CGS International
July 3, 2025

Malaysia’s Market Recovery: Tariffs, Rate Cuts, and Reforms Set the Stage for a KLCI Rebound in 2025

Executive Summary: From Market Rout to Renewed Optimism

Malaysia’s equity market has weathered a stormy first half of 2025, battered by external shocks such as US tariff escalations and volatile global risk sentiment. Yet, CGS International anticipates a strong comeback in the second half of the year, underpinned by several tailwinds: easing tariff tensions, a likely resumption in the US Federal Reserve’s rate cut cycle, and a structural strengthening of Malaysia’s domestic economy. With foreign shareholding at record lows and compelling market valuations, the outlook for the FTSE Bursa Malaysia KLCI (KLCI) is cautiously optimistic, with a year-end target of 1,670.

1H25 Market Review: External Headwinds Dominate

• The KLCI declined 6.7% in the first half of 2025, but this was cushioned by the ringgit’s 6.2% appreciation, resulting in a currency-adjusted return of just -0.9%.
• Malaysia’s performance lagged the MSCI AC ASEAN Index, which gained 3.4% over the same period—mainly led by Singapore’s STI (+12.4%).
• Market volatility was largely driven by external factors: US policy shifts on AI and tariffs, Trump’s inauguration, and a global tariff hike—Malaysia was hit with a 24% rate, comparatively lower than the ASEAN average of 33% and below key Asian peers’ 28% average.
• Despite a sharp drop to a YTD low of 1,401 points in April, the KLCI rebounded strongly (+13.1% by mid-May) as global tariff tensions eased and the US rescinded a controversial AI rule.
• Profit-taking ensued on renewed geopolitical risks, but the KLCI still eked out a 1.3% gain in 2Q25.

Tariff Tensions: Short-Term Pain, Medium-Term Relief

• Malaysia’s exposure to the US and China is significant in trade terms (13.2% and 12.4% of exports in 2024, respectively), but less so for listed equities—estimated revenue exposure for the KLCI is just 0.5% (US) and 4.9% (China).
• Sectors with higher US revenue exposure: Gloves, Technology, EMS, and Gaming. For China: Ports, Automotive, Technology, and Petrochemicals.
• Past US tariff cycles under Trump suggest escalation may be a negotiating tactic, with eventual de-escalation and trade deals likely. Early signs in 2025 indicate a faster shift toward resolution, with Malaysia poised to reach a mutually beneficial agreement with the US before the July deadline.

Monetary Policy Tailwinds: Rate Cuts and Ringgit Strength

• The Fed’s real federal funds rate (FFR-CPI) remains well above long-term averages, signaling room for further FFR reductions beyond the expected 50bp cut in 2H25. Bank Negara Malaysia (BNM) is projected to make a milder 25bp OPR cut.
• Narrowing FFR-OPR spreads historically correlate inversely with the KLCI: as US-Malaysia rate differentials shrink, the ringgit strengthens and local equities rally.
• Episodes of narrowing spreads since 2005 have seen the ringgit appreciate, most notably with a +13.3% gain from Mar 2010 to May 2011. The ringgit’s appreciation is positive for domestic demand-driven sectors, while exporters (Gloves, Tech, Petrochemicals) could face margin pressure.

Malaysia’s Economic Reform Agenda: Fiscal Discipline and Investment Momentum

• Despite external challenges, the Unity Government (UG) has pressed ahead with meaningful reforms: two rounds of sales and service tax (SST) revisions, ongoing subsidy rationalization (with RON95 fuel next in line), and strategic policy blueprints under the Madani Economy.
• Gross fixed capital formation (GFCF) grew at an average of 11.6% year-on-year from 1Q24 to 1Q25, driven by record-high approved investments (RM379bn in 2024; +15% yoy).
• Malaysia’s political landscape is more stable, with PM Anwar’s government outlasting previous administrations and approval ratings rising.

SST3.0 and Subsidy Rationalisation: Sector Impact and Fiscal Outlook

• SST3.0, implemented in July 2025, broadens the tax base, raising the sales tax on many discretionary and non-essential items and expanding the service tax scope. Estimated to add RM10bn to annual revenues, with a minor 10-20bp bump to inflation.
• Sector implications:
  • Banking: Retail-focused banks (Public Bank, Hong Leong Bank) less impacted; Bank Islam could benefit as Islamic finance is exempt.
  • Healthcare: 6% service tax on non-citizen private healthcare; limited impact due to low foreign patient mix.
  • Construction & Property: 6% service tax on construction (excluding residential); 8% service tax on rental for non-residential property may pressure weaker REITs.
• RON95 subsidy rationalisation could save RM8bn per year, targeting the highest income brackets and foreigners. Diesel subsidy removal in 2024 already contributed to a 13.5% drop in subsidy spending; total subsidies projected to fall by 22% in 2025.
• MOF projects Malaysia’s fiscal deficit to narrow to -3.8% of GDP in 2025, aided by SST3.0 and potential RON95 subsidy savings.

Comparisons to Past Reform Cycles: The Najib Parallel

• Malaysia’s current reform trajectory mirrors the post-GFC period under Najib, which saw subsidy rationalisation, new consumption taxes, and direct cash handouts. The KLCI returned 97% during Najib’s tenure, with the forward P/E rating rising significantly.
• The current government enjoys a stronger parliamentary majority, making reform implementation smoother.

Valuation and Technical Indicators: The Case for a KLCI Rebound

• Despite the recent recovery, the KLCI trades at 14.1x P/E (-0.9 s.d. below the 5-year mean), 1.44x P/BV (-0.2 s.d.), and at a 6.6% discount to the regional peer group (ASEAN-5).
• The “Buffett indicator” (market cap to nominal GDP ratio) remains near trough levels, a signal that has historically marked market bottoms and subsequent rebounds of 6% to 29% within 1-3 months.
• Foreign shareholding on Bursa is at a record low of 19%, significantly below the post-GFC peak of 25%. A return to “market-weight” could bring +RM24.8bn in potential foreign inflows—over twice the size of the largest annual net inflow of the past decade.
• Domestic institutional investors, led by EPF, are being encouraged to increase local allocations, with EPF targeting a 70% domestic investment level.

KLCI Earnings Outlook and Sector Contribution

• KLCI earnings growth is forecast at +5.4% in 2025 (down from an earlier 9.0%), led by:
  • Financials: +3 percentage points, with 6.2% net interest income growth expected.
  • Agribusiness: +1.4 percentage points (KLK’s low base recovery).
  • Utilities: +0.9 percentage points (Tenaga’s Majung 4 plant restart).
• Telecommunications projected to drag due to Axiata’s deconsolidation of XL and a stronger ringgit.
• 2026 KLCI earnings growth seen picking up to +7.3%.

Sector Ratings and Investment Strategy

• Overweight: Banking, Construction, Consumer Discretionary, Healthcare, Oil & Gas, REITs, Transport, Utilities
• Neutral: Agribusiness, Automotive, Consumer Staples, Real Estate, Technology, Telecommunications
• Underweight: Gloves, Petrochemicals

High Conviction Stock Picks: Detailed Analysis

Conclusion: KLCI Set for a Second-Half Rebound

The Malaysian equity market stands at a turning point. With external shocks abating, monetary tailwinds gathering, and domestic reforms taking hold, CGS International expects a volatile but ultimately positive second half for 2025. The KLCI is forecast to reach 1,670 by year-end, representing attractive upside amid rock-bottom foreign shareholding and compelling valuations. Investors are encouraged to focus on sectors and stocks with robust domestic demand, fiscal resilience, and exposure to reform-driven growth.