The Sabah Dilemma: Malaysia’s state relations challenge

A landmark ruling by the Malaysian High Court has overturned decades of federal-state financial policy and exposed the injustice of the revenue split between Kuala Lumpur and the resource rich state of Sabah.

The court ruling was handed down last October. But Prime Minister Anwar Ibrahim is still grappling with how to respond, such are the profound implications for federalism, fiscal equity, and centre-state relations.

Whatever way one looks at it, Kuala Lumpur faces a hefty bill at a time when central government finances are under enormous strain, driven by skyrocketing energy costs.

And there is more than a financial cost. The court ruling highlights deep structural tensions in Malaysia’s federal arrangements and fuels grievances that tear at the federation. Addressing this will require more than a new generous revenue transfer deal.

At the heart of the dispute is a provision of the Malaysia Agreement 1963 (MA63) promising Sabah would receive 40% of net federal revenue raised from the state. 

This special grant originates from the Inter-Governmental Committee (IGC) Report and MA63, which promised Sabah (and Sarawak) enhanced fiscal autonomy to compensate for joining the Federation. The Federal Constitution stipulates this revenue sharing arrangement; it is not a discretionary grant but a constitutional obligation, subject to periodic review. 

The entitlement was honoured in the early years post-1963, with reviews conducted up to 1974. However, from then to 2021 no reviews were conducted, a period Sabahans called the “Lost Years”. During that period, the Federal Government paid Sabah a fixed annual special grant of RM26.7 million ($A 9.4 million). This amount was set in the First Review Order for 1969–1973 and simply rolled forward. This is far below a 40% share of the revenue Sabah generates from its rich resources of oil and gas, timber, and palm oil. 

In 2022, the Sabah Law Society (SLS) filed a judicial review against the Federal Government and Sabah State Government. SLS argued that the failure to conduct mandatory reviews breached constitutional duties, resulting in unlawful deprivation of funds needed for development. On 17 October 2025, High Court Justice Celestina Stuel Galid ruled decisively in favour of SLS. 

The Court ruled that:

• The Federal Government breached its duty by not conducting the second review in 1974.
• The 40% entitlement remains valid and payable for each year from 1974 to 2021.
• Parts of the 2022 and 2023 Review Orders (which set low fixed grants without addressing arrears) were quashed.
• Mandamus orders required a proper review within 90 days and an agreement on quantum within 180 days. 

The judgement affirmed that the entitlement is a constitutional right, not a political favour. 

Despite public assurances from Prime Minister Anwar that the government accepted the 40% principle and would not appeal the core entitlement, federal actions tell the opposite story. The government appealed aspects of the High Court judgment, particularly the mandamus timelines and certain wording perceived as offensive to past leaders. It sought and obtained a stay of execution from the Court of Appeal on 6 April, pausing the review and payment deadlines pending appeal. The stay grants the federal government a permanent hiatus, with compulsory reviews now on hold. 

Anwar, meanwhile, has repeatedly stated a commitment to honouring the court ruling and paying Sabah, yet the sheer amount involved—tens of billions of ringgit in arrears—  makes full compliance daunting amid fiscal constraints. The combination of partial appeals, procedural stays, and slow negotiations despite court orders suggests the federal strategy is to delay as long as possible. 

The federal government’s realistic options appear limited:

• Pay arrears in instalments over many years. However, even this may strain federal finances and face resistance if Sabah demands faster disbursement. 
• Forgive debt as an interim settlement, thus reducing what the Sabah government owes the federal government (e.g., development loans, infrastructure financing). This could provide substantial relief without immediate cash outflow but requires transparent accounting.
• Negotiate the final settlement at an amount far below the full debt, closing the matter politically and settling it legally. This is the most likely path but risks accusations of selling out Sabah’s rights.

The current Gabungan Rakyat Sabah (GRS) government under Chief Minister Hajiji Noor, who is aligned with the federal unity government, is often seen as beholden to Anwar. During the court-ordered 90 days of negotiations, only four meetings were held between the federal and Sabah governments, reinforcing perceptions of foot-dragging. 

To understand what is really happening, it is necessary to see the federal actions as part of federal-state interactions since independence. Since 1963, the Malay political establishment have viewed Sabah (and Sarawak) as resource peripheries whose wealth, especially oil and gas, primarily benefits and belongs to the centre. Putrajaya sees Malaysia as a centralised federation with a supreme federal government. Paying substantial arrears runs against this entrenched instinct of centralised command and control. 

This also explains why Putrajaya has limited respect for MA63’s spirit. The unilateral changes post-1974, such as “Project IC” altering Sabah’s demography, suggest a principle that Sabah could be managed rather than treated as an equal partner. Federal interventions in Chief Minister appointments and reliance on the Sabah branch of the United Malays National Organisation (UMNO) to temper “Sabah for Sabahans” sentiments exemplify this approach. 

Putrajaya appears to believe time is on its side: delay through legal processes and bureaucratic red tape, apply subtle economic and security pressure and wait for electoral cycles to dilute state nationalism. The constant reminders that Sabah relies on federal defence against Philippine claims of sovereignty, the 2013 Lahad Datu armed intrusion, and federal control over key infrastructure (water, electricity, etc) underscore the power asymmetry. The best case scenario for Putrajaya would be to overturn the 2025 landmark judgement through a series of appeals. This can be done quite easily but it takes time. 

Sabah stands at a critical juncture. With the 16^th general election (GE16) approaching, the question is whether the “Sabah for Sabahans” sentiment will surge again or if national parties, including Sabah UMNO, will regain ground. Court victories alone cannot restore rights; genuine political settlement is essential. 

This requires a united, assertive Sabah government and actors across the Sabah political spectrum being willing to confront Putrajaya when necessary. The current soft approach, waiting for the outcome of GE16, rather than pushing hard pre-election, angers many Sabahans and plays into federal hands. Delaying allows Putrajaya to minimise payouts through prolonged negotiations. 

History shows that, without sustained pressure, such claims fade. Sabah leaders must maintain momentum and demand a fair settlement before GE16, or risk repeating past marginalisation. True federalism demands respect for constitutional promises, not perpetual postponement. Only strong, unified Sabah leadership can translate legal wins into fiscal justice.

James Chin is Professor of Asian Studies, and a leading scholar of contemporary Malaysian politics.

Image: An aerial view Sabah Administrative Building Sabah State Government / Shutterstock.com