KUALA LUMPUR (Reuters) - Malaysian Prime Minister Najib Razak will aim to reduce unhappiness over rising costs of living when he unveils his 2018 budget on Friday, ahead of an election that must be held within 10 months.

FILE PHOTO: Malaysia's Prime Minister Najib Razak speaks at the opening of the International Conference on Deradicalisation and Countering Violent Extremism in Kuala Lumpur, Malaysia, January 25, 2016. REUTERS/Olivia Harris/File Photo

Prices rose sharply in Malaysia - where household debt is among the highest in Asia - after Najib cut subsidies and in 2015 imposed a broad-based consumption tax, denting his popularity.

The leader also faces a political challenge from his mentor-turned-foe, former Prime Minister Mahathir Mohamad, who called Najib a thief in connection with a scandal at state fund 1Malaysia Development Berhad (1MDB). Najib has denied any wrongdoing.

Najib will bank on the new budget to shore up support before his five-year tenure ends in June.

Given the coming election, “it will be more surprising if he announces something not people friendly,” said Brian Tan, a Singapore-based economist with Nomura.

Stronger global commodity prices have aided the oil-dependent economy and given Najib some room to boost spending. But progress in narrowing the fiscal deficit - expected at 3 percent this year compared with 6 percent in 2009 - would plateau next year if the government focuses on pre-election spending, said Moody’s analyst Anushka Shah.

“It depends on what they do... whether they spend it on handouts and be seen as more populist or whether they save it, in which case we should see a reduction in the deficit,” Shah said.

CHANGE IN GST?

Most economists expect the new budget’s fiscal deficit target will be slightly below 3.0 percent.

Any widening of the deficit would disappoint foreign investors. They have gradually returned to Southeast Asia’s third largest economy as the ringgit currency, after a tumultuous period, strengthened 6 percent against the dollar this year.

Najib, who has pushed a pro-business stance since becoming premier in 2009, dismantled decades-old fuel subsidies after narrowly winning the 2013 elections, to stave off the threat of a sovereign rating downgrade.

To bolster government revenue in 2018, Najib will likely broaden the scope of the goods and services tax imposed in 2015 to include e-commerce transactions, though he is unlikely to change the 6 percent rate.

The extra revenue is expected to fund “goodies” for Malaysia’s 1.6 million civil servants - a key vote bank for his Barisan Nasional (BN) ruling coalition - to mitigate the strain from pricier goods and services.

Civil servants saw a salary hike between 7 and 13 percent in 2012, ahead of the 2013 polls. But the recent sharp price increases may be eroding support among them.

‘GOODIES’ ARE EXPECTED

The opposition naturally anticipates that the coming budget will have handouts to help the BN win votes in the election.

“Malaysians can expect many goodies... budgets are one of the political tools for Barisan Nasional to prepare them for general election,” said Kerk Chee Yee of the opposition Democratic Action Party (DAP).

Najib, who is also finance minister, has already rolled out billions of ringgit worth of handouts for palm plantation settlers and armed forces veterans, and affordable housing projects, new schools and hospitals across the country.

“We have to ensure quality of life of Malaysians (by) introducing more affordable housing, steady level of income growth, managing cost of living and certain initiatives that can supplement income,” Najib said on the government’s official budget website.

He is likely to maintain cash handouts to low income earners, provide tax breaks for middle income earners and expand policies to provide affordable housing.

($1 = 4.2240 ringgit)