KUALA LUMPUR (July 1): Malaysia is set for a seventh consecutive year of foreign equity outflows, limiting support for the local market as election uncertainty keeps overseas investors cautious, according to Phillip Research.

The research house said foreign inflows could remain limited in the second half of 2026, with election uncertainty compounded by renewed inflation risks and growing pressure on government finances from higher fuel subsidies.

The caution comes despite Phillip raising its 2026 gross domestic product (GDP) growth forecast to 4.7% from 4.5%, within Bank Negara Malaysia’s official projection of 4% to 5%.

Phillip expects resilient domestic demand, healthy labour market conditions and steady investment activity to support growth, while exports could receive a further lift from the global semiconductor upcycle.

Malaysia’s electrical and electronics exports have increasingly become the main driver of export growth, supported by stronger global demand for semiconductors used in artificial intelligence (AI)-related applications.

Favourable employment conditions should continue to underpin household spending, while the progressive implementation of projects approved over recent years would sustain private and public investment, the research house said.

Still, inflation and the government’s rising fuel subsidy bill have emerged as major risks to the outlook.

Phillip estimated that Malaysia’s headline inflation could rise to as high as 5% if domestic fuel prices fully reflected prevailing market prices. The continued RON95 subsidy has cushioned households from higher global oil prices but increased the burden on public finances.

Budget 2026 allocated RM49 billion for subsidies and social assistance based on an assumed crude oil price of US$60 to US$65 a barrel, while crude had averaged above US$90 as of June 19.

Higher-than-budgeted subsidy spending could complicate the government’s fiscal consolidation plans and raise concerns over its ability to meet the fiscal deficit target of 3.5% of GDP.

The research house said renewed scrutiny from international rating agencies could also emerge if elevated energy prices caused public finances to deteriorate more sharply than expected.

Phillip expects Bank Negara to keep the overnight policy rate unchanged at 2.75% for the rest of the year, although it said the risk of higher interest rates had increased should inflation intensify.

It also revised its end-2026 ringgit forecast to between RM4.10 and RM4.20 against the US dollar, from RM4.05 to RM4.15 previously, amid a potentially wider US-Malaysia interest-rate differential and rising fiscal pressures.

Against this backdrop, Phillip expects the Malaysian stock market to remain largely flat and trimmed its end-2026 FBM KLCI target to 1,700 points from 1,710, citing a lack of strong near-term catalysts.

The revised target implies a modest upside from the KLCI’s close of 1,664.06 points on Tuesday.

Phillip nevertheless said Malaysian equities could perform better in the second half, supported by resilient corporate earnings and investment themes linked to AI, green energy, infrastructure and tourism.

The research house said investors should focus on companies benefitting from AI infrastructure, the green energy transition, broader infrastructure spending and tourism recovery.

It remained positive on seven sectors, namely banking, construction, electronic manufacturing services, healthcare, industrials, renewable energy and transportation, which it expects to perform better than the broader market.

Construction and electronic manufacturing services companies are expected to benefit from continued foreign investment and supply-chain diversification, while industrial and renewable-energy players stand to gain from the rapid expansion of data centres and related power infrastructure.

Banking remains a proxy for the domestic investment upcycle, while healthcare offers more defensive and resilient earnings visibility, Phillip said.

The research house downgraded the oil and gas sector to 'neutral' from 'overweight', as the recovery remained uneven despite Petroliam Nasional Bhd (PETRONAS) indicating higher capital expenditure.

Phillip said project flows and earnings had yet to show meaningful improvement across the sector.