High-wire act for Anwar

MORE than numbers, Prime Minister Datuk Seri Anwar Ibrahim’s fourth Madani budget is a credibility test for both his government and Malaysia’s fiscal reform path.

After a string of policy backpedalling on luxury tax, sales and service tax (SST), and fuel subsidy reforms – as well as the hasty passage of a government procurement bill widely criticised by civil society – Anwar can no longer afford half-measures that undermine his reformist credentials.

The Madani administration, now midway through its five-year mandate, also faces mounting pressure to show it can manage public funds prudently.

It was recently forced to abandon a RM187mil plan to buy four Black Hawk helicopters after the Yang di-Pertuan Agong denounced the aircraft as “flying coffins.”

The episode adds to concerns raised by the auditor-general earlier this year, who flagged “serious irregularities” in state spending.

Among the findings are Felcra Bhd’s RM241.8mil lease acquisitions of oil palm estates from 2022 to 2024, and procurement weaknesses in Universiti Kebangsaan Malaysia’s tenders worth RM58.5mil.

Irregularities flagged by the auditor-general aren’t unique to the Madani era, but the administration’s reformist mandate has heightened public expectations for cleaner governance and tighter oversight.

With Budget 2026 on the horizon, the stakes are higher than ever.

The nation’s economic growth is moderating with external demand softening, business sentiment weakening and households reeling from rising cost of living.

Kenanga Research forecasts federal government revenue growth to ease to 3.6% in 2026 as weaker oil-linked income offsets gains from SST expansion and e-invoicing.

Under such circumstances, policymakers face the dual challenge of shoring up revenue and enforcing fiscal discipline while avoiding a public backlash, turning Budget 2026 into a political and economic balancing act.

To give Anwar credit, since he took the helm as both prime minister and finance minister in late 2022, Malaysia trimmed its fiscal deficit to 4.2% of gross domestic product (GDP) by the end of the first half of 2025 (1H25).

This compares to a deficit of 6.4% in 2021, at the height of the Covid-19 pandemic.

Meanwhile, statutory government debt stood at 62.7% of GDP in the 1H25, below the 65% statutory ceiling. However, it remains well above the pre-pandemic 2019 level of 52.5%.

Fiscal discipline will again be the cornerstone of Budget 2026, which Kenanga Research expects to be the largest budget in Malaysian history with over RM430bil in spending.

“The government has shown strong political will in implementing fiscal discipline, ensuring that its actions do not cause negative economic shocks.

“With such a track record, it should be able to bring down the fiscal deficit next year,” according to Bank Muamalat Malaysia Bhd chief economist Mohd Afzanizam Abdul Rashid.

OCBC senior Asean economist Lavanya Venkateswaran also forecasts the fiscal deficit to narrow, albeit modestly, to 3.4% to 3.6% of GDP in 2026.

“We expect strong revenue collection to continue, with spending rationalised in a more modest manner,” she says.

That said, ballooning debt service charges (DSCs) remain a time bomb.

The federal government’s DSC increased by 10% per annum in 2020 to 2024 to average RM42.1bil per year, eating up about 16% of federal revenue.

This means that 16 sen out of every RM1 federal government revenue goes towards repaying interest on debt alone.

Speaking to StarBiz 7, Socio-Economic Research Centre executive director Lee Heng Guie says the ratio could widen if domestic interest rates rise.

“High DSCs are a significant concern because they consume a large portion of a government’s budget, leaving less for essential services and potentially lead to higher taxes or reduced spending.

“If domestic interest rates go higher in the years ahead, it will raise the cost of servicing debt, adding to fiscal pressures and posing risks to financial stability,” adds Lee.

The cost to service debt will remain high as long as the country takes up new debts to fund the difference between its revenue and expenditure.

Malaysia’s high indebtedness is largely a legacy issue, worsened by the borrowings during the Covid-19 period.

A 2024 research titled “Does the threshold effect of government debt on growth exist for Malaysia?” shows that federal government debt grew faster than nominal GDP from 1997 to 2022.

While the country’s total debt is still growing, reaching RM1.3 trillion as at end-June 2025, the Madani administration has reduced its new annual debt to RM77bil in 2024 from RM99bil in 2022.

Balancing relief with reforms

There is still a lot of room for fiscal reform but Anwar and his team face a tough time balancing relief with reforms.

Malaysia has for a number of months now been reporting low and controlled inflation, as measured by the consumer price index.

In August, headline inflation was recorded at 1.3% year-on-year, compared to July’s 1.2%. The mild inflation environment is expected to continue for the rest of the year and potentially 2026.

However, this does not entirely reflect the reality on ground, with households complaining about rising cost of living.

In view of this, Budget 2026 is expected to extend targeted relief measures to households still grappling with cost-of-living pressures.

Mohd Afzanizam says Budget 2026 will likely entail higher allocation for cash transfers under Sumbangan Tunai Rahmah (STR) and Sumbangan Asas Rahmah (Sara).

It is worth noting that allocations for both STR and Sara already hit RM15bil in 2025 – the highest in the nation’s cash assistance history. This was a 50% increase from 2024’s RM10bil.

