Its maiden deal with European shipbuilders DCN International and Izar involved two new Scorpene-class submarines and an overhauled ex-French navy submarine, the Agosta 70, for initial training.
"The submarines will significantly expand Malaysia's naval capabilities and usher the navy into a new era of development and progress," Defence Minister Najib Razak told a news conference.
The Scorpene SSK was selected from several other bids because of its high-technology features including an integrated combat system with torpedo launcher and launching missiles from underwater, he said.
It was also designed for missions ranging from anti-submarine and anti-surface warfare to special operations and intelligence gathering.
Najib said the submarine deal, which comes two months after Malaysia ordered missile systems and tanks, was not an arms build-up but to boost the navy's capacity to police the country's long and porous border.
He noted that neighbouring Singapore also has its fleet of submarines and fighter aircraft but "nobody makes a big fuss of it."
Not competing with neighbours
"We are not competing, Singapore has Apache helicopters, that doesn't mean tomorrow we have to go out and buy attack helicopters. Why do you continue to take this line as though we are competing or heading towards a confrontation?" he said.
"We have such a large body of water to police. We need submarines because it is a force multiplier. They can appear anywhere and because they are stealth, they are hard to detect. That makes our deterrent value much higher."
The first new-generation medium-sized Scorpene submarine will be assembled in Cherbourg in France, and the second at Izar's Cartagena shipyard in Spain.
Najib said one vessel would be delivered in three years, and the second in 2009. Payment would be staggered over six to seven years, with half of the value conducted via barter trade and offset investment arrangements.
Under the deal, he said France would buy RM819 million (230 million euro) worth of Malaysian palmoil, RM327 million (92 million euro) of other commodities, and invest RM491 million (138 million euro) for training and technology transfer to local firms here.
"Forex savings is 50 percent. This is the first time we've undertaken a contract in which the foreign exchange savings is as much as 50 percent."
He said 186 Malaysian officials would be trained by the French navy over the next two to four years to operate the submarines, which would be primarily based at the Sepangar Bay in Sabah state on Borneo island.
Najib dismissed reports that the contract involved a spin-off deal to give Malaysia Airlines more landing rights in Paris.
The Malaysian carrier currently flies three times a week to Charles de Gaulle airport in Paris but wants to increase the frequency to five times a week, according to local reports.
"No additional (landing rights). It is not within the purview of this contract," he added.
The establishment of Malaysia's first submarine fleet is part of an armed forces modernisation programme that was derailed by the 1997/98 Asian financial crisis.
Regional arms race
The government had also, in April, ordered British and Russian missile systems.
Malaysia has also announced plans to buy more than 60 tanks from Poland and is considering a deal to buy Russian Sukhoi SU-30 fighter jets.
Kuala Lumpur's shopping spree has sparked fears of a regional arms race, but Malaysia says its increased weapons procurement programme is for defence, not aggression.