Malaysia as a polity exhibits a very highly centralised federal structure which in practice makes it more like a unitary state[1]. The Federal Constitution decrees that with the notable exceptions of land matters and matters pertaining to the Islamic religion, all other areas which are subject to governmental jurisdiction fall under the federal purview[2].

In particular, state governments are not empowered to directly collect income taxes and corporate taxes, nor export, import and excise duties, and they are also largely restricted from borrowing internationally. They have to depend on revenues from forests, lands, territorial waters, mines, petroleum and gas royalties, the entertainment industry, and most importantly, transfer payments from the central government.

Along with this centralised financial control, the federal government has authority over external affairs, defense, internal security, justice (except civil law cases among Malays or other Muslims and other indigenous peoples which are adjudicated under Islamic and traditional law), federal citizenship, commerce, industry, labor matters, communications, transportation, health, education and other matters.

Such limited jurisdiction and responsibilities of state governments (and in most cases, limited independent sources of revenue) has prompted Dr Toh Kin Woon (Penang state executive councillor, 1995-2008) to remark that "you could shut down the Penang state government and not many people would notice it." The annual operating budget of Universiti Sains Malaysia for instance was double that of the Penang state government in 2008.

Indeed, the recent trend in the federal-state balance of jurisdiction has been towards greater federalisation rather than devolution, as indicated by instances such as:

- municipal clinics being absorbed into the Ministry of Health

- nationalisation of petroleum and gas resources, and assertion of federal discretionary powers over the royalties due to state governments (Terengganu’s ‘wang ehsan’)

- erosion of the state autonomy agreed to as part of the terms of accession of Sabah and Sarawak into the Federation of Malaysia

- sewage disposal services, traditionally a function of local authorities, which went through a process of centralisation, privatisation, nationalisation over the period 1996-2004, after a failed attempt at centralisation-cum-privatisation by Indah Water Konsortium (IWK)

- the National Water Council proposing to rebalance the jurisdiction over water management away from the states, as one response towards mismanagement by some state water authorities and their privatised counterparts.

Post-March 2008 realignments

The existing lopsided balance of federal vs. state jurisdiction in Malaysia has been an effective tool of central control thus far, sustained by the uninterrupted incumbency of a ruling federal coalition anchored by its dominant partner, Umno. Whether by design or otherwise, the periodic rotation and redistribution of Umno’s top leadership positions among its regional support bases have blunted what might otherwise have been more pronounced centrifugal tendencies in federal-state power configurations.

In the aftermath of the March 2008 general elections, some re-alignments were anticipated, between KL and the states ruled by the Pakatan Rakyat coalition, but were also discernible in BN-ruled states.

In Terengganu state, where the control over royalties from petroleum and gas has inflamed factional infighting within Umno Terengganu, the royal house stepped in with a proposal for a sovereign wealth fund to receive and to manage these revenues and accumulated assets.

The Terengganu Investment Authority (TIA) was duly established on Feb 27, 2009 with a projected fund size of RM11 billion. RM6 billion would be raised through bond issues in the capital markets collateralised by its annual royalties from Petronas, while the remaining RM5 billion would be raised with the backing of a guarantee from the federal government.

The governance structure of TIA would have the menteri besar of Terengganu (MB Inc) holding 100 percent of the ordinary shares of TIA (the Minister of Finance Inc and the TIA Foundation would be issued one preference share each, entitling them to nominate one director each and to 10 percent of TIA’s annual profits), the Sultan of Terengganu would chair a board of advisers, and a management team of professionals would be reporting to a board of directors.

A key architect of TIA was reportedly Joe Low, a Penang-born businessman described as a member of Najib Abdul Razak’s inner circle and also an adviser to the King, Sultan Mizan Zainal Abidin of Terengganu.

The TIA however also had an unintended effect, i.e. setting a precedent whereby a state government could leverage on a guarantee provided by the federal government, to raise investment capital from local and international financial markets for development projects over which the federal authorities may exercise only limited control.

In its inaugural RM5 billion capital-raising exercise in May 2009, TIA’s 30-year Islamic bonds were oversubscribed, attracting tenders from local and foreign investors whose bids exceeded RM8 billion within two days of its launch. As if to drive home the point, the Penang state government immediately requested a similar federal guarantee for a RM5 billion capital-raising exercise to finance priority development projects in the state.

In July 2009, Prime Minister Najib Abdul Razak, fresh from talks with leading officials of Abu Dhabi’s sovereign wealth fund Mubadala Development, announced that the TIA would be federalised and renamed as 1Malaysia Development Berhad (1MDB). It would be wholly owned by the Minister of Finance Inc (MoF Inc) and would report directly to the prime minister.

Meanwhile, the management of Terengganu's oil and gas royalties would revert to the pre-TIA status quo, leaving unresolved for the moment the discretionary use of Terengganu’s oil and gas royalties by an incumbent state government, an issue that had fomented much dissension and shifting alliances within its ranks. (Terengganu of course was ruled by PAS from 1999-2004 when the federal government controversially re-designated Terengganu’s oil and gas royalties as ‘wang ehsan’ (goodwill money) subject to federal discretion and control. Meanwhile, the PAS-led state government in Kelantan is currently pressing its claims for RM1 billion in royalties from oil production 150km off the coast of Kelantan, which began in 2004).

