PETALING JAYA: The World Bank has recommended that Malaysia’s Budget 2027 to be announced on Friday focus on rebuilding the country’s fiscal space while supporting investment, productivity and vulnerable households.
Apurva Sanghi, lead economist for Malaysia at the World Bank, said the country needs to strengthen tax revenue, make public spending more efficient, improve incentives for businesses to grow and expand protection for gig workers and older Malaysians.
“One of Malaysia’s biggest structural issues is the declining tax revenue in gross domestic product (GDP). It’s difficult to increase tax rates, but there are ways to still increase tax revenues without increasing tax rates. Revisit and possibly lower current high thresholds at which higher marginal personal income tax applies.
“Right now, the thresholds on personal income taxes are rather high compared to many other countries. Lowering the threshold without increasing the tax rate is one way to get more revenue.
“There could also be a consideration of placing greater limits on reliefs and deductions, particularly at the upper end of the income distribution,” he said at the presentation of Part 1 of the Malaysia Economic Monitor at Sasana Kijang in Kuala Lumpur yesterday.
Malaysia’s tax revenue-to-GDP ratio has dropped from 15% about 15 years ago to 12.77% at present. Furthermore, federal government debt has risen above 65% of GDP, while debt-servicing costs are increasing. Now 17 sen of every ringgit of government revenue is used to service debt.
Apurva advised streamlining the multi-tier corporate income tax structure for small and medium enterprises (SMEs) into a single preferential rate, while phasing out preferential treatment once firms cross SME growth thresholds to eliminate growth-inhibiting “tax cliffs”.
The World Bank advised supporting investments by allowing 100% expense for qualifying new capital investments and relaxing restrictions on carrying forward business losses, ensuring firms undergoing multi-year investment cycles are not penalised by upfront tax rules.
Apurva said the country should also consider implementing neutral tax reform to eliminate the cascading tax-on-tax and embedded supply chain burdens of the sales and service tax, which currently erode exporter competitiveness.
While acknowledging the structural advantages of a goods and services tax framework, the World Bank noted that regressivity can be mitigated through targeted transfers while fixing historical administrative issues such as delayed tax refunds.
On the spending side, Apurva said Budget 2027 must prioritise subsidy rationalisation particularly for fuel subsidies, which could balloon to a RM40bil bill this year from RM19bil in 2025.
Fiscal savings should be directed toward expanding social safety nets, including scaling up cash transfer programmes (Sumbangan Tunai Rahmah or STR and Sumbangan Asas Rahmah or Sara), extending the Employment Insurance System or EIS to cover gig workers, and strengthening non-contributory social pensions (Bantuan Warga Emas) to cover senior citizens as Malaysia approaches a super-aged demographic status.
That aside, the World Bank noted Malaysia’s economic growth so far this year has exceeded expectations despite difficult external conditions. It raised its projected real GDP growth to 5.1% for 2026. Growth is projected to moderate to 4.7% in 2027 for the economy.
Apurva said the performance was encouraging because real GDP per capita is almost 18% higher than before the Covid-19 pandemic. External demand has played the leading role, while domestic demand has provided only a supporting contribution.
Malaysia has benefited substantially from the global artificial intelligence (AI) boom. Data-centre (DC) investment accounted for almost half of announced greenfield foreign direct investment in 2023 and 2024. Malaysia has also become a regional leader in DC capacity and has recorded strong AI-related export growth.
More than 70% of Malaysia’s overall export growth in early 2026 was attributed to stronger demand for AI-related products. The longevity of the AI boom will depend on the take-up rates for the services and the sustained investments by the hyperscalers.
Commodity exports, particularly liquefied natural gas, have also supported the economy. However, growth excluding AI-related goods has been weak, the World Bank identified. This concentration creates an important vulnerability. The broader economy has not yet fully captured the gains.
Domestic demand has remained steady rather than accelerated. Private consumption grew 4.8% in the second quarter compared with the first quarter, while private investment slowed from 7.8% to 4.3% over the same period.
Consumer sentiment, business confidence and private investment as a share of GDP have not returned to strong upward trends. Business confidence, according to the World Bank’s presentation, is currently as weak as during the pandemic.
The World Bank noted inflation has remained moderate as subsidies have limited the pass-through of higher costs to households, but warned producers are experiencing rising cost pressures since the Middle East conflict broke out.
The bank found lower-income households have experienced particularly mild price pressures. Households earning below RM3,000 a month recorded average inflation of about 1.2% in the first half of the year.
Apurva attributed this partly to government transfers and support programmes directed towards such households.
The World Bank identified three major risks to Malaysia’s outlook. The first is a reversal or slowdown in the global AI boom. Higher interest rates increase the cost of capital, while high valuations may fall as competition intensifies. Public opposition to DCs could also restrict investment. A sharp correction in AI-related assets could trigger global risk aversion and capital outflows from emerging markets. It could also weaken trade and growth in the United States and China, two economies closely linked to Malaysia.
Previous World Bank analysis suggested that a one-percentage-point slowdown in US growth could reduce Malaysia’s growth by 0.8 percentage points.
The second risk is renewed uncertainty over oil prices and the Middle East conflict. Although the shock has so far been less severe than feared, inventories are being depleted, export restrictions could emerge and governments may lose the fiscal capacity to maintain price support. Disruptions could affect not only oil and gas but also chemicals, fertiliser, food and renewable-energy equipment.
On top of that, a stronger-than-expected El Niño weather event could raise food prices, a serious concern because food accounts for roughly 30% of Malaysia’s consumer basket.
“The third risk is continuing uncertainty over US tariff policy. Malaysian exporters face a statutory tariff rate of 10%, although exemptions reduce the effective rate to around 6.5%. Electrical and electronics products are notably protected, but this also creates exposure. Around 27% of Malaysia’s domestic value added is linked to electrical and electronics goods, the highest share in Asean. If exemptions are removed, Malaysian manufacturing exports and growth could be affected disproportionately,” Apurva said.
He also advised AI adoption be based on three foundation pillars - stronger basic education, better digital skills and a stronger innovation system.
Learning poverty affects about four in 10 Malaysian children, while nearly half of employers report difficulty finding workers with computer or data skills. Malaysia’s patent applications have also declined over the past decade, even as applications increased in other Asean economies.
The World Bank’s advice is for Malaysia to “think small” about AI. Instead of focusing only on large language models and headline-grabbing projects, the country can use practical AI tools in healthcare, education, public administration and SMEs. AI could reduce administrative burdens, improve medical diagnosis, help teachers personalise instruction and make government services more efficient.