Mohd Afzanizam also suggests income tax cuts of one to two percentage points for taxable incomes between RM35,000 and RM100,000 – a move aimed squarely at the squeezed middle class.

Meanwhile, Lee says that Budget 2026 may consider lowering the personal income tax rate by 1% for annual chargeable income below RM70,000 and RM100,000.

“Budget 2026 may also increase income tax reliefs for medical expenses, life insurance and education,” he adds.

These measures, while aimed at providing relief for households, will exert pressure on the operating budget.

Compounding further pressure on the budget is the government’s higher spending on emoluments and pension support in 2026, especially since the civil servants are in line for a second round of salary increases, says Lavanya.

This, nevertheless, would provide greater support for households, she adds.

The fact that the government has already embarked on fuel subsidy reforms would alleviate the pressure on the government coffers. While Anwar has backpedalled on his earlier announcement of restricting the top 15% income earners from RON95 petrol subsidy, the new mechanism is still expected to deliver savings of RM2.5bil to RM4bil.

The earlier plan would have resulted in RM8bil savings.

The current mechanism, which no longer filters recipients by income levels, requires non-citizens to pay RM2.60 per litre for RON95 petrol. Citizens pay RM1.99 a litre for the first 300 litres.

Despite the obvious change in subsidy mechanism, Mohd Afzanizam argues that the technical infrastructure is now in place.

“Once Malaysians have become more familiar with using MyKad at the pump, the next step is to re-target the subsidies based on income level, leading to more savings.”

Small tax steps

After the expansion of SST and the introduction of capital gains tax and dividend tax in recent years, Budget 2026 is unlikely to feature sweeping tax reforms.

A carbon tax, floated in Budget 2025, is expected to be introduced next year, targeting “brown” industries such as steel and energy.

Investors can expect a light-touch approach, one which is incremental rather than transformational.

According to Lee, concerns about the implementation of a broader capital gains tax scope is unlikely.

This is because it would be a dampener on domestic capital markets amid the persistent risk of financial volatility coming from the global market.

Sin and sugar taxes may be increased, with proceeds earmarked for healthcare, aligning fiscal policy with public health priorities

The reintroduction of the goods and services tax – abolished in 2018 – remains politically toxic.

Lavanya notes that while unlikely, “if it is explored, we would view it as a positive development”

On the business side, tax incentives are likely to expand.

Lee points to measures like higher thresholds for small and medium enterprises (SMEs) to qualify for preferential tax rates, enhanced reinvestment allowances, and research and development deductions as high as 400%, mirroring Singapore’s model.

“Allowing multiple claims in digitalisation grants for SMEs would allow businesses to better match the incentive to their actual growth plans. Provide pre-approved generative artificial intelligence solutions with up to 50% grant support.

“To ease the financing cost of micro, small and medium enterprises, the government can provide stamp duty exemption on instrument of agreement for a loan or financing in relation to a micro financing scheme for up to RM300,000, and increase from RM100,000 for loan or financing agreements executed from Jan 1, 2026,” he suggests.

Growth engines: Beyond consumption

Malaysia’s budgets have often tilted towards consumption rather than investment.

Budget 2026 will test whether Anwar can shift that balance towards longer-term growth engines.

Lavanya expects development expenditure to remain broadly steady from 2025 levels, but with greater emphasis on leveraging external financing.

“The authorities have been working towards broadening the sources of development spending beyond the budget.

“Initiatives like GEAR-uP and public-private partnership models are intended to mobilise capital for infrastructure and industrial upgrading,” she says.

Guided by the Ekonomi MADANI framework’s objectives and principles, GEAR-uP aims to unlock RM120bil over five years to drive socioeconomic reforms and jumpstart Malaysia’s industrial transformation.

The programme is anchored by six major government-linked investment companies, namely, Khazanah Nasional Bhd, the Employees Provident Fund, Permodalan Nasional Bhd, Retirement Fund Inc, Lembaga Tabung Angkatan Tentera and Lembaga Tabung Haji.

Budget 2026 should also drive labour policy innovation.

Mohd Afzanizam highlights the Progressive Wage Policy, which he likens to a “targeted wage subsidy” that could help raise salaries in line with skills.

“Expanding its allocation beyond the current RM200mil could catalyse a more productive and better-compensated workforce,” he says.

Such policies align with the government’s narrative of moving Malaysia up the value chain, re-skilling workers and fostering high-value industries from digital services to green technology.

Budget 2026, scheduled for tabling on Oct 10, will be keenly watched by ordinary Malaysians, investors and rating agencies.

If it fails to deliver, it will not be for lack of ideas.

Analysts anticipate a comprehensive package framed as a “Sustaining Economic Resilience Plan,” focused on cost-of-living relief, business continuity, re-skilling, sustainable practices, and equitable access to resources

The risk lies in execution.

For Anwar, it is not just about balancing the books.

Budget 2026 is about balancing narratives: convincing households that relief is real, persuading investors that consolidation is credible, and proving to both that his government will not flinch when tough reforms are due.