KUALA LUMPUR, Oct 24 — Malaysian Prime Minister Najib Razak said he’s prepared to take unpopular steps to put the economy on a path to sustainable growth as stocks rallied ahead of his 2014 budget speech tomorrow.

Stocks closed at a record today in Kuala Lumpur and 10-year bond yields dropped the most since June on optimism Najib will rein in spending, further cut state subsidies and introduce a goods and services tax. Fitch Ratings reduced the outlook on the Southeast Asian nation’s investment-grade rating to negative in July, citing rising debt and a lack of budgetary reform, prompting the prime minister to raise fuel prices.

“The government will do what is right for our economy,” Najib said in an e-mailed statement, without providing details. “Some measures may not be popular now, but over the medium term what is good for the economy is also good for the people.”

The FTSE Bursa Malaysia KLCI index of shares rose 0.3 per cent to 1,818.93 in Kuala Lumpur. The yield on the 3.48 per cent bonds due in 2023 declined 11 basis points to 3.62 per cent, the lowest since July 8, according to data compiled by Bloomberg. The ringgit appreciated 0.2 per cent to 3.1608 per dollar. It reached 3.1413 on Oct 19, the strongest since June.

“Investors have been buying Malaysian stocks because economic growth has been fairly stable and the market is expecting the budget to contain measures to further spur growth,” said Ang Kok Heng, who helps manage US$428 million (RM1.35 billion) as chief investment officer at Phillip Capital Management Sdn in Kuala Lumpur. “The Malaysian market has been advancing in line with global equities.”

Fuel prices

Najib, who is also finance minister, increased fuel prices for the first time since 2010 in September and has said he’d delay some public projects. The country has run annual budget shortfalls each year starting 1998. The nation’s proportion of debt to gross domestic product of 53 per cent is the highest among Southeast Asia’s biggest economies, data compiled by Bloomberg show.

Malaysia will probably implement an initial 4 per cent goods and services tax that will generate RM20.5 billion, or as much as 14 per cent of total tax revenue, in the first year, according to an Oct 16 report from DBS Group Holdings Ltd. The government earlier planned to introduce the tax by 2011.

“The market is expecting Najib to announce further measures to cut the fiscal deficit,” said Wong Chee Seng, a currency strategist at Ambank Group in Kuala Lumpur. “This is the main driver for the ringgit’s strength today.”

Goods tax

Fiscal consolidation will be good for Malaysia’s economic growth, Wee Choon Teo, a foreign-exchange analyst at Nomura Singapore Ltd, said in an interview today. Any action to rationalise subsidies and implement a goods and services tax will be taken positively by the market, he said.

The government must fulfil its pledges to the people while avoiding populist measures that undermine economic stability, said Najib, whose coalition was re-elected in May.

“We cannot control what happens abroad, but we can work to strengthen the domestic resilience of our economy,” said the prime minister, pointing to the recent global financial crisis.

The KLCI index rose for a seventh day, the longest winning streak since December. The gauge was trading at 15.9 times projected 12-month earnings, a two-month high, compared with 10.6 times for the MSCI Emerging Markets Index. Felda Global Ventures Holdings Bhd and Petronas Dagangan Bhd climbed more than 1 per cent in Kuala Lumpur, the two largest gainers in the benchmark.

Debt swaps

Malaysia’s GDP is forecast to increase 4.5 per cent to 5 per cent this year, after climbing 5.6 per cent in 2012, according to an Aug 21 statement from the central bank. Policy makers have kept borrowing costs at 3 per cent since May 2011 to spur growth in Southeast Asia’s third-largest economy.

One-month implied volatility in the ringgit, a measure of expected moves in the exchange rate used to price options, fell 12 basis points, or 0.12 percentage point, to 8.25 per cent and is down from 10.96 per cent at the end of last month, according to data compiled by Bloomberg.

“The ringgit is likely to strengthen in a knee-jerk reaction to tomorrow’s budget announcement,” Ho Woei Chen, Singapore-based economist at United Overseas Bank Ltd, said in an interview. “Any rise probably will not be sustainable given that focus may return to quantitative easing tapering concerns.”

The lender forecasts the ringgit will weaken to 3.28 per dollar by year-end. That compares with the median estimate for 3.24 in a Bloomberg survey of 36 analysts.

Deficit target

Malaysia is rated A- by Fitch, the fourth-lowest investment grade. The cost to insure Malaysia’s sovereign debt for five years using credit-default swaps dropped to 111.5 this month from 131.5 on Sept 30, CMA prices show. That’s down from the year’s high of 157 in August.

Moody’s Investors Service said last month the budget deficit may exceed 4 per cent of GDP this year, warning the government’s fiscal targets will become “increasingly out of reach” without additional measures to contain it. The shortfall was 4.5 per cent in 2012, while Najib is seeking to cut it to 3 per cent by 2015 and to balance the budget by 2020.

A government report tomorrow may show consumer prices rose 2.5 per cent in September from a year earlier, compared with 1.9 per cent in August, according to the median forecast of 17 economists surveyed by Bloomberg News. That would be the fastest since January 2012. — Bloomberg