKasih and personal income tax registries, for easier administration. Floating prices in line with changes in the global market price of oil also ensure uniformity and clarity of petrol prices, avoiding confusion and dissatisfaction. This simplicity makes the reform more practical to implement and easier for consumers to understand.

Timing is another critical factor. Initiating such reforms early in the election cycle provides the government with a window to demonstrate positive outcomes and tangible benefits, such as a stronger fiscal position and more targeted social assistance before the next election. In contrast, delaying these reforms could undermine efforts to achieve fiscal sustainability and increase the risk of political backlash. Moreover, larger fiscal savings from the staggered reform would make it easier for Malaysia to comply with its newly enacted fiscal rules, including the goal of reverting to a 60% debt-to-GDP ratio by 2028.

The success of subsidy rationalisation also depends heavily on public perception and effective communication. Clear messaging about the expanded cash transfer programmes and the broader economic benefits of subsidy removal is essential to building public trust. A study by the World Bank shows that packaging subsidy reform with compensatory measures financed by subsidy savings could significantly increase public support. By highlighting how reforms will support vulnerable households and redirecting savings to fund critical social and economic priorities, the government can build a narrative of shared national benefit.

In conclusion, rationalising petrol subsidies is critical to rebuilding Malaysia’s fiscal resilience. While the government’s commitment to reform is commendable, the proposed tiered pricing measures face significant implementation challenges and are unlikely to achieve sufficient fiscal savings. A phased subsidy removal plan, paired with direct cash assistance for vulnerable groups and supported by clear, transparent communication offers a more effective and equitable solution. Such an approach not only addresses inflation concerns similarly to the tiered pricing mechanism but also simplifies implementation. Given the substantial challenges associated with enforcing two-tiered pricing, adopting a phased approach to a floating price system is a more practical and impactful alternative.

As Economy Minister Datuk Seri Rafizi Ramli has described, RON95 fuel subsidy rationalisation is a “once in a generation” policy decision. It is crucial to get it right and the time for decisive action is now.

Dek Joe Sum is an associate economist at the Asean+3 Macroeconomic Research Office

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