Malaysia: Budget 2025 targets fiscal gap of 3.8% of GDP, lowest in post-pandemic period

• Government stays focused on fiscal consolidation
• Fiscal spending projected at record MYR 421bn
• Revenue seen rising by 5.5% on better economic outlook, broadening of tax base
• GDP estimated to expand by 4.5%-5.5% following better-than-expected economic activity in 2024
• Gross borrowings to maintain downtrend while gross debt to remain broadly stable
• Subsidy bill to be slashed further

The federal government on October 18?presented the budget for 2025, aiming to bring down the fiscal deficit to 3.8% of GDP, the lowest in the post-pandemic period, from 4.3% in 2024. Supported by higher revenue and reduction in hefty subsidy bill, the smaller budget gap reflects the ruling coalition's firm progress towards gradual fiscal consolidation. PM Anwar Ibrahim in his budget speech in the Dewan Rakyat vowed to implement "more aggressive and inclusive" fiscal reforms next year.

The government targets to spend a record MYR 421bn in 2025, with more than a quarter of the funds allocated for the ministries of education and health. After already rationalizing subsidies for electricity, chicken, water and diesel, it plans to cut blanket subsidies for widely used RON95 gasoline by mid-next year, which proves that transition to targeted subsidies is central to the government's fiscal reform agenda.

Although no new taxes have been introduced, revenue is expected to be enhanced by 5.5%, driven by better economic outlook, broadening of the tax base and stricter revenue collection systems such as e-invoicing. The government reaffirmed its commitment to narrow the fiscal deficit to 3% of GDP and debt to 60% of GDP in the medium-term, as laid out under the Public Finance and Fiscal Responsibility Act 2023.

Macroeconomic framework

The government projects Malaysia's economy to expand between 4.5% and 5.5% in 2025, compared with an upwardly revised 4.8-5.3% in 2024, which has surpassed the initial target of 4%-5% due to better-than-expected activity in agriculture and construction sectors. Healthy domestic demand, amid favourable labour market conditions, and a resilient external sector are expected to support economic expansion next year. On the supply side, the services sector will remain the main driver of growth on the back of thriving tourism activities, sustained exports and acceleration of tech-related activities.

On the price front, the government sees inflation to remain manageable at 2.0%-3.5% in 2025, but slightly up from 1.5%-2.5% in 2024 as it anticipated upward pressure from domestic policy measures, alluding to further subsidy cuts especially for the widely used RON95 gasoline.

Meanwhile, the current account surplus is forecast to pick up from MYR 43.4bn in 2024 to MYR 49.1bn in 2025. Goods surplus is expected to edge up while the services deficit is expected to narrow owing to robust tourist earnings. These gains, however, are likely to be partly offset by higher outward remittances and profits repatriation.

Federal Government Budget

Revenue

The government seeks to collect MYR 339.7bn in revenue in 2025, some MYR 15.7bn or 5.5% more than the revenue mopped up in 2024. The bulk of this expansion would come on the back of improved income tax from companies and individuals as well as better sales and services tax (SST) receipts. On the other hand, petroleum income tax is expected to decline, in anticipation of lower crude oil prices. Moreover, although dividend from PETRONAS is seen to stay stable at MYR 32bn, the government forecasts lower proceeds from investment income next year, which will weigh on non-tax revenue.

Key measures announced in the budget include:

• Scope of SST to be gradually expanded from May 2025. Sales tax to be charged on non-essential goods such as premium imported items while services tax to be widened to commercial services such as fee-based financial services
• 2% tax will be levied on dividend income exceeding MYR 100,000 received by individual shareholders
• Carbon tax on steel- and iron-making industries and energy firms to be introduced by 2026
• Further tax relief for first-time homeowners, companies that employ women returning to work, and educational institutions that develop new digital tech courses such as artificial intelligence
• Excise tax rate for sugary beverages to be increased by 80% from January 2025
• Windfall profit levy thresholds for crude palm oil raised by MYR 150 each for Peninsular Malaysia and Sabah and Sarawak to MYR 3,150 and MYR 3,650, respectively

Expenditure

Fiscal spending in 2025 is projected at MYR 421bn in 2025, up by 4.2% from the revised estimate of 2024. The expansion is expected to come entirely on account of operating expenditure, driven by higher emoluments, resulting from an?increase in salaries?for civil servants, as well as higher pension payments and a rise in debt service charges. In contrast, spending on subsidies and social assistance is forecast to be slashed by 14.4%, reflecting the government's commitment to pursue subsidy reform initiatives to address leakages and wastages. PM Anwar in his budget speech said that blanket subsidy for the RON95 gasoline will be withdrawn in the middle of next year.

It is noteworthy that the government planned to float RON95 gasoline prices this year but postponed the decision, citing the need to focus on evaluating the impact of diesel subsidy rationalization, which was implemented in June. The delay led the 2024 subsidies and social assistance spending target to be missed by MYR 8.6bn.

Meanwhile, development expenditure is projected to remain unchanged at MYR 86bn in 2025, of which more than a fifth, MYR 17.6bn, has been allocated for financing transport-related projects. Another MYR 21.9bn will be spent on improving health facilities and educational institutions.

Budget financing

The government is estimated to face a budget deficit of MYR 80bn in 2025, equalling 3.8% of GDP, which represents a fiscal correction of 0.5pps from the previous year. The primary budget deficit, i.e., expenditure without debt service charges, is forecast to consolidate further to MYR 25.3bn (1.2% of GDP), down from MYR 33.5bn (1.7% of GDP) in 2024.

The government is expected to continue to rely on borrowings from local commercial banks to plug its fiscal deficit. Gross borrowings in 2025 have been pegged at 10% of GDP. According to our calculations, this translates into MYR 208.2bn, with MYR 80bn allocated for deficit financing while MYR 128.bn for principal payments on debt. Moreover, sovereign bond supply is likely to remain broadly constant next year, given that gross borrowings are estimated at MYR 206bn (10.6% of GDP) in 2024.

The federal government debt is projected to stay flat at 64% of GDP by the end of 2025. The government sees the?debt growth to maintain a downward trend, reducing from 8.6% in 2023 to approximately 7.5% in 2024 and to around 6% in 2025.

Conclusion

Although the budget for 2025 is short on bold reforms, it will be welcomed for targeting higher revenue without burdening the lower-income groups and instead mobilizing additional revenue from high-income groups, such as through the tax on dividend income exceeding MYR 100,000 and sales tax on luxury goods. Further, an increase in minimum wage and social assistance, coupled with a hike in salary for civil servants, are likely to boost consumers' purchasing power. These, along with tight labour market, subdued inflation and relatively low interest rates, would aid household spending, thereby supporting growth. The GDP growth forecast of 4.5%-5.5% for 2025 is in line with the World Bank's and Asian Development Bank's projections of 4.5% and 4.6%, respectively.

The announcement of imposing carbon tax from 2026 pushes forward Malaysia's ESG agenda and a step towards its target to achieve net zero greenhouse emission by 2050. Besides, the rationalization of RON95 gasoline subsidy is seen as an environment-friendly policy as it will not only reduce pressure on public finances but also address wastages.