National polls are expected in either late 2011 or early 2012, well ahead of the 2013 date by which they must be held and investors are waiting to see if Prime Minister Najib Razak will implement reforms to match his rhetoric after a series of flip-flops on a goods and services tax and subsidy cuts.
Najib has delivered measures such as granting new bank licenses and cutting the fiscal deficit, although that target may be under threat from rising prices of food and fuel, which are subsidised in Malaysia. But he has shied away from big subsidy cuts and tax reforms and softened an earlier promise to reform controversial preferential equity ownership rules for the majority ethnic Malays.
Disappointed investors are increasingly opting for faster- reforming neighbours such as Indonesia. Analysts expect Najib may be willing to push through reforms after the next general election, but only if he manages to win a strong mandate.
Following is a summary of key Malaysia risks to watch:
POLITICAL CONFLICT
Political tensions spiked after the last general election in 2008. The National Front lost in five of Malaysia's 13 states and ceded its two-thirds majority in parliament to an opposition led by former Deputy Prime Minister Anwar Ibrahim.
The People's Alliance opposition is however beginning to show signs that it is losing momentum, defeated in two recent by-elections amid a rift in Anwar's own party.
Najib needs to regain the ruling coalition's two-thirds control of parliament and win at least two of the five states it lost to stamp his mark on power.
Any less and he would come under pressure from Malay activist groups opposed to some of his economic reforms, and from within his own United Malays National Organisation (UMNO) party that anchors the National Front.
The political uncertainties since 2008 have weighed on foreign investment but hot money has flowed into the Malaysian bond market this year, reversing investment outflows and pushing the ringgit currency to 13 year highs against the dollar.
What to watch:
-- State-wide elections in the Borneo state of Sarawak. Unhappiness among minority ethnic Chinese in the ruling coalition's bastion state could lead to a loss of its two-thirds majority in the state legislature. This would embolden the opposition, weaken Najib's position and lead to a likely delay in the timing of the national polls. Most political analysts expect the government to hold on to its two-thirds majority in the state.
-- Minorities. Many of Malaysia's mainly ethnic Chinese and Indian minorities abandoned the government in the 2008 elections due to increasing concerns of marginalisation, hollowing out the ruling coalition's smaller parties. Many remain weak and unable to regain momentum. Sarawak will show whether Najib has succeeded in winning them back.
-- Opposition leader Anwar Ibrahim's sodomy trial. Charged in 2008 for sodomising a former male aide, Anwar claims the case is a political conspiracy by the government. A verdict is likely this year. A guilty verdict would anger Anwar's supporters and could escalate political tensions sharply.
ECONOMIC REFORM
Najib has pledged to reform a decades-old affirmative action policy favouring Malays with economic privileges such as business and replace it with a "New Economic Model" to promote greater economic competition.
Investors complain that abuse of the policy spawned a patronage-ridden economy, making Malaysia less attractive to investors than neighbouring states.
Najib has rolled back elements of the policy, axing a rule that firms must offer stakes to Malays, but his plans face growing opposition from conservative Malay rights groups supported by many within UMNO.
Najib cut Malaysia's fiscal deficit from a 20-year high of 7 percent of gross domestic product in 2009 to 5.6 percent in 2010 and has promised to lower it to 5.4 percent in 2011. That may be in doubt due to the rise in commodity prices as Malaysia subsidises fuel and food.
That said, Malaysia is a net beneficiary of rising commodity prices in terms of economic growth and it would also boost revenues from oil.
What to watch:
-- The phased rollout of the New Economic Model, and how far Najib will accommodate conservative Malay pressure groups.
-- The introduction of a Goods and Services Tax, which has been postponed twice. The government says it remains committed to introducing the tax with an initial rate of four percent.
-- Continuing roll-out of details of the "Economic Transformation Programme" (ETP), an ambitious plan aiming to attract $444 billion worth of investment in the next 10 years in order to double the country's national income.
-- Crude oil prices holding above $100 a barrel will add pressure to the government to cut fuel subsidies further, risking a political backlash that could hurt the ruling coalition's aims of securing a strong election win.
RACE AND RELIGION
Race and religion have always been explosive issues in Malaysian politics. Najib took power pledging a more inclusive approach to ethnic Chinese and Indian minorities, but some in his UMNO party are casting this approach aside in a bid to woo conservative Malays.
The caning last year of three women for having illicit sex is viewed as the government's increasing adoption of a stronger Islamic agenda, and this has worried some investors.
What to watch:
-- Efforts to resolve religious disputes. The government set up an interfaith committee to promote religious harmony.
-- If the government tries to woo Muslim voters with conservative policies, investors may be spooked.
-- A severe worsening of tensions could raise the spectre of sectarian unrest, but this is not regarded as likely.
CORRUPTION
Malaysia used to be regarded as one of the region's more reliable countries, but perceptions of worsening corruption and a lack of judicial independence have damaged investment. Malaysia was ranked a record-low 56th position in anti-corruption body Transparency International's global ranking in 2009 and remained in the same spot in 2010.
What to watch:
-- Government efforts to deal with a scandal over a port trade zone close to Kuala Lumpur that exposed links between politics and business. False government guarantees given when the bonds were sold have triggered concerns among holders of $1 billion of bonds that they might not be repaid.
Last year, Najib promised to prosecute any wrongdoing with regards to the port project and this move could be an attempt to show investors that the country is serious about tackling corruption. A veteran ethnic Chinese politician has been charged over the case.
-- A probe into major losses at the energy division of Sime Darby Berhad , a government-linked company and the world's largest planter by land area. The company has filed civil suits against its former CEO after having to provide for 2.1 billion ringgit ($690 million) in losses from energy projects in the Middle East and in Sarawak state.
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