ANALYSIS-Political backing for Malaysia reforms stalls

* Petrol, electricity price hikes, GST abandoned

* Concerns over budget consolidation, investment flows out

* Rising tide of radicalisation in UMNO to damage reform

* General election unlikely before 2011 Sarawak polls

By David Chance and Razak Ahmad

KUALA LUMPUR, March 15 (Reuters) - Buoyed by strong oil prices and the prospect of 5 percent economic growth this year, Malaysia's government has backed off unpopular reforms, fearing a backlash that could end its 52-year monopoly on power.

At the weekend the government abandoned plans to introduce a goods and services tax just weeks after it halted implementation of petrol price hikes aimed at cutting its subsidy bill and electricity price rises.

In all three cases it cited the need to "engage with the public", a message that may derail Malaysia's bid to reverse investment outflows and tackle a budget deficit that has overshot its targets since 2007 to hit a more than 20-year high of 7.4 percent of gross domestic product in 2009.

"They have obviously got a huge deficit building up and so the fact that they're delaying fiscal management at the expense of looking at the elections will obviously not be taken that well by the markets," said Anthony Nafte, senior economist at CLSA.

Longer term, failure to implement fiscal reform leaves Malaysia, Asia's third-most trade dependent economy, vulnerable to external economic and commodity price shocks.

When Najib Razak became premier last April, replacing the man who in 2008 led the National Front government to its worst ever election results, he pledged to soothe battered relations between Malaysia's races and to speed economic reforms.

A year on and amid vocal complaints by Malay Muslims, who account for 55 percent of this Southeast Asian country's 28 million population, over issues like Christians' use of the word "Allah", that message has been diluted.

"What Najib is now doing is backing away from reforms to consolidate his power base," said Bridget Welsh, a Malaysia expert at Singapore Management University.

Najib's United Malays National Organisation faces a growing challenge from the opposition Pan Malaysian Islamic Party (PAS).

Elections do not have to be held until 2013, but it is increasingly likely that they could be held either in conjunction with state polls in Sarawak on Borneo Island, expected in the first quarter of 2011, or shortly afterwards.

Sarawak provides the National Front with 30 of its 137 MPs in a parliament where the government lost its two thirds majority and thus its ability to change the constitution and to redraw electoral boundaries for the first time in 2008.

Independent political analyst Ong Kian Ming calculates that UMNO won 58 percent of the Malay vote in mainland Malaysia in 2008. That is too narrow a margin to risk in any new elections and Najib will need to ensure that he is seen as a clear winner in mainland Malaysia, not just a winner in Sarawak.

"I don't think Najib will call for elections too early. As it is, he has the upper hand and... by attrition and harassment he can win a lot of ground against the opposition," said Ooi Kee Beng, fellow at Singapore's Institute of Southeast Asian Studies.

MALAYSIA'S NEIGHBOURS ATTRACT INVESTMENT

While Malaysia has leaked money over the past two years to the tune of $61 billion, according to government investment flow data last week, neighbouring Indonesia has seen investment surge.

The Malaysia data comprises portfolio and direct investment and "other" flows, according to the Statistical Office.

Even though economists say that as one of Asia's largest bond markets Malaysia was bound to be hit by a wave of selling during the global financial crisis, outflows have continued in 2009.

"Najib needs to bring in foreign investment to move Malaysia from a middle income country that is dependent on commodities and electronics exports to a more robust economy," said Singapore Management University's Welsh.

In 2009 Indonesia graduated to the top of the emerging market class, joining Brazil, Russia, India and China, the so-called BRIC countries. It attracted $10 billion of portfolio investment last year.

Malaysia by contrast has seen many of its biggest companies such as leisure group Genting, Axiata Group and YTL Corp seek investment opportunities in faster growing markets overseas.

That has stymied Malaysia's ability to use its ample domestic savings to fund investment and investment rates stand at around 19 percent of GDP, according to the International Monetary Fund, one of the lowest levels in Asia.

UMNO NOW DOMINATES NATIONAL FRONT

The traditional dynamics of the National Front are also changing with UMNO's allies still weakened by the 2008 general election when ethnic Chinese and Indian voters deserted the coalition, worried by corruption and rising sectarianism.

That has left the Front more dependent than ever on UMNO which is battling an Islamist party for Malay votes and has meant the rhetoric of some of its members has become more radical.

Recent rows over the use of "Allah" by Christians, attacks on churches and battles over conversions and the spread of sharia law have provided a rallying point for conservatives within UMNO.

"UMNO has always been a party that is supposed to build the nation, but at the same time it is highly conservative where its power base and its ideology are concerned," said Ooi at the Institute of Southeast Asian Studies.

"If there are elections soon, then the issue of Islam and 'Malay Supremacy' will be the rallying cry for UMNO. UMNO will go out fully as a racialist party. The risk is that it will cost its allies even more seats."

(Editing by Andrew Marshall)