This article first appeared in Forum, The Edge Malaysia Weekly on October 19, 2026 - October 25, 2026
The Malaysian economy is largely sheltered because of huge subsidies. The direct effect is the creation of an environment with low inflation, low interest rates, low growth and, finally, relatively lower wages. The prolonged period of this sheltered economy mirrors the environment of the local stock market, which has largely been stagnant.
Exactly 10 years ago, the benchmark index was also hovering at about 1,650 points. So, if anybody had made a long-term bet on the index-linked counters, they would have not gained much. The returns on capital invested against the price of the index-linked stocks would probably have been negative.
Nevertheless, these index-linked companies do declare dividends. Hence, after taking into account the dividends, investors would have got a positive return that is well above the average inflation rate of less than 2% per annum.
But a rate of return just above the Malaysian inflation rate would be insufficient for anyone relying on the dividends for their monthly upkeep, as the cost of living is well above the average inflation rate for anyone wanting to have a comfortable lifestyle. That is because the Malaysian inflation rate does not really tell the true story about the cost of living.
Fuel, essential food items, electricity and water are all subsidised. Over and above the subsidies, the government gives direct financial assistance in the form of Sumbangan Tunai Rahmah (STR) to the bottom 40% of the population and Sumbangan Asas Rahmah (Sara) across the board to all Malaysians.
STR and Sara are political tools that cannot be easily removed. They are a form of direct financial assistance to the people and will become a political hot potato if they are rolled back.
Even the subsidies for fuel and electricity are a sensitive matter. The government reduced the subsidy on fuel and electricity for a few months before restoring the benefits in a populist move.
There is a cost to keeping up the subsidies, the tab for which is ultimately picked up by taxpayers. The money comes from the federal government’s operating expenditure (opex) that is funded by taxpayers.
According to the 2027 Treasury report on the Fiscal Outlook and Federal Government Revenue estimates, the amount allocated to subsidies and social assistance is expected to increase significantly by 34.7% to RM74.5 billion this year, accounting for 20.5% of total opex because of the Middle East conflict.
When Budget 2026 was unveiled last year, the projected spending on subsidies and social assistance was 11.7% of the opex. In fact, in the last three years, the amount allocated to subsidies and social assistance has come down because of the implementation of targeted subsidies.
More money set aside to maintain the subsidies and social assistance means less money for development.
Another consequence of Malaysia’s sheltered economy is that it leads to an artificial rate for the cost of funds. Bank Negara Malaysia’s overnight policy rate has been kept at 2.75%, even though key policy rates around the world have been rising.
The US Treasury market is the biggest and most important benchmark to determine the cost of funds in the world. The yields on all tenures of US Treasury bills went up in recent months when it became evident that the war in the Middle East was not going to end soon.
Year to date, the yield on the 10-year US Treasury bill is up 106 basis points (bps). Bond yields rise when the prices of debt paper go down. Investors sell debt paper on expectations of higher inflation and a repricing of the cost of funds.
The rise in US bond yields is largely due to higher inflation and an expected higher trajectory in rising interest rates. Analysts are expecting the US Federal Reserve to raise the federal funds rate by at least another 25bps in December.
Even in a country like Japan, which is generally known for its low interest rates, low growth and low inflation regime, bond yields have been rising. The current 10-year Japanese government debt paper carries a yield of 3%, which is significantly higher than the average of 0.7% over the past 20 years.
Interest rates in other developing countries have also gone up in tandem with the developments in the US Treasury market. In Australia, banks offer promotional fixed deposit rates of more than 5% after the central bank raised its key policy rate a few times.
In Malaysia, however, the fixed deposit rates are still relatively low because of the managed inflation. The yield on the Malaysian Government Securities (MGS) 10-year debt paper is 3.85%.
How long can interest rates be kept at such levels, considering that global bond yields have gone up much higher? If the yields are not attractive, why would foreigners, who make up between 20% and 30% of the debt market participants, take up MGS?
Many are predicting that global bond yields will continue to rise, reflecting a regime of higher interest rates for the longer term. If the yields in the US bond market continue to rise, Malaysia may not have a choice but to also reprice the cost of funds.
If such a move happens, it will be good for the economy. A repricing of the cost of funds will help ensure a more efficient allocation of capital. For instance, the artificial intelligence-related infrastructure investment boom could be reviewed.
Funds and stocks that give paltry dividends will also come under pressure to give better returns to investors. Hopefully, it will lead to Malaysia exiting the era of low growth, low inflation, low productivity and low wages with a market-driven approach to determining the cost of funds.
Interest rates have been low in Malaysia for far too long. A whole generation of investors do not know what it is like to invest in an environment where interest rates can be as high as 8%.
When the cost of funds is high, companies and investors will need to work harder to ensure their capital gives better returns. Investments that give paltry returns will not have access to capital because passive investors will always have the option of putting more money into risk-free fixed deposits.
M Shanmugam ([email protected]) is a contributing editor at The Edge
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