Neutrality by Sector: Malaysia’s Geoeconomic Alignment under Anwar

INTRODUCTION

In 2025, Malaysia’s Foreign Minister Mohamad Hassan named an elephant in the room: “the space for neutrality… is shrinking, particularly in areas such as trade, technology and regional security”. By not taking sides, Malaysia has ensured significant non-interference in its affairs. Moreover, when businesses face growing pressure to decouple, friendshore, and ringfence strategic resources, neutrality functions as economic insurance — preserving access to multiple markets and supply chains.

Malaysia tries to stay neutral at the macro and whole-of-economy levels. The government uses diversification, alongside diplomatic engagement, to avoid overdependence on either the US or China. Yet neutrality at the macro level is increasingly constrained because of structural alignment at the sectoral level. Structural alignment refers to how specific industries become embedded in ecosystems dominated by a certain country, oftentimes a major power. This happens through accumulated know-how, critical raw materials, proprietary technologies, processing capacity, and dominant standards— in ways that create high exit costs for co-actors, and hence geoeconomic leverage for the dominant player. This matters because neutrality is typically measured at the macro level — balanced trade flows, diversified investment, diplomatic engagement with both sides. But aggregate figures can obscure how structurally dependent a critical sector already is, and therefore how exposed the broader economy is. A country can look neutral in the aggregate and be significantly aligned where it matters more such as sectors carrying disproportionate economic and security weight. When space to be neutral shrinks in a critical sector because of technical dependence and structural alignment, it shrinks at the macro level too because most governments would not risk jeopardising that sector to preserve impartiality elsewhere.

This article  examines Malaysia’s economic neutrality under the Anwar administration.  The first section provides an overview of efforts to maintain macro neutrality, specifically US-China equidistance and diversification, undertaken while technical dependence and structural alignment in key sectors constrain whole-of-economy neutrality. Thereafter, a comparison of two sectors illustrates this in contrasting ways: semiconductors, where structural integration skews towards Washington, and rare earth elements (REE), a neutral sector that may not remain non-aligned due to Chinese technical dependencies. We conclude with policy recommendations.

NATIONAL NEUTRALITY: AN INCREASINGLY DIFFICULT BALANCE

With significant economic stakes riding on its image of neutrality, Malaysia under Prime Minister Anwar Ibrahim has been negotiating for autonomous space in two ways.

Great Power Equidistance

Malaysia’s pursuit of equidistance— maintaining broadly symmetric engagement with economic powers— has become both more imperative and more difficult to maintain as US-China rivalry escalates. From 2023 to 2025, Malaysia faced persistent accusations of tilting toward China. Such impressions were possibly amplified by the flurry of activity surrounding the 50^th anniversary of bilateral ties and by frequent high-level visits to and from China. Anwar’s rhetoric also amplified the partnership while downplaying disagreements with Beijing. This contrasted with muted US engagement in the latter half of the Biden Presidency (2022-24). Putrajaya and Washington had different priorities, and “Malaysia [did] not seem to figure in Washington’s top three [most important partners in Southeast Asia] other than for its place in the semiconductor value chain”. President Trump’s October 2025 ASEAN Summit visit marked his first meeting with Anwar. To ensure balanced relations, Putrajaya elevated bilateral ties to Comprehensive Strategic Partnership status in 2025. Care was also taken to make the ceremony and the optics comparable for both President Trump’s and President Xi’s visits.

The aggregate economic picture supports the equidistance story; both great powers are major trade and investment partners (see Charts 1 and 2).

Chart 1: Malaysia’s Top 5 Trading Partners (2023-2025)

Chart 2: Malaysia’s Top 5 Investment Partners (2023-2025)

Yet aggregate figures can obscure technical dependence and structural alignment, which constrain Malaysia’s overall capacity to be non-aligned. The US-Malaysia Agreement on Reciprocal Trade (ART) illustrates this well. Putrajaya signed concessions which would skew Malaysia’s economy towards Washington because of vulnerabilities in its semiconductor sector. Decades of US and US-allied investment, access to US-origin design tools and fabrication equipment, and market linkages (see also the Semiconductor Section) underpin Malaysia’s position as a major back-end semiconductor hub. The resulting integration has generated substantial trade volumes and domestic spillovers, and the broader electrical and electronics (E&E) sector is too big an economic growth and development engine to jeopardise. E&E exports to the US stood at RM120 billion in 2024, or roughly 20% of total E&E exports; semiconductors made up half, or RM60.6 billion. Semiconductors also support 72,000 skilled workers and 7,200 local suppliers, including small and medium enterprises. In 2025, Tengku Zafrul Aziz, who formerly helmed the Ministry of International Trade and Industry (MITI), told Parliament that while semiconductors were exempted from Liberation Day tariffs, there remained the threat of a 100% tariff on semiconductors under Section 232 that allowed the sitting president to impose tariffs on national security grounds. The ART secured a US commitment to factor Malaysia’s cooperation into any future Section 232 determination.

