PETALING JAYA: Malaysia may miss its fiscal deficit target of 3.5% of gross domestic product (GDP) this year, as elevated fuel subsidy spending and geopolitical uncertainties continue to pressure government finances.
While targeted subsidy measures such as the expanded Budi Diesel programme could help curb leakages and generate savings, the government is still likely to face a larger-than-expected subsidy bill this year.
“The scheme is timely and necessary and, similar to Budi95, is well designed to reduce fuel overconsumption and manage household compensation costs.
“That said, we estimate that the subsidy bill slippage will be large, at close to 1% of GDP in 2026 versus the budget’s estimate,” OCBC senior Asean economist Lavanya Venkateswaran told StarBiz.
Lavanya expects Putrajaya to miss its fiscal deficit target of 3.5% of GDP, having pencilled in fiscal slippage of 0.1% of GDP as early as March. She now sees the risk of slippage widening to 0.2%, implying a fiscal deficit of around 3.7% of GDP.
Much of the country’s fiscal outlook still depends on the outcome of the US-Iran peace deal.
According to Sunway University economics professor Yeah Kim Leng, a continued closure of the Strait of Hormuz could push oil prices above US$100 a barrel and worsen Malaysia’s fiscal deficit to between 4% and 5% of GDP this year.
“If the blockade is successfully lifted by both countries, oil prices are expected to hover between US$80 and US$90 a barrel, thereby easing Malaysia’s fuel subsidy burden. Under this scenario, the country’s fiscal deficit is likely to come in at around 3.6% to 3.8% of GDP,” he said.
The United States and Iran signed an interim memorandum of understanding on June 17 to extend a ceasefire, keep the Strait of Hormuz open and work towards a final peace deal within 60 days.
The agreement has eased oil supply concerns, with Brent crude falling from above US$100 a barrel to below US$80.
However, uncertainty remains over the durability of the deal amid delays in follow-up talks and conflicting statements on the waterway’s status.
The Finance Ministry has launched the Budi Madani Diesel programme as part of Malaysia’s targeted fuel subsidy reform, replacing the cash-based Budi Diesel scheme from July 1.
The new MyKad-based system allows eligible users to buy subsidised diesel at RM2.10 per litre and expands coverage from about 180,000 to 700,000 recipients.
The government expects around RM2bil in annual savings, though this may only partly offset wider subsidy pressures.
TA Research estimates that fuel subsidy expenditure could still reach about RM37.2bil this year, even after incorporating the projected RM2bil savings from the Budi Diesel programme.
Together with cash aid schemes such as Sumbangan Tunai Rahmah and Sumbangan Asas Rahmah, as well as other subsidy programmes, total subsidy and social assistance spending could rise to between RM55bil and RM60bil, exceeding the Budget 2026 allocation of RM49bil.
At the upper end of the brokerage’s projections, subsidy and social assistance spending could overshoot budgeted levels by as much as RM11bil, potentially lifting operating expenditure to RM349.2bil and making it more challenging for the government to achieve its fiscal deficit target of 3.5% of GDP.
“The key question is how the government intends to finance a potentially larger subsidy bill,” the research house said, adding that it expects the fiscal deficit to “widen modestly” to 3.6% of GDP in 2026.
One mitigating factor, TA Research said, is the upside to petroleum-related revenue, given that its base-case Brent crude assumption of US$80 per barrel remains well above the US$65 per barrel assumption underpinning Budget 2026.
“As a rule of thumb, every US$10 increase in Brent crude prices typically generates around RM3bil in additional government revenue.
“Based on our assumptions, the US$15 premium relative to the budget assumption could translate into RM4.5bil in additional petroleum-related revenue, partially offsetting the increase in subsidy expenditure,” it said.
Sunway University’s Yeah said it is plausible to achieve the projected RM2bil annual savings from the Budi Diesel programme due to reduced leakages and smuggling.
However, he cautioned that savings may be offset by an increase in the number of recipients and a higher allocation of 300 litres per month for diesel vehicles used for individual businesses.
To generate additional savings, Yeah noted that the government has issued guidelines for a 10% budget cut this year, aimed at reducing non-essential and discretionary spending across ministries.
“Tighter spending discipline, together with expanded efforts to further improve tax administration efficiency, will help reduce the revenue-expenditure gap.
“Other revenue enhancement measures introduced since 2022 – such as the expanded sales and service tax, capital gains tax on unlisted shares, low-value goods tax, dividend tax and global minimum tax – are also in place to shore up government revenues,” he said.
OCBC’s Lavanya, however, said there is limited room for further fiscal savings, noting that capital expenditure is usually the first area targeted for cutbacks to help contain the fiscal deficit.
“These expenditure cuts, however, are unlikely to be dramatic or sustained for prolonged periods considering the authorities remain focused on infrastructure spending and bolstering potential growth prospects.
“Historical precedent suggests modest development expenditure cutbacks of 3% to 5% year-on-year, similar to the 2019 to 2020 period,” she said.
Bank Muamalat Malaysia Bhd chief economist Dr Mohd Afzanizam Abdul Rashid said while there is a risk of missing the 3.5% fiscal deficit target, the focus should be on policymakers’ response to external shocks rather than the target itself.
“In this regard, targeted fuel subsidies remain in place, underscoring the government’s commitment to fiscal discipline.
“There are also measures to ensure businesses affected by the higher cost of doing business continue to have access to financing through financial guarantee schemes and funding programmes offered by the relevant agencies,” he said.
Meanwhile, UOB senior economist Julia Goh said there remains a “reasonable possibility that the government could still meet its deficit target”, as lower oil prices ease subsidy pressures while targeted subsidy reforms, expenditure discipline and petroleum-related revenue continue to support the fiscal position.
Goh said the situation “remains fluid” and that following the interim US–Iran peace agreement, oil prices have become more volatile, with downside risks emerging as supply normalisation improves sentiment.
“While this introduces some uncertainty to revenue assumptions, the recent moderation in energy prices – along with Malaysia’s ability to secure alternative supply sources – has provided some near-term relief,” she said.
More importantly, Goh said government’s oil-related revenues are partially cushioned by a broader set of inflows, including petroleum income tax, royalties and export duties, which help offset fuel subsidy costs and stabilise fiscal receipts even in a softer price environment.
“On the expenditure side, recent policy measures point toward fiscal consolidation. The targeted diesel subsidy mechanism under the Budi Madani framework replaces the earlier RM400 cash assistance and consolidates the current RON95 framework, which uses a MyKad-based system nationwide.
“This is complemented by broader efforts to rationalise spending, including a commitment to cut non-essential expenditures. These measures signal a shift towards more disciplined public finances, even as cost pressures remain elevated,” she said.
In any case, in the event of any revenue shortfall, Goh said “there are still buffers available”, as the government retains the option of higher dividend contributions from government-linked entities, which could help bridge gaps “without materially altering its fiscal stance”.
