Weak spots remain amid broadly strong macro-fundamentals

After having experienced a robust growth trajectory, averaging +4.7% y/y in the 2000s and +5.4% y/y between 2010 and 2019, Malaysia was severely hit by the Covid-19 pandemic, experiencing a -5.5% y/y contraction in GDP in 2020, followed by a modest recovery of +3.3% in 2021. On the back of a buoyant global environment, higher commodity prices and a recovery in domestic demand, the economy saw a strong rebound in 2022, growing by +8.7%. In 2023, the economy remained resilient to the challenging external environment, high inflation and tight monetary policy and grew by +3.6%, primarily driven by private consumption. Growth was still supported by strong domestic demand in 2024, as well as easing monetary policy and a recovery in external demand. Looking ahead, we expect growth to average around +4.2% per year in the medium term until 2030.

Fiscal policy in Malaysia has been broadly expansive after the onset of the pandemic, with the fiscal deficit increasing from 4.9% to 5.9% of GDP during the 2020-2022 period. However, the fiscal deficit narrowed to 4.6% in 2023, and decreased further in 2024. Fiscal consolidation will likely remain an area of focus for Malaysian policymakers. As a matter of fact, the 2025 budget will bolster government revenue through expanded taxes and a global minimum tax, while also cutting subsidies as they have been a major driver of spending since the pandemic. The government is targeting a deficit of 3.8% in 2025, despite record budget spending.

With the aim of finding an equilibrium between supporting economic growth and keeping inflation under control, the Bank Negara Malaysia – the central bank of Malaysia – is likely to maintain a neutral policy stance after having implemented a cumulative 125bps hike in the policy rate in 2022-2023. We forecast inflation to moderate to 2.1% and 2.2% in 2025 and 2026, respectively, declining from 2.5% in 2023. However, inflationary pressures from the 2025 budget, including subsidy cuts and broader taxes will prevent the central bank from a premature monetary policy easing in the near term.

Malaysia exhibits an above-average business environment but is facing a downward trend. The Heritage Foundation’s Index of Economic Freedom survey 2023 assigns the economy rank 42 out of 184 economies, down from rank 22 in 2021. The latest rank reflects weaker scores in terms of financial freedom and government integrity. However, tax burden, trade freedom, government spending and monetary freedom remain bright spots. Meanwhile, the World Bank Institute’s annual Worldwide Governance Indicators 2023 survey indicates that Malaysia performed well in terms of government effectiveness and regulatory quality, although the voice and accountability, as well as the political stability and absence of violence/terrorism, remain weak spots. Lastly, our proprietary Environmental Sustainability Index ranks Malaysia 107 out of 210 economies, up from rank 147 the previous year. There is particular room for improvement in terms of renewable electricity output and the recycling rate.

Malaysia’s predominant political party, United Malays National Organization (UMNO), has long held power in the ruling coalition. The situation changed in 2018 amid a corruption scandal, launching an era of political instability, with four different governments in five years. In the November 2022 election, none of the contestants won a parliamentary majority, which was the first time that Malaysia has seen a hung parliament since its independence. After intense negotiations, the leader of the multicultural Pakatan Harapan (PH) coalition, Anwar Ibrahim, became Malaysia's 10th Prime Minister, heading a unity government. Stability and continuity have been key features of Anwar’s speeches in addition to the signing of a memorandum of understanding between the component parties in the PH coalition. In addition, he has pledged to work with the pro-Malay factions in the coalition and focus on areas such as economic growth and anti-corruption rather than on reforms on sensitive issues including race-related policies. In 2023, Anwar Ibrahim presented the “Madani Economy” framework, a 10-year plan aimed at boosting competitiveness while reducing the fiscal deficit. This plan sets medium term targets that will shape future policy and budgets, such as increasing female labor force participation, achieving a 3% deficit or ranking Malaysia among the top 30 economies globally.