The Malaysian political scene is entering a new era of possibilities, given that neither the ruling Barisan Nasional coalition nor the opposition Pakatan Rakyat alliance are in the best of health, with both sides suffering from a host of unsolved problems. In all, many of the risks still centre on the delicate race relations within the country, although we highlight that other factors such as the potential depletion of oil reserves will also weigh on long-term political stability.

Minority groups, namely the Chinese and Indians, have been increasingly vocal in recent years over the government's perceived favouritism towards the Malays. Indeed, much of the dissatisfaction has been attributed to the inability of some Chinese and Indian citizens to secure government-sponsored tertiary scholarships or university places, relative to their Malay counterparts due to the NEW Economic Policy (NEP)-linked ethnic quotas. We are concerned that such perceptions of unfairness among the younger generation will only serve to further polarise the different racial groups within the country. Furthermore, it has been reported that certain quarters of the ruling United Malays National Organisation (UMNO) and opposition Islamic Party of Malaysia (PAS) – both Malay-based parties – are considering further cooperation, which could lead to greater concentration of power, potentially flaming more discontent among the minority races.

Having announced two fiscal stimulus packages amounting to MYR67bn (US$19bn) or roughly 10% of GDP, government finances are in poor shape and we are not expecting the administration to be able to balance its budget over the next five years. Although there are indications that the government is considering the implementation of a goods and services tax (GST, also recommended by the IMF to hasten the country's fiscal consolidation), the tax is unlikely to be in place within the next couple of years, pending more groundwork. According to Minister of Defence Dato Seri Dr Ahmad Zahid bin Hamidi, who assumed his post in March 2009, the defence ministry can help the country's economy should the industry be developed with the right marketing strategy. It is able to market local products such as unmanned aerial vehicles (UAV), bullets for various types of firearms, military vehicles and specialist services such as repairing planes. Ahmad Zahid added the government is ready to form a special purpose vehicle (SPV) to offer financial packages to local companies to expand their businesses from service centres to products manufacturers.

Despite its status as a Muslim-majority country, Malaysia is still at risk of being targeted for terrorist strikes by Islamic radicals, which would most likely have a particularly destabilising effect, given the lack of precedence for such attacks, unlike neighbouring Indonesia. Indeed, a number of regional bombings have been linked to terrorists born and trained in Malaysia, including the Johor-born Noordin Top, who was killed by Indonesian police in September 2009. If such a scenario should occur, we would expect that key landmarks, such as the Petronas Twin Towers, would be prime targets.

In addition, there is also a possibility of increased ‘Islamisation’ of the country, especially if the Malay UMNO and PAS parties forge closer ties in the future. In such a scenario, we foresee greater proliferation of religious practices such as gender segregation in public places nationwide – which includes separate queues for men and women in shopping centres – as is currently enforced in the PAS-dominated state of Kelantan. If that happens, we would expect racial ties between the Muslim Malays and non-Muslim ethnic minorities to be further strained.