KUALA LUMPUR (REUTERS) - Malaysia's economy is expected to expand 5.4 per ent this year, picking up from growth of 4.7 per cent in 2013, as brightening exports outweigh an expected cooling in domestic demand, the World Bank said on Friday.

Exports, a mainstay of the South-east Asian economy, are likely to grow 6.3 per cent this year and 6.2 per cent in 2015 as a global recovery boosts demand for the country's key shipments such as oil and electronics, the bank said. "Export growth will be driven by higher energy, commodity and petrochemical production, as new investments start to come online," the World Bank said in its annual Economic Monitor report on Malaysia's outlook.

However, the report added that high levels of household debt were a risk to growth as interest rates looked set to rise.

The central bank is expected to begin raising interest rates in July for the first time in three years, partly due to what it describes as financial imbalances such as consumer indebtedness. Household debt levels in Malaysia climbed to 86.5 per cent of GDP in 2013, among the highest in Asia.

The report noted that the real interest rate has become negative, with inflation picking up to 3.7 per cent in the first four months of this year, compared to the benchmark interest rate of 3 per cent.

While Malaysia's banking sector is well capitalised, with low levels of non-performing loans, the rise in interest rates could cause "excessive retrenchment" in household spending, the report said. "We're not saying necessarily we see a risk to financial sector stability, we see more of a risk to growth," said Mr Frederico Gil Sander, senior country economist.

Private consumption growth is expected to ease to 6.5 per cent this year due to fiscal tightening and higher interest rates, the World Bank said.

Malaysia's exports grew a meagre 0.6 per cent in 2013, but have rebounded in recent months led by electronic exports as the United States, Europe and other major economies recover. The political crisis in Thailand also may have helped Malaysia's exports as electronics manufacturers shifted production, the report said.

Malaysia was broadly on track to meet its goal of reducing the fiscal deficit to 3.5 per cent of GDP this year from 3.9 per cent in 2013, but would only do so if it follows through on pledges to further cut fuel subsidies and implement a broad-based consumption tax, said World Bank Country Director Ulrich Zachau. "One thing that will be critical for that is that the measures that are announced and which we very strongly welcome on the subsidy reform side go ahead and are implemented," he said.

Prime Minister Najib Razak, in his annual budget speech to parliament last October, announced his government would bring in a goods and services tax (GST) in 2015 at a rate of 6 per cent, above market expectations of 4 or 5 per cent.

The government's economic report, released just ahead of the budget speech, said that spending on subsidies, including fuel, would total 39.4 billion ringgit (S$15.3 billion) in 2014, down from 46.7 billion ringgit in 2013.

In a report on Friday, DBS Group Research highlighted Malaysia's fast-growing household debt as a reason why interest rates are likely to rise this year. It expects the central bank to raise the benchmark rate to 3.5 per cent by September from 3.0 per cent now. "The low interest rate environment and the property boom are the key reasons for the rise (in debt)," it said. "Many are treating the property market as the new deposit box that pays higher returns than what banks are offering."