This reversal by the federal authorities might have been a pre-emptive move to forestall further requests from other states for their own investment funds (which might weaken federal control over development financing):

By becoming a sovereign wealth fund, 1MDB will have Malaysia as its priority instead of just one state, according to a source. It puts all states on equal footing at a time when there are a couple of states that are tinkering with the idea of establishing their own state-based investment funds. Establishing the 1MDB will also do away with the [pressure on] Government to provide further guarantees for other state-based funds. The Star, July 22, 2009

Additionally, it could also reassure TIA’s co-investors in Malaysian ventures (such as Mubadala’s participation in a RM6.26 billion property development project in Pulau Bidong, Terengganu) that the investment vehicle for a joint venture would be insulated from local political uncertainties and discontinuities such as may erupt in states like Terengganu.

Meanwhile in Selangor, the state government is exploring its options vis-à-vis zakat (Muslim religious tithes) as a potential source of development finance for the state. Since zakat contributions are currently deductible against federal income taxes, this could be yet another intriguing attempt at fiscal devolution which relies on the state’s jurisdiction over Islamic affairs. The challenges are daunting though, given the parties involved and the potential stakes, not to mention Selangor’s religious pluralism.

In East Malaysia, Sabah and Sarawak, accounting for 52 out of Barisan Nasional’s 137 parliamentarians, have become crucial swing states in the federal power equation post-March 2008, providing leverage for increased development allocations as well as cabinet positions and political office, if not for reinstated autonomy.

If a durable two-coalition system emerges and over time approaches parity in electoral strength, there might eventually be less resistance to some degree of devolution, in anticipation of fluid scenarios in the (rotational) exercise of federal and state governmental power. This is unlikely to be a smooth process, and might well entail, as Dr Nungsari Ahmad Radhi envisages, an over-extended, centralised federalism forced to cede de facto jurisdiction at the periphery, when it overreaches in its ambitions relative to the resources that it can muster.

Oil and federalism

In 2008, Petronas’ payments to the federal government (RM72.5 billion as dividends, taxes, and export duties) accounted for 45 percent of federal revenues in that year. Whether Petronas can continue to be a major source of federal largesse may increasingly depend on its foreign operations, which contributed 30 percent of its revenues in 2007, as domestic reserves of oil and gas are progressively depleted.

In 1999, the Indonesian parliament (Dewan Perwakilan Rakyat) enacted Undang-Undang Pemerintahan Daerah No. 22 Tahun 1999 (Law No. 22, 1999 on Local Government) which devolved substantial responsibilities in public works, health, education and culture, agriculture, communication, industry and trade, capital investment, environment, land, cooperatives, and human resources to local governments while retaining security and defence, foreign policy, monetary and fiscal matters, justice, and religious affairs as central government prerogatives.

It is tempting to link this with Indonesia’s declining oil production (since 1998) and its status as a net oil importer (since 2004). Notwithstanding oil and gas revenues contributing 33 percent of the Indonesian government’s revenues from 1997-2000, the main impetus for Indonesia’s decentralisation came from the 1997 financial crisis and the demise of Suharto’s autocratic regime, which released pent-up demands for regional autonomy especially from its resource-rich provinces.

Depending on the adequacy of revenue sharing arrangements between central and local authorities, we might witness mounting pressures for the devolution (or sharing) of revenue raising powers (local taxation), to accompany the devolution of governmental responsibilities for meeting citizen needs and expectations.

Devolving a National Health Fund?

In Malaysia, the possible emergence of a national health (insurance) fund (in effect, a supplementary tax in the form of payroll deductions plus matching contributions from employers and the self-employed) may provide an opportunity to lobby for the decentralization of aspects of the financing (and provision) of healthcare. The Canadian model for national health insurance for instance comes to mind, where provincial and federal authorities have shared responsibilities along with the commensurate powers of taxation for the financing of healthcare.

There is little dispute that certain health functions and health facilities such as peak referral institutions, control of communicable diseases (immigration and health, quarantine), equalisation grants and cross-subsidies to poorer states, National Institutes of Health (research and the deployment of its outputs), international health engagements, etc, should remain as federal health prerogatives.

But there is no compelling reason why the Penang Hospital for instance should not be restructured to be a devolved institution reporting to the Penang state government, along with a devolved system for the allocation of requisite financial resources.

Indonesia required a financial crisis which catalysed the devolution of a highly centralised and militarised unitary state. Will our famed Malaysian luck allow us to restructure the existing balance of jurisdiction between federal, state, and local governments without a comparable national trauma?

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[1] Conversely, one could argue that Malaysia in 2009 has a surfeit (multiplicity) of state governments. Not as dramatic as in the case of Perak state where a constitutional crisis continues to simmer as rival claimants to governmental power pursue their options through legal and political channels, Penang is “blessed” with an unelected parallel “shadow government” which unashamedly receives federal allocations (e.g. for tourism development) which should properly be channeled to the legitimately constituted state government elected in March 2008.

[2] Sabah (North Borneo at the time), upon attaining self-government as part of the decolonization process, negotiated a 20-point agreement as a basis for its entry into what would be the Federation of Malaysia on September 16, 1963. An analogous 18-point agreement provided the basis for Sarawak’s concurrent entry into the federation.

Both agreements allowed for considerable autonomy for the two territories in the areas of immigration, the civil service, education, and development and finance, but this autonomy has been eroded over the years.

PROF CHAN CHEE KHOON is the Convenor, Health & Social Policy Research Cluster, Women's Development Research Centre (Kanita), Universiti Sains Malaysia.