Malaysian growth hides vulnerability - FT.com As Malaysian prime minister Najib Razak delivered a speech at a Kuala Lumpur hotel recently, he was interrupted by the ringing of a mobile phone. He reached into his pocket to check it was not his own. "I have the latest iPhone 5 by the way," Mr Najib told the audience as he waited for the noise to stop. "And to balance it I also have a Samsung," he added, patting his other pocket. Mr Najib's balancing act drew some laughs. But the challenge he faces in balancing the country's books is no cause for amusement. Malaysia has been a star performer in the region as the global economy has wilted, growing at an enviable 5.4 per cent in the second quarter. Indeed, the Asian Development Bank this month raised its Malaysian gross domestic product growth estimate for the full year to 4.6 per cent, from 4 per cent, despite cutting its overall forecast for developing Asia. Much of Malaysia's growth has been driven by strong domestic demand and government spending on infrastructure projects such as the new mass transit system for the capital, and Iskandar, an enormous industrial zone. Malaysia's stock market is at record highs and big ticket initial public offerings have turned the capital Kuala Lumpur into a boom town for bankers. But lurking beneath the surface is a worrying structural fiscal deficit that threatens to undermine Malaysia's growth story, highlighting how even some of the strongest economies in south-east Asia may yet be exposed to economic shocks from the eurozone and a slowdown in China. Malaysia's vulnerability was also highlighted last week when the price of palm oil - a key export - plunged on worries about oversupply. Malaysia does not face an immediate crisis and is blessed with abundant natural resources - oil, gas and palm oil. Yet the government is likely to come under increasing pressure to balance its books and bring down a fiscal deficit, economists say. At 52.6 per cent of GDP, the deficit is the highest in Asia after India and Pakistan. "The government can no longer rely on the old model of using oil-related revenue to sustain a large budget deficit and fund widespread subsidies, social transfers and grand infrastructure projects," says Vincent Tsui, economist at AllianceBernstein. Last week Mr Najib aimed to strike a balance in his last budget before an election that must be called before April. Like others before, it was packed with cash handouts for lower income workers, including a M$200 ($65) rebate for 1.5m young people to purchase smart phones. Such largesse was widely seen as a pre-election ploy to shore up support for the ruling Barisan Nasional coalition. It faces a tough battle with the opposition, led by Anwar Ibrahim, after losing its two-thirds majority in parliament for the first time at the last poll in 2008. The spending comes on top of existing subsidies for household items such as sugar and gas. Much of this has been paid for by a steady flow of revenues from Malaysia's extensive oil and gas reserves funnelled through Petronas, the national oil company. It provides an estimated 40 per cent of the budget in a special dividend. Yet declining production at home and rising exploration costs mean Petronas is in "robust discussions" with the government about renegotiating the dividend, a senior figure familiar with the talks says. Petronas is also uneasy about subsidies, arguing that they encourage excessive consumption. Mr Najib has made clear he understands the need to tackle the fiscal deficit. Even as he committed a further M$2.8bn to projects in nanotechnology and aerospace he insisted the budget, which aims to cut the fiscal deficit to 4 per cent of GDP next year, from 4.5 per cent now, was "fiscally responsible." Mr Najib also proposes cutting sugar subsidies by 37 per cent. There are also political limitations. Introduction of a general sales tax, widely seen as one solution, would be politically unpalatable given how accustomed many Malaysians are to cash handouts. And if the coalition wins only a slim majority - as many expect - this could limit Mr Najib's scope to implement deeper economic reforms even further.