Fulcrum: Malaysia's budget funds the states by bargaining, not by rule — ISEAS – Yusof Ishak Institute (Fulcrum)

Aerial panorama of the Singapore Strait and the Pasir Panjang container terminal — Singapore Strait and Pasir Panjang Port Terminal (2016)Photo: Bob Tan / Wikimedia Commons · CC BY-SA 4.0 · resized · Source

Institution: ISEAS – Yusof Ishak Institute (Fulcrum)
Author: Tricia Yeoh
Country · language: Singapore · English
Affiliation: Government-linked research institute

Summary

Writing on ISEAS's Fulcrum platform on 29 October, Tricia Yeoh reads Malaysia's 2027 budget through the lens of transfers to the states. On 9 October Prime Minister Anwar Ibrahim presented a 510-billion-ringgit federal budget, the largest in the country's history. In the author's view, it may be the last annual budget before the 16th general election.

The fiscal footing is narrow. Because of the war in the Middle East, the fuel subsidy bill for 2026 rose from a projected 15 billion to 40 billion ringgit. The budget deficit is 3.6% in 2026, with a 2027 target of 3.3%. Debt service reaches 16.2% of revenue in 2027, breaching the internal 15% threshold. Debt stands at 63.7% of national income, above the statutory 60% target. Off-budget financing, meaning spending channelled through state investment companies and public-private partnerships, grows from 30 billion to 50.2 billion ringgit.

Operating grants to the states rise from 10.8 billion ringgit in 2026 to 12.63 billion in 2027. That is an increase of about 17%, against 5–10% in previous years. The special grant to Sabah and Sarawak under Article 112D of the constitution has risen from 125.6 million ringgit in 2022 to 1.5 billion a year for 2026 and 2027. A further 3.3 billion ringgit has been set aside for road projects in the two states.

Yeoh spells out the political logic of the increase. Sabah and Sarawak hold 56 of the 222 seats in parliament, or 25.3%. Because UMNO and BN are not expected to contest the election together with the ruling bloc, the path to a majority runs through Borneo. The author proposes tying transfers to an objective equalisation formula administered by an independent fiscal commission.

Blind spot

The piece reads the transfers through a political lens but does not price their lasting cost. With debt service rising to 16.2% of revenue while the grant base grows 17%, it does not discuss which line will fund the increase while the subsidy bill stays tied to oil prices. Nor does it quantify the burden that would follow if Sabah's claim to a 40% share of revenue is upheld in court.

Talay assessment

Bottom line

Malaysia is expanding state grants by 17% ahead of the election while debt service rises to 16.2% of revenue. This means the cost of the oil shock is being pushed into off-budget items and future years. The binding constraint is the fuel subsidy bill; while prices stay high, the 3.3% deficit target will be under strain. The likeliest path is that the target holds on paper while off-budget financing grows.

Likely effects

Malaysian public financesNegative1–6 months
Off-budget financing rising from 30 billion to 50.2 billion ringgit means the official deficit understates the true borrowing requirement.
Federal-state balanceUncertain1–6 months
A special grant of 1.5 billion ringgit a year to Sabah and Sarawak amplifies demands for an equalisation formula in the other four less developed states.
Oil-importer budgetsNegativeWeeks
The subsidy bill rising from 15 billion to 40 billion ringgit shows the scale of fiscal leakage in oil-importing countries that cushion fuel prices through the budget.

Possibilities, ranked

1
Target holds on paper55%
The deficit target stays at 3.3%, but the subsidy and grant burden is financed through state companies and partnerships.
Watch: The off-budget liabilities figure in Malaysia's 2027 mid-year fiscal report
2
Subsidy reform accelerates30%
Without waiting for the election, the government extends targeted fuel subsidies and pulls the debt-service ratio towards 15%.
Watch: An official announcement extending targeted fuel subsidies to new products
3
Rating pressure15%
Oil stays high, the deficit rises above 3.6% and rating agencies revise the outlook to negative.
Watch: Outlook decisions on Malaysia from the rating agencies

Probabilities are calibrated judgement based on the sources, not measurement, and are revised as new information arrives. Not investment advice.

Original publication: fulcrum.sg · 29 October 2026

This page summarises the institution's view and does not reflect the view of Talay Insight. No direct quotation is used.