DOES Malaysia become less vulnerable to the US-Israel and Iran war crisis-induced disruptions?
The impact of war and oil shocks on the Malaysian economy is largely determined by the degree of oil price increases (permanent or temporary) and duration of supply disruptions.
As a small and open trading nation, Malaysia’s export performance is heavily reliant on the global economic outlook, especially the economic health of its key trading partners, which drives demand for Malaysian goods.
A bigger than expected slowdown in global growth due to the perfect storm – a convergence of the Middle East conflicts, soaring energy and gas prices, supply chains disruption, and tariffs policy uncertainty would dent Malaysia’s exports.
Recent episodes of geopolitical tensions in the Middle East showed that a short-lived, low-intensity shock inflicted moderate economic friction, while a prolonged, high-intensity conflict could trigger severe inflationary shock, increased business costs, reduced consumer spending and business activities, and, in worst-case scenario, could lead to a global recession.
The Malaysian economy has had experienced a few episodes of major oil price shocks, largely triggered by intensified geopolitical conflicts in the Middle East.
It is worth mentioning that the first oil shock (1973-1974), Yom Kippur War and Arab Oil Embargo acted as a catalyst for Malaysia to become a significant oil exporter and becoming a key contributor of the federal government’s budget and economic growth.
Over the past three decades, Malaysia has transitioned into a net oil importer since 2022, primarily due to maturing domestic oil fields leading to declining crude production, coupled with rapidly rising domestic consumption as well as economic development.
Prior to 2022, Malaysia’s position as a net oil exporter had allowed it to benefit from oil price surges.
On balance, higher oil prices have had manageable impact on the Malaysian economy.
Higher oil-related federal revenue was offset by fuel subsidies to keep domestic inflation manageable.
Inflationary pressures were heightened. Historically, Malaysia has had experienced inflation between 2% and 3% annually, but oil shocks inflicted by wars in the Middle East have caused notable deviations above this range.
A period of high inflation averaging 13.9% per annum in the first oil shock (1973-1974) and 5.1% per annum in the second oil shock (1979-1980: Iranian Revolution) and 8.2% per annum in the Iran-Iraq war (1980-1988), largely driven by soaring global oil prices, rising import costs, and higher prices for industrial raw materials.
Bank Negara Malaysia’s (BNM) monetary policy committee or MPC has acknowledged the uncertainties from the ongoing conflict in the Middle East, indicating that the impact on the global and Malaysian economy will depend on how these developments evolve.
The key variables in transmitting an oil shock to a recession are the duration and magnitude of price surges, the central bank’s monetary policy response, and pre-existing state of the economic cycle.
While Malaysia is in a position of strength to withstand a “perfect oil storm” amid the ongoing tariff policy uncertainty, a global economic fallout from persistent oil shocks will transmit through the domestic economy via trade, financial and inflation channels.
The Malaysian economy ended the year 2025 on a resilient note – 5.2% gross domestic product (GDP) growth, resilient consumer spending and robust investment, a record high approved investment, moderate inflation, strong labour market conditions and sound financial sector.
The fiscal reforms have improved the fiscal space. These positive initial conditions provide cushion, albeit not infinite against global headwinds.
However, the overall net impact on the domestic economy is mixed between neutral and moderately negative or positive, depending on the degree of transmission and our economy’s shock absorption capacity.
Prolonged oil shocks act as a significant and multi-faceted disturbance to the domestic economy via various transmission channels, characterised by immediate (first-order) disruptions to costs and income, followed by prolonged (second-order) inflationary and structural shifts.
These shocks affect economic growth via production, consumption and investment, consumer inflation and business operating costs, and the fiscal budget via direct and indirect channels.
In 2025, Malaysia remained a net crude oil importer (minus 1.7% of GDP) since 2022, net liquefied natural gas (LNG) exporter (2.2% of GDP) and a small net petroleum products exporter (0.2% of GDP) (see table).
The key transmission channels of oil shocks and a slowdown in global economy and our regional trading partners, especially China and Asia are as follow:
> Demand destruction effect: Rapid increases in oil and gas prices driven by supply disruptions cause “demand destruction,” where elevated prices force consumers to reduce disposable income and cut back on discretionary spending as well as increase businesses production costs, leading to a broader economic slowdown.
While the diesel and RON95 petrol subsidy quota-based programme has sheltered consumers and some businesses (public transport and specific logistics vehicles) for now, businesses outside the “subsidised quota” have incurred high fuel costs.