In exchange for preserving the semiconductor sector’s vitality, which is highly dependent on technical components from the US-dominated semiconductor architecture, Malaysia agreed to mirror US export controls. This is a significant shift that directly erodes Malaysia’s neutrality in the ongoing US-China tech war. Previously, when Malaysia imposed new AI chip export controls in July 2025, Putrajaya framed this as a response to US transhipment concerns, but the actual MITI directive used neutral multilateral language—no country-specific restrictions, no named destinations. This prudence limited blowback from all sides. The ART abandons that language. Articles 5.1 and 5.2 require Malaysia to mirror US export controls, customs duties, quotas, and restrictions on goods deemed threatening to American security.

In exchange for preserving the semiconductor sector’s vitality, which is highly dependent on technical components from the US-dominated semiconductor architecture, Malaysia agreed to mirror US export controls.

Signing the ART also eroded Malaysia’s capacity to cooperate with third countries caught in the same crossfire. The ART creates direct contradictions with Malaysia’s existing commitments, such as in DEFA and CPTPP; Malaysia cannot simultaneously honour both. Article 3.3 notes, for instance, that Malaysia cannot enter digital arrangements which “jeopardise US interests”. This is not merely a China problem. Other trading partners cannot engage with Malaysia on terms that violate the ART. The ART erodes neutrality with other trading partners too, beyond narrowing policy space between Washington and Beijing. The relative tilt towards Washington did not go unnoticed; Beijing sought a new MoU for parity two months later.

Diversification

Malaysia under Anwar has also sought to expand neutral space through diversification. A country, whose raw materials and technology flows and supply chain architecture are part and parcel of a major power’s ecosystem, lacks meaningful room for manoeuvre when that power raises demands. Diversification is not merely a commercial strategy, but a means towards real non-alignment and neutrality.

Thus, Malaysia under Anwar struck various trade deals and is inking more (see Table 1). But diversification does not always beget greater strategic autonomy. It can more effectively restore macro neutrality if it reduces exposure to technical chokepoints and hedges structural dependence in critical sectors; but if it increases trade volumes without altering the technical architecture, it is merely diversifying within the same technical ecosystem rather than limiting the leverage of those technical chokepoints.

Table 1: Malaysia’s Economic Diversification under Anwar

Free Trade Agreement	Latest Development
Comprehensive and Progressive Trans-Pacific Partnership	Entered into force November 29, 2022
BRICS Partner Status	Recognised October 24, 2024
Malaysia-United Arab Emirates Comprehensive Economic Partnership Agreement	Signed January 14, 2025
Malaysia-European Union FTA	Talks revived January 19, 2025
Malaysia-Gulf Cooperation Council	Talks launched May 26, 2025
Malaysia-European Free Trade Association FTA	Signed June 23, 2025
ASEAN Trade in Goods Agreement	Upgraded October 25, 2025
US-Malaysia Agreement on Reciprocal Trade	Signed October 26, 2025
China-ASEAN Free Trade Agreement	Upgraded October 28, 2025

On that test, the Malaysia-European Union (EU) Free Trade Agreement holds significant prospects. The EU, similarly caught between Washington and Beijing, commands segments of critical supply chains, including semiconductors, and offers standards-based market access and regional heft that could help insulate from US or Chinese political leverage.

Malaysia’s BRICS partner status follows the same logic of diversifying technical partnerships and ecosystems. China and India are two BRICS economies who are actively building domestic capacity in critical sectors such as semiconductors, in explicit competition and complementarity respectively, with the US-led ecosystem. For Malaysia, the EU, India, and BRICS semiconductor efforts represent a realistic path to easing the technical chokepoints — standards, equipment, processing — that currently make the US-led ecosystem difficult to exit.

However, none of these alternatives are mature and instead remain in early stages relative to US-linked supply chains and the architecture Malaysia is already embedded in. Structural alignment does not pause while alternatives develop. The longer these options take to materialise, the deeper Malaysia’s integration in the existing ecosystem becomes.

SECTORAL NEUTRALITY: CHALLENGES TO NON-ALIGNMENT

Two sectors illustrate how structural alignment shapes Malaysia’s neutral space in contrasting directions: semiconductors, where alignment is already deep and deepening with documented macro-level consequences, and rare earths, where neutrality still exists, but is under strain. Both are critical to Malaysia’s development and to the US-China competition for technological dominance. Together, they show that neutral space is not evenly distributed within the overall economy, and not even within different parts of the same sector.

