UPDATE 2-Malaysia backs away from unpopular fuel price hikes

(Adds analysts, detail)

* Malaysia to abandon fuel subsidy cuts

* Worries over economic reforms pledged by PM Najib

* Signals government gearing up for key Sarawak polls

* No impact on central bank rate policy

By Razak Ahmad and Royce Cheah

PUTRAJAYA, Malaysia March 4 (Reuters) - Malaysia's government said on Thursday it had abandoned plans to hike fuel prices, a move that cast doubt on its commitment to cutting its budget deficit and its willingness to implement unpopular economic reforms.

Fuel subsidy cuts were a cornerstone of Prime Minister Najib Razak's plans to cut the budget deficit to 5.6 percent of gross domestic product this year from a morethan 20-year high of 7.4 percent in 2009.

The decision came after the government delayed electricity price hikes and rolled back plans for real estate taxes.

Political analysts said the decision to halt the complex, means-tested scheme signalled that the government was gearing up for state elections in its key support region of Sarawak, which provided 31 of its 137 MPs.

"Hopefully, it is not symptomatic of what's going on in the government right now, that they are not necessarily prepared to deliver market friendly structural reforms," said HSBC's regional economist, Robert Prior-Wandesforde.

The government had pledged to slash its subsidy bill for fuel and food to 20.9 billion ringgit ($6.21 billion) this year from 24.5 billion in 2009. [ID:nnKLA010451]

Najib has promised to unveil a new set of economic liberalisation measures in March in a bid to reverse foreign investment outflows that saw portfolio investors pull a net $2.5 billion out of Malaysia in the first three quarters of last year.

Najib has already trimmed some of the economic privileges enjoyed by the 55 percent of the 28 million population that is Malay and is the key votebank for the National Front coalition that has ruled this Southeast Asian country for 52 years. [ID:nKLR470446]

Najib announced much stronger than expected economic growth for the fourth quarter of 2009 at 4.5 percent , signalling the end of Malaysia's recession and possibly the end of external pressure for reforms.

"Malaysia only reforms when it is under pressure. The moment they feel they are out of the woods, the economic pressure disappears," said Bridget Welsh a Malaysia specialist at Singapore Management University.

Economists said that the decision not to pursue petrol price hikes would not impact central bank policy by delaying the need for interest rate hikes.

Central banks around the region are reviewing rates as price pressures build, but many appear to be waiting until their economic recoveries are on more solid ground.

Bank Negara Malaysia meets today and is expected to leave its benchmark rate unchanged at a record low of 2 percent , according to a Reuters poll. [ID:nSGE62106N]

"The growth in the economy will lead to demand-pull inflation and not supply-side inflation," said Patricia Oh, economist at TA Securities, who expects a rate hike in May.

CRUCIAL POLLS IN SARAWAK, MALAYS FEAR REFORMS

While a general election does not have to be held until 2013, state elections are due in Sarawak on Borneo Island next year.

The National Front government suffered its worst-ever losses in 2008, losing its two-thirds parliamentary majority and being ousted as the government of four of Malaysia's 13 states.

Najib has campaigned heavily in Sarawak since he took office in April last year after his predecessor was ousted and was there earlier this week to shore up support for a key component of his 13-party coalition government.

Political turmoil has gripped the Malaysian Chinese Association (MCA), the National Front's second largest party after Najib's United Malays National Organisation, and eight top party officials resigned from the MCA central committee, triggering internal party polls.

At the same time, Malay groups opposed to reforms are becoming increasingly vocal and tensions have risen as Muslims fear their rights are being threatened by Christians' use of the word "Allah" for god. [ID:nSGE61I07S]

Sarawak elections "are nearby, most likely this year," said Shaharuddin Badaruddin, associate professor at Universiti Teknologi Mara in Kuala Lumpur.

(Editing by David Chance and Kim Coghill)