Fiscal policy in Malaysia has been broadly expansive after the onset of the pandemic, with the fiscal deficit widening 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 to -4% in 2024. The 2025 budget bolstered 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 -3.6% in 2025, despite record budget spending. Fiscal consolidation will likely remain an area of focus for Malaysian policymakers, as shown by the 2026 budget, which includes tax increase measures and the implementation of a carbon tax. We expect the fiscal deficit to remain stable around -3.6% in 2026 and 2027.

With the aim of finding an equilibrium between supporting economic growth and keeping inflation under control, the Bank Negara Malaysia (BNM) – the central bank of Malaysia – implemented a cumulative 125bps hike in the policy rate in 2022-2023. With inflation lowering to +1.4% in 2025 from +3.4% in 2022, BNM delivered a -25bps policy rate cut in 2025. As we forecast inflation to remain moderate at +2.0% and +1.9% in 2026 and 2027, respectively, we expect the central bank to keep rates constant in 2026-2027.

The economy’s short-term financing risk is deemed low. While structural macroeconomic vulnerabilities are manageable, it is worth monitoring public finances and external debt.

The large round of fiscal stimulus since the pandemic has widened the fiscal deficit and elevated public debt to around 70% of GDP since 2023 (compared to an average of 55% in the 2010s). We expect public debt to stay around 70% over the next two years. On the brighter side, most of the public debt is expected to be funded onshore. On the current account front, Malaysia is estimated to have registered a surplus of +1.5% in 2025, which is forecast to expand to +1.8% in 2026, primarily driven by a goods trade surplus. That said, Malaysia's dependence on foreign trade and its structure also make it vulnerable to the ongoing US trade war, as well as potential cyclical swings in sectors such as electrical machinery and equipment, electronics and commodities. As global trade becomes increasingly driven by geopolitics, Malaysia could emerge as an alternative to China, but the country's heavy reliance on China could also weaken the resilience of its external sector.

Malaysia exhibits an above-average business environment but is facing a downward trend. The Heritage Foundation’s Index of Economic Freedom survey 2025 assigns the economy rank 44 out of 184 economies, similar to the previous year’s ranking but down from rank 22 in 2021. The deterioration reflects weaker scores in terms of financial freedom, government integrity and fiscal health. However, tax burden, trade freedom, government spending and monetary freedom remain bright spots. Meanwhile, the World Bank Institute’s annual Worldwide Governance Indicators 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. 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 last election, in November 2022, none of the contestants won a parliamentary majority. 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. 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. Malaysia has thus enjoyed a stable political environment since 2022, which is likely to remain the case in the coming few years.