Semiconductors

Malaysia’s semiconductor sector reflects openness to different economic partners, and looks balanced on the surface. Both major powers need Malaysia: the US to assemble and test chips outside Chinese territory, China to manufacture in a plug-and-play territory (e.g. with readily available skilled workforce, and supplier networks) while avoiding US tariffs. Chinese participation operates in a distinct tier— 40% ownership of Malaysia’s SilTerra foundry, with more than 80 Chinese firms in Penang’s E&E ecosystem (up from 16 before US controls tightened). Under this “China for China and Penang for the rest of the world” strategy, more Chinese companies are setting up higher-end semiconductor manufacturing, such as eight-inch wafer production in Malaysia. Consequently, Malaysia occupies a specific and significant position within the global semiconductor supply chain: reportedly holding a 13% share of the global outsourced semiconductor assembly and test (OSAT), and being the sixth-largest semiconductor exporter.

But this openness to all economies papers over a technical architecture already significantly aligned to one side. Malaysia functions as a critical back-end node within a value chain that is predominantly US-led (see Chart 1).  The US dominates integrated circuit design and electronic design automation, while allies EU, Japan, Korea and Taiwan control primary swathes of materials, equipment and wafer fabrication. Meanwhile, China plays a substantial role in manufacturing and materials, and its presence in Malaysia is growing. Yet the technical stack underpinning Malaysia’s role in global supply chains remains heavily reliant on inputs governed by US-origin regulatory regimes. This alignment weighed heavily in Putrajaya’s calculus in signing the ART, as explained above.

Chart 3: Semiconductor Segment Dominance by Country

Technical dependence has been shrinking the space for neutrality, and that space is narrowing further through two dynamics that may then constrain macro-level neutrality. The first is the contraction of the dual-hosting window. To understand why, it helps to know how the semiconductor industry is structured. Some companies produce advanced chips, which are used in AI systems and cutting-edge computing, and are subject to the tightest US export controls. Legacy or mature chips — older, less precise, but still essential for cars, industrial machinery, medical devices, and defence systems — were until recently treated as commercially benign and largely outside US restrictions. Malaysia currently hosts both: US-aligned firms operating at the advanced tier, and Chinese firms mainly operating at the mature tier. That dual-hosting arrangement has been Malaysia’s practical expression of sectoral neutrality. But controls are expanding upward into advanced chips, e.g. those used for AI, and downward into legacy nodes, with China’s 38% dominance of mature-node OSAT prompting Washington to consider restrictions on Chinese-sourced legacy chips. With Malaysia committing to mirror US export controls under the ART — which may extend not just to advanced chips but potentially to mature ones —it becomes harder for the country to appear credibly neutral to Beijing, regardless of aggregate trade figures or diplomatic gestures at the macro level.

The second dynamic is Malaysia’s own upgrading strategy; its efforts to become a more developed—and as a bonus, more important—semiconductor player may complicate its stance of neutrality. The National Semiconductor Strategy targets moving into advanced packaging and IC design, with the overarching goal of boosting manufacturing wages, creating high-skilled jobs, and transitioning Malaysia to a high-income status. But advanced packaging, i.e., packing multiple chiplets into a more sophisticated chip, is critical for AI and other cutting-edge technologies. Going up the value chain draws Malaysia into more geopolitically contested and technically US-dependent segments; the strategy designed to increase Malaysia’s economic value also accelerates alignment pressure. Even where Malaysia seeks diversification, such as partnering with UK-based ARM for chip design, participation in global intellectual property and licensing systems remains embedded in regulatory environments shaped by major powers. One may argue that the US needs Malaysia to be in advanced packaging, so it would not exercise coercion there. But being needed means being subject to conditions, not exempt from them. As Malaysia moves deeper into the US-led ecosystem through upgrading, the conditions that brought about the ART do not ease — they compound.

Rare-Earth Elements (REE)

Malaysia’s REE sector is currently neutral with two parallel supply chains operating on Malaysian soil: one Western-oriented and one Chinese-linked, with both major powers actively engaged. This is the sector’s genuine optionality — and it contrasts sharply with semiconductors, where the two ecosystems are structurally incompatible at the advanced tier. But the technical conditions which reduce optionality are already looming, and the consequences for this industry follow the same structural logic: where one party controls a technically indispensable step, macro-level neutrality has a limit set not by political choice but by the technical architecture.

