March 10 (Bloomberg) -- Malaysia’s government announced an additional 60 billion ringgit ($16 billion) in spending and tax incentives over the next two years as it said the economy may contract for the first time in a decade.

Finance Minister Najib Razak, unveiling a second stimulus in Kuala Lumpur today, said the economy may shrink as much as 1 percent this year or expand that amount at best, compared with a previous forecast of 3.5 percent growth. The plan, more than eight times the size of a November package, will swell the 2009 budget deficit to 7.6 percent of gross domestic product.

“We cannot depend on orthodox economic recovery policies,” Najib, who is also deputy prime minister, said in parliament. “Without these efforts, the economy faces the prospect of a deep recession.”

Najib, due to replace Abdullah Ahmad Badawi as premier later this month, pledged 25 billion ringgit to help companies obtain credit and raise funds as the government seeks to compensate for collapsing exports. The measures follow a slump in support for the ruling coalition in elections last year.

“Global demand has dried up, pounding Malaysian overseas shipments of almost everything from commodities to electronics,” said Azrul Azwar Ahmad Tajudin, an economist at Bank Islam Malaysia Bhd. in Kuala Lumpur. “Between a swelling budget deficit and a deep recession, a bloated budget deficit is the lesser of the two evils.”

Ringgit Rises

Malaysia’s ringgit rose by the most in two weeks today on optimism the stimulus package will help shore up investor confidence. The currency gained 0.7 percent to 3.6905 per dollar as of 5:20 p.m. in Kuala Lumpur, according to Bloomberg data.

The benchmark stock index fell 0.4 percent at the 5 p.m. close, paring declines of as much as 1.2 percent earlier.

The government will create a 5 billion-ringgit loan- guarantee program, and a fund of the same value to provide working capital to small businesses, which account for one third of the economy.

A new state-owned Financial Guarantee Institution will probably help credit-strapped companies raise 15 billion ringgit of bonds, Najib said. Businesses will no longer need approval for rights offers.

The stimulus was “bigger than expected,” said Pankaj Kumar, who manages $540 million of assets as chief investment officer at Kurnia Insurans Bhd. in Kuala Lumpur. “It looks pretty well thought out, but at the end of it, we have to see how it’s implemented and distributed.”

Budget Deficit

The additional spending unveiled today will widen this year’s budget deficit to the biggest since 1987. Najib had estimated a budget gap of 4.8 percent of GDP in November.

Asian nations have unveiled stimulus plans worth about $700 billion and cut borrowing costs as the deepening global slump pushed Japan, Hong Kong, Singapore and Taiwan into recession. Malaysia’s central bank has cut its benchmark interest rate by 1.5 percentage points to 2 percent in the three meetings since late November.

Malaysia will accelerate 8.4 billion ringgit of projects under a five-year plan and the government will recruit 63,000 people in state agencies. It will also give tax deductions for companies that hire retrenched workers, Najib said.

The country’s two plans combined are equivalent to about 10 percent of GDP. That compares with 8 percent in Singapore, and more than 10 percent in China, according to Bank Islam’s Azrul.

Credit Ratings

“Funding of the deficit is not a major problem, with the financing coming mainly from domestic sources,” Lee Heng Guie, chief economist at CIMB Investment Bank Bhd. in Kuala Lumpur, said in a March 2 report. “That said, the credit rating agencies will continue to keep a close watch on Malaysia’s fiscal sustainability and external financing conditions.”

The outlook on Malaysia’s long-term local currency credit rating of A+ was cut to “negative” last month by Fitch Ratings, which cited an expected worsening of the country’s budget position this year and next.

The government, which raised a record 60 billion ringgit from domestic debt sales last year, will hold its biggest debt auction in almost five years this week.

The government is confident the additional spending can be funded from domestic sources and won’t “crowd out” the private sector, Najib said. It plans to sell 5 billion ringgit in Islamic savings bonds to Malaysians this year, he said.

The deficit may be “far bigger than projected,” said Robert Prior-Wandesforde, an economist at HSBC Holdings Plc in Singapore, in a note after today’s plan was announced. The recession may still “prove extremely pronounced.”

Malaysia’s $181 billion economy expanded 0.1 percent in the fourth quarter from a year earlier, and exports fell the most in 15 years in January. Nomura Holdings Inc. predicts a full-year economic contraction of as much as 4 percent.

To contact the reporter on this story: Soraya Permatasari in Kuala Lumpur at soraya@bloomberg.netRanjeetha Pakiam in Kuala Lumpur at rpakiam@bloomberg.net

Last Updated: March 10, 2009 07:39 EDT