The Malaysian government's decision to cut the decades-old diesel subsidy program is "a significant milestone" for the administration of Prime Minister Anwar Ibrahim, as such a move is part of long-term reforms to sustain growth in Southeast Asia's third-largest economy, analysts say.

While increased fuel prices are expected to boost inflationary pressures, experts expect headline inflation this year to be within the government's forecast of 2 to 3.5 percent.

The cuts in diesel subsidies kicked in on June 10, with retail prices of the fuel rising by about 55 percent to 3.35 ringgit ($0.71) a liter. The eastern Malaysian states of Sabah and Sarawak are exempted from the subsidy cuts.

Cutting fuel subsidies is expected to narrow the country's fiscal deficit and save the government about 4 billion ringgit per year. Anwar said the savings could be redirected to those who need cash assistance, such as rice farmers and small traders.

Yeah Kim Leng, professor of economics at Sunway University in Kuala Lumpur, said Malaysia's shift from blanket to targeted diesel subsidies is "a significant milestone "for Anwar's unity government.

He added that the cuts in subsidies are part of the government's economic reforms to restore fiscal balance, curb smuggling and optimize the use of limited government funds and depleting oil resources.

Yeah noted that businesses where diesel is the primary fuel, such as logistics and transport, have been identified as being eligible for the targeted subsidy program, mitigating the rise in inflation. Inflation had remained low and stable at 1.8 percent in the past few months.

He said the government's commitment to using subsidy savings for "productive spending", such as on public health and social welfare, can moderate the public backlash against increased prices.

Khor Yu Leng, research head for Southeast Asia of the Singapore-based consultancy Segi Enam Advisors, said cutting the diesel subsidy is "a relatively small fiscal matter" and will serve as a test case for the rationalization of other subsidies, such as for petrol.

"This massive subsidy bill is restricting the government's ability to spend on infrastructure that we need," she said.

There might be a "small spike "in food costs on the back of higher transport prices, Khor said. "This will be temporary as prices will normalize after a few months."

Serina Abdul Rahman, lecturer at the Department of Southeast Asian Studies, National University of Singapore, said that given Malaysia's high national debt, the government has no choice but to cut subsidies. Malaysia's external debt stood at 68.2 percent of its GDP by the end of 2023, according to Bank Negara Malaysia, the central bank.

'Overlooked problem'

Serina said that while the government has promised to extend assistance to farmers and fishers, accessing these subsidies can be difficult for those in rural areas who do not know how to deal with administrative bureaucracy. "This is usually the most overlooked problem," she said.

The Malaysian government provides its citizens with various subsidies, including for fuel, eggs, cooking oil, rice and electricity.

Anwar, who is also the finance minister, said in a statement on June 17 that the government still bears around 7 billion ringgit in subsidies and the diesel subsidy rationalization aims "to ensure that subsidy wastage no longer continues while ensuring that the savings are returned to the wider population".

Kuala Lumpur-based lender Maybank said progress in fiscal consolidation can also have a salutary effect on the ringgit.