Oil and LNG export earnings will benefit from higher prices. Our ballpark estimates indicate that an average Brent crude price of US$100/bbl could result in a net increase of RM2.5bil in export earnings of crude petroleum and LNG to RM13.7bil in 2026 (RM11.2bil in 2025 based on an average crude price of US$69.04/bbl).
While the second-order export impact from a slowdown in global demand is expected, a diversified export structure provides a buffer against external demand volatility, with resilient demand in the semiconductor and artificial intelligence or AI sector ((DRAM, NAND, and high bandwidth memory (HBM)) providing cushion amid supplies disruption of key chipmaking elements such as helium and bromine.
> Supply-side/cost effect: Oil shocks typically boost Malaysia’s mining sector output (5.7% of GDP in 2025 vs 9.2% in 1990) because higher global prices encourage increased production of crude oil and natural gas amid its contribution to GDP has been declining over the decades.
Increased energy costs and raw materials due to the supply chains disruption, higher shipping rates, insurance premiums and logistic cost raise transportation and production expenses for firms, reducing output or delaying production and inducing inflationary pressure. Direct cost increases have knock-on impact on industries and sectors that falling outside “the fuel subsidy-quota” scheme, such as construction, aviation, plantation and manufacturing sectors.
The affected industries include industrial products and consumer goods. Among the heavy users of gas and electricity in the manufacturing sector are iron and steel, textiles, cement, and glass products. The agricultural sector will also be impacted as crude oil is serving as a primary energy source for machinery fuel (diesel), transport, and the production of fertiliser, pesticides and plastics.
The prolonged escalation of conflict in the Middle East, characterised by widespread airspace restrictions, airport disruptions and increased airfares and insurance costs, is causing significant disruption to international travel from the region, Europe, and the United States, which threatens to dampen the tourism and hospitality sector in Malaysia, causing a dent on Visit Malaysia 2026.
> Inflationary impulse: Higher prices for fuel directly raise headline inflation and can lead to higher core inflation via the second order price transmission effect. The fuel subsidy mechanism has partially shielded consumers and businesses from the first-round oil shocks.
If the Brent crude price stays at US$90-US$100/bbl for three months, the
government would be compelled to raise the current subsidised RON95 of RM1.99 per litre, to keep fuel subsidies manageable.
With the fuel (diesel and petrol) carrying a combine weightage of 5.7% and transportation’s weightage of 11.3% in the consumer price index (CPI) basket, a 10%-15% increase in fuel prices would raise the CPI growth by between 0.6 and 0.9 percentage points.
The best-case scenario for inflation is estimated between 2.5% and 3.5% (assuming the oil price is at US$80-US$90 per barrel); worse case is 4%-6% (assuming the oil price is at US$90-US$120 per barrel).
> Fiscal effect: Sustained high oil prices create risk to strain the fiscal deficit and reduce the limited fiscal space for development expenditure, requiring a recalibration and reprioritising of spending, including prudent spending and subsidies cut to rein in the fiscal deficit.
The net impact of higher global oil prices on the fiscal deficit is negative as an increase in oil-related revenue is largely offset by high fuel subsidy payment.
If we assume average Brent crude price increased to US$100 per barrel from US$65 used in the preparation of the 2026 budget, an additional US$35 increase in oil price will generate an extra increase in federal revenue by RM10.5bil, but it will be more than offset by RM19.8bil for fuel subsidy payment.
This will increase the budget deficit ratio by 0.4 percentage points from the budget’s targeted deficit ratio of 3.5% of GDP in 2026. As of now, the government has incurred an additional RM3.2bil per month for fuel subsidies (RM2bil for RON95 petrol and RM1.2bil for diesel) compared to RM700mil previously.
> Monetary policy effect: Higher fuel prices act like a tax on the economy as it increases cost, reduces consumer spending and dampens business investment. Given that the expected increases in inflation comes from a low level, we expect BNM may respond to oil-induced inflation by keeping the overnight policy rate unchanged at 2.75%, while continuing to closely monitor the transitory impact of the oil shock on economic growth and inflation.
Lowering interest rates during an oil shock to support growth and boost aggregate demand could lead to “demand-pull” inflation, which compounds existing cost-push pressures from higher energy prices, risking elevating inflation.
Lee Heng Guie is the executive director of the Socio-Economic Research Centre. The views expressed here are the writer’s own.
