Bank Negara, in its annual outlook, said growth will be driven from an increase in commodity exports and an $444 billion Economic Transformation Programme to boost public and private investment.
That comes when domestic demand is expected to moderate as the government cuts subsidies for essential items ranging from petrol and power to sugar, in a bid to lower the fiscal deficit. Still, rising wages and low unemployment will support consumption.
Inflation will pick up, although pressures could be absorbed from an expanding Malaysian economy. There is a risk that inflation could go much higher on rising commodity prices, excessive wage hikes and strong domestic demand - a scenario that the central bank says won't happen for now.
"Despite moderation in domestic demand, it will continue to be the main anchor of growth, led by the private sector amid public sector consolidation," central bank Governor Zeti Akhtar Aziz told a media conference.
Bank Negara, like many of its Asian peers, based its somewhat rosier outlook on expectations for improving exports this year, but it warned of downside risks to the global economy such as still-high U.S. unemployment, weaker government spending in the euro zone and concerns about China's economy.
EXPORT, DOMESTIC DEMAND DRIVEN
Malaysia's exports are expected to more than double to 5.8 percent from 2.4 percent in 2013, with growth driven by shipments of higher-priced palm oil that will offset lower valued oil and gas exports.
Exports in January jumped a stronger-than-expected 12.2 percent from a year earlier, due to a strong rise in shipments of electrical and electronic products as well as an increase in refined petroleum products.
Imports will accelerate to 8.9 percent in 2014 against 7 percent last year, as manufacturers buy more parts and materials to meet higher electrical and electronics orders. Resilient domestic demand and investments also will underpin growth in capital and consumption imports.
With imports rising at a faster pace than exports, the current account surplus is expected in 2014 is likely to narrow to 30.8 billion ringgit from 37.3 billion last year.
Malaysia became vulnerable to a global emerging market sell-off last year when its current account surplus plunged in the second quarter to 2.6 billion ringgit from 8.7 billion ringgit in the first three months and 22.9 billion ringgit before that.
"Malaysia's well developed capital markets, resilient external position and strong banking system will continue to provide the country with the capacity and policy flexibility to absorb volatility in capital flows," Bank Negara said.
Strong domestic demand also helps. While subsidy cuts may clip its growth to 6.9 percent from 7.6 percent in 2013, investments in infrastructure and services, higher wages and government cash handouts to lower-income earners will support consumption, Bank Negara said.
Bank Negara set its inflation target at 3-4 percent in 2014, against 2.1 percent in 2013, citing the impact of subsidy cuts.
But it said that moderating domestic demand and expansion in capacity should limit the risks.
Economists polled by Reuters earlier this month said Bank Negara is likely to raise its benchmark interest rate, which stands at 3 percent, by 25-50 basis points in the second half of 2014 as price pressures intensify.
The central bank said higher costs, if not monitored, could lead to a second round of price hikes in goods and services that may see wages grow in a manner not consistent with productivity.
"Recognising these risks, monetary surveillance will remain focused on identifying signs that inflation is becoming more pervasive and persistent, where a monetary policy would become more appropriate," the central bank said.
"The continued low global and domestic interest rate environment would also make it important to be vigilant to the build-up of financial imbalances," it added.
In Malaysia, cheap credit from banks has spurred property buying and boosted house prices. Lending to households now stands at 57 percent of outstanding bank loans.
However, the property market has started to cool after new restrictions were announced last year, with housing loan applications declining 27 percent in December from November, based on central bank data.