Malaysia’s REE sector is still nascent, but its technical dependence is likely to lean towards China because upstream and midstream development specifically require Chinese technical capability. The New Industrial Masterplan 2030 values Malaysia’s 16–18 million tonnes of REE reserves at RM747 billion. These are ionic clay deposits, and extraction requires a Chinese-developed technique called in situ leaching (ISL) that was refined over decades in Jiangxi and Fujian. Extraction alternatives are scarce and not yet commercially scalable because 99% of ionic clay REEs are in China, which the Malaysian Chamber of Mines confirmed in February 2026. The technical chokepoint, in other words, is Chinese — and it sits at the upstream stage that determines whether Malaysia’s RM747 billion in estimated ionic clay reserves can be unlocked at scale.

Malaysia’s REE sector is currently neutral with two parallel supply chains operating on Malaysian soil: one Western-oriented and one Chinese-linked, with both major powers actively engaged.

Midstream processing may also depend on Chinese partnership, as illustrated by Brazil’s Serra Verde project. Serra Verde is an ionic clay operation currently producing both light and heavy rare earths, with active Western investment and strategic backing. Yet despite that support, Serra Verde’s ore is locked into offtake agreements with China, because China was “the only customer who could process the product and separate the product”. Globally, China controls approximately 60% of mining, 91% of separation and refining, and 94% of permanent magnet production. Malaysia’s two significant REE operations may hint at a similar future. Malaysian company MCRE uses ISL technology from state-owned enterprise Chinalco to extract rare earths from Malaysia’s ionic clay, with ore being exported directly to China. Then there is Lynas, an Australian midstream refinery backed by the US Department of Defence and Japan’s Organization for Metals and Energy Security, and linked to the upcoming South Korean JS Link magnet factory. But while Lynas’ Kuantan facility is the largest heavy-rare earth processing plant outside China, it processes hard-rock minerals shipped from Australia and not ionic clay deposits. Further, it only produces refined ores at 1,500 tonnes/year compared to China’s processing capacity, which runs into tens of thousands of tonnes annually. 

The macro-level implication, as with semiconductors, is straightforward. Malaysia is sitting on some of the most geopolitically contested and desirable elements globally: neodymium, praseodymium, dysprosium— all essential for magnets in EV motors, wind turbines, and defence technologies. The country can develop midstream and downstream capacity with Western partners — and the Lynas and JS facilities are steps in that direction. Malaysia can also maintain openness, welcoming Chinese partnership to balance the Critical Minerals MOU signed with Washington in October 2025. That picture looks neutral. But if ionic clay extraction remains technically dependent on Chinese know-how, as do options for midstream processing for the foreseeable future, then the sector’s development will technically lean towards Beijing. The Anwar administration has signalled its ambitions to turn REE into another strategically critical sector. If it develops on these terms, Malaysia may find itself in the same position it is already in with semiconductors — unable to afford friction with Beijing across various issues beyond rare earths, because the cost of disrupting that technical dependence would be too high.

Chart 4: REE Segment Dominance by Country

POLICY IMPLICATIONS

Structural alignment in critical sectors — where technical dependence creates high exit costs — constrains macro-level neutrality before political choices are made, and in ways that aggregate measures of trade flows and diplomatic engagement cannot detect.

Semiconductors illustrate this in its most developed form: technical integration in a US-led architecture, deepened by the Madani government’s upgrading commitments, made certain macro-level positions untenable before the ART negotiation opened. REEs show the same structural logic at an earlier stage, where neutrality still exists but path dependency shaped by Chinese technical dominance is already visible.

Two implications arise:

Measuring neutrality at the right level. Neutrality is typically assessed at the macro level — balanced trade flows, diversified investment partners, diplomatic engagement with both sides. Those metrics are meaningful, but insufficient. If Malaysia relies on aggregate trade and investment flows to assess neutral space, it will underestimate where exposure has already accumulated. Malaysia could undertake a systematic sectoral review. That is a harder measurement to make than tallying FDI figures, but it better reflects where neutral space actually exists and where it is quietly eroding. This avoids providing false reassurance to Malaysia itself as much as to its partners. The gap between aggregate appearance and structural reality is not just an analytical problem — it is a strategic vulnerability.

Multilateralism for managing technical dependence. Macro-level balancing through equidistance and diversification remains important, but there can be a mismatch because these often cannot directly address technical dependence that accumulates through investment terms, licensing arrangements, standards adoption, and so on at a sectoral level. But even with diversifying technical partnerships and feedstock sources to reduce ecosystem dependencies, for instance, bilateral alternatives remain vulnerable to the same weaponised interdependence. The more durable instrument is multilateral governance of these chokepoints, such as technology standards bodies, where no single party holds unilateral control. So long as the rules-based order governing critical supply chains remains weak or contested, sector-level technical dependence will continue to set the terms that macro-level neutrality must navigate around.

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This is an adapted version of ISEAS Perspective 2026/37 published on 19 May 2026. The paper and its references can be accessed at this link.