Malaysian Prime Minister Najib Razak’s record spending binge, aimed at shoring up support before elections as early as next month, may risk the country’s first credit-rating downgrade since the Asian financial crisis.

Standard & Poor’s “might have to think about” a potential cut in a few years unless the next government enacts measures to boost revenue and reduce subsidies after the vote, Takahira Ogawa, an analyst at the rating company, said in an interview. Moody’s Investors Service and Fitch Ratings also said Malaysia must take steps to bring down its debt-to-GDP ratio, which the International Monetary Fund projects may climb to a 20-year high of 55.9 percent this year.

Najib Razak, Malaysia's prime minister. Photographer: Sabine Albers/Bloomberg

Najib, 58, has raised civil servant salaries and pensions, waived school fees and boosted handouts for the poor in a bid to extend the ruling party’s 55-year lock on power. His National Front coalition won its lowest-ever share of the vote in 2008, and failure to secure a clear mandate may lead to political gridlock that would impede plans to strengthen public finances.

“Elections have delayed the required policy adjustments and aggravated the fiscal situation as populist policies take center stage,” said Chua Hak Bin, an economist at Bank of America Merrill Lynch in Singapore. “Not going through with structural reforms, including introducing a broad-based consumption taxand reducing fuel subsidies, will eventually hurt Malaysia’s credit standing.”

Debt Ratio

Malaysia’s ratio of gross debt to gross domestic product rose to an estimated 55 percent in 2011 from 35 percent in 2000, according to IMF. South Africa, which shares with Malaysia an A3 rating from Moody’s, has a ratio that fell to 36 percent in 2011 from 42 percent in 2000.

Malaysia is rated A- by Standard & Poor’s, along with Botswana, which has a debt ratio of 16 percent. Indonesia, Southeast Asia’s largest economy, is rated BB+ by S&P and has seen its debt fall to 25 percent in 2011 from 95 percent of GDP in 2000, according to the IMF.

Najib unveiled a record 232.8 billion ringgit ($76 billion) budget in October, saying the government would increase civil servant salaries by as much as 13 percent and also remove school fees for primary and secondary students. Households with monthly incomes of 3,000 ringgit or less have begun receiving one-off cash handouts of 500 ringgit.

Spending on salaries and allowances is projected to rise 4.2 percent to 52 billion ringgit in 2012 versus an estimated 49.9 billion ringgit in 2011, according to numbers released by the government in October. Malaysia has also set aside more than 3 billion ringgit not included in the proposed budget to finance the pay raise for civil servants, according to the treasury department.

‘Particularly Crucial’

“This election is particularly crucial given that the long-term outlook for fiscal sustainability and economic growth will likely hinge on the next government’s reform agenda,” Christian de Guzman, a Singapore-based assistant vice president at Moody’s said in an e-mail. “While both sides of the political divide readily acknowledge the need for such reforms, getting them passed will indeed be much more difficult with a weak mandate.”

Najib may call an early election in May or June, ahead of the due date in early 2013, according to four officials who spoke last month on condition of anonymity because the talks are private. Najib told reporters on March 19 that winning back the two-thirds majority lost in 2008 would be “challenging.”

Public Opinion

Satisfaction with Najib’s leadership rose to 69 percent in February from 59 percent in August, according to the latest poll by the Merdeka Center for Opinion Research.

Any risk of a downgrade isn’t reflected in credit markets, with the cost to protect Malaysia’s sovereign debt from default dropping 36 basis points this year to 110 basis points on April 25, according to data provider CMA, which compiles prices quoted by dealers in the privately negotiated market. That compares with 170 in Indonesia and 133 in Thailand.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a government or company fails to adhere to its debt agreements. A basis point equals $1,000 annually in a contract protecting $10 million of debt.

“The bigger concern is after the general election,” Kun Lung Wu, a Singapore-based economist at Credit Suisse Group AG, said in a telephone interview. “Whenever there’s another global shock, either a global downturn or drop in commodity prices, particularly oil prices, then that could easily send the debt- to-GDP ratio much, much higher.”

Oil Producer

Malaysia is Southeast Asia second-largest oil producer after Indonesia. Petroliam Nasional Bhd., the state-owned oil company which manages the country’s energy reserves, accounted for about a third of the government’s revenue in 2011.

Malaysia’s economy may expand 4 percent to 5 percent in 2012, Bank Negara Malaysia said in its annual report released in March. That compares with last year’s 5.1 percent rise.

Since Najib took office on April 3, 2009, the benchmark FTSE Bursa Malaysia KLCI Index (FBMKLCI) has risen 74 percent and hit a record on April 3. The MSCI Asia Pacific index has gained 43 percent in the same period.

While the debt level of many countries rose amid the global financial crisis of 2008-2009, Malaysia stands out, said Fitch analyst Andrew Colquhoun.

“Malaysia has yet to articulate a clear strategy for getting the debt ratios back down,” he said, adding that the country is over-dependent on oil revenue. “Structural fiscal reforms including tax reform remain on the back-burner.”