(This version of the January 11 story has been corrected in paragraph 9 to show by-election was in a neighbouring constituency)

By Emily Chow

SUNGKAI, Malaysia (Reuters) - The Malaysian plantation district of Sungkai has become an initial - and unlikely - battleground for an election that embattled Prime Minister Najib Razak is expected to call this year.

Sungkai is home to ethnic Malays who work for the national palm plantation operator, Federal Land Development Authority (Felda). Known as "Felda settlers", they have long been among the beneficiaries of government affirmative action programs for Malays, who form the majority of the population.

The Felda settlers have been a rock solid vote bank for Najib's ruling coalition, even as urban Malays have poured into the opposition camp in recent years, alienated by a series of political scandals.

Najib's coalition lost the popular vote in the last general election in 2013, but still won a majority of seats in Malaysia's gerrymandered constituencies.

Malaysia's opposition is hoping the settlers could be the next to defect, which was why opposition lawmaker Rafizi Ramli on Sunday night was in Sungkai, a former mining town that now mainly relies on palm oil and rubber planting.

The settlers have been angered by Felda's decision to purchase a 37 percent stake in Indonesian palm oil firm PT Eagle High Plantations for $505 million, more than a 100 percent premium based on its closing share price on Wednesday.

FELDA'S DEBTS

Eagle High is owned by one of Indonesia's richest men, Peter Sondakh, who has done a number of deals in Malaysia and is a longtime friend of Najib.

Najib's office did not respond to requests for comment about the deal. Sondakh has not publicly commented about the deal in Jakarta.

Just six months ago, Najib's United Malays National Organisation (UMNO) party secured a sweeping victory in a by-election in a neighboring constituency in northern Perak state.

But on Sunday night, more than 300 people gathered on the lawn of a Sungkai resident under a dank tropical night to hear opposition lawmaker Rafizi Ramli tell the cheering crowd: "We will change our prime minister and our government."

"Felda's debts are growing ... and the government will use the settlers money to pay it off," said Rafizi, a 39-year-old lawmaker from People's Justice Party (PKR).

"If we don't stop this, the debt will be shouldered by our future generations."

Felda has said the deal will not impact its existing commitments and programs to improve the well-being of the settlers. Felda itself is planning a series of roadshows to convince settlers in its plantation areas of the deal's benefits.

QUARTER OF PARLIAMENT

Felda settlers are the majority voters in at least 54 of the 222 seats in the national parliament, and has helped bring the UMNO-led Barisan Nasional (National Front) coalition to power in every election since independence in 1957.

Even the opposition's attempt to highlight a multi-billion dollar alleged money-laundering scandal at state investment fund 1Malaysia Development Berhad (1MDB) that erupted in 2015 did not resonate with rural voters.

The Felda issue, however, affects them directly.

"All this while, UMNO has won the elections because there are 54 parliamentary seats in the Felda (settlers) areas. Now I am sure the sentiment has changed," said Mazlan Aliman, president of the National Felda Settlers' Children Society (ANAK).

He estimates that over half of his association members and their families will vote for the opposition party if the Eagle High deal goes through. "If this happens, (Barisan Nasional) will lose in the upcoming elections," Mazlan said.

Najib has to call elections by 2018, but a government source told Reuters he may do it earlier, possibly in the second half of this year.

ELECTION HEADWINDS

The prime minister is heading into the next election already saddled with the scandal around 1MDB, which has been investigated in a half-dozen countries for money laundering. His government said nearly $700 million of 1MDB money that wound up in Najib's personal bank account came from an unnamed Saudi.

Yet Najib, who has steadfastly denied any wrongdoing, retains a tight grip on UMNO by commanding a vast patronage system that spreads the largesse among ordinary Malays as well as party apparatchiks.

He is wielding sticks along with the carrots: Anwar Ibrahim, the charismatic opposition leader, remains in jail on sodomy charges, activists and politicians have been charged with sedition, critical news websites have been closed.

Rafizi, the lawmaker who spoke at the Sungkai rally, is himself on bail pending an appeal after he was sentenced to 18 months in jail for leaking a confidential 1MDB document.

But the prime minister is fighting economic headwinds. The ringgit currency has fallen by more than a quarter over the past two years, prices have risen after state subsidies were slashed and a national goods and services (GST) tax launched, and economic growth is expected to slow in 2017.

All that is being felt in rural Malay heartlands such as Sungkai, and is contributing to the sour faces over the Felda-Eagle High deal.

FELDA'S FALLEN FORTUNES

Felda, created by Najib's father and Malaysia's second prime minister, resettled and employed the rural poor in the palm industry. It helped lead Malaysia to become one of the world's two largest producers of palm oil, along with Indonesia.

The settlers leased government land for palm cultivation and many also own shares in Felda Global Ventures (FGV), a unit of Felda that raised over $3 billion in a listing in 2012.

But Felda's fortunes have slumped in recent years - its shares fell by over 60 percent since its IPO. The shares plunged another 5 percent on Dec. 23, when the Eagle High deal was announced.

"This is a waste of money," said Khalili Kasim, a 64-year-old settler, saying Felda should be providing housing loans, or educational aid instead of putting money into Eagle High.

"Land owners should be rich, but why are some of us still struggling and living under the poverty line?" Khalili said.

But the opposition will be fighting an uphill battle to secure the votes of Felda settlers, who have long been loyal UMNO supporters.

"In the lead-up to the elections, if they (UMNO) can develop measures that can persuade the voters ... then they can still mitigate the concerns arising from the purchase of Eagle High," said Ibrahim Suffian, director of independent opinion polling firm Merdeka Center.

"But this is not a done deal; it is a developing story."

(Editing by Praveen Menon and Bill Tarrant)