By Ernest Z. Bower & Phuong Nguyen

Diplomatic relations between China and Malaysia are now in their 40^th year, and both governments have said they regard their mutual friendship as special. In 1974, Malaysia became the first country in the Association of Southeast Asian Nations (ASEAN) to establish diplomatic relations with China.

Economic ties have formed the foundation of the relationship, with bilateral trade reaching $106 billion in 2014. Malaysia has been China’s largest trading partner in ASEAN since 2008, as well as its third-largest trading partner in Asia after Japan and South Korea, a notable benchmark given Malaysia’s population is just over 25 million. Both sides have pledged to try to increase trade volume to $160 billion by 2017.

Malaysian companies have long sought to invest in China, with Malaysian foreign direct investment in China reaching $7 billion in 2013. Chinese investment is Malaysia is growing, but remains relatively small compared to foreign direct investment from other large economies such as the United States, Japan and the EU. Promisingly, the two governments have worked steadfastly to boost the number of large investment projects in each other’s countries. In Kuala Lumpur’s view, China’s path to become the world’s largest economy is inevitable within the next two decades, and it is in Malaysia’s best interest to cement strong business ties with China early on.

These efforts culminated in the China-Malaysia Qinzhou Industrial Park, which broke ground in Guangxi province in 2013, and the Malaysia-China Kuantan Industrial Park, which began operations in the state of Pahang the same year. In order to complement each other’s economies, the former will specialize in food processing, biotechnology, and information technology, while the latter will host businesses in steel manufacturing, aluminum processing, and palm oil refinery. China has been upgrading the Malaysian port at Kuantan, illustrating Beijing’s strategy of relying on key port cities to build secure transport corridors along the One Belt and One Road initiative.

Economic cooperation has recently expanded into the financial sector. The two countries’ central banks last year agreed to establish a yuan clearing bank in Kuala Lumpur, part of China’s quest to internationalize the renminbi. An important regional banking center and hub for Islamic banking, Malaysia is one of the world’s top 10 offshore yuan centers and the second country in Southeast Asia, after Singapore, to host a yuan clearing bank.

A strong foundation in trade and investment has allowed the two countries to explore ways to cooperate in the security sphere. China and Malaysia in 2005 signed an agreement to advance bilateral defense cooperation – the first of its kind between China and a Southeast Asian country – and in 2014 held their first joint military exercise in Malaysia. In addition, Malaysia and China will co-chair this year’s ASEAN Regional Forum Disaster Relief Exercise, expected to take place in May, in the states of Kedah and Perlis.

China has a particular interest in emphasizing its strong traditional ties with Malaysia in 2015 because Malaysia is chairing ASEAN and will host the ASEAN Summit and the East Asia Summit. In many ways, the bilateral relationship should be considered a model for how China can strategically engage a smaller neighbor and a case in point that China’s rise should not be cause for fear among many in the region. This is even more significant as Beijing seeks to carry out Xi’s new policy of placing China’s neighbors at the center of its diplomacy.

Yet like all relationships, China-Malaysia ties increasingly face several fundamental challenges. These issues are beyond bilateral in nature, and many governments across the region have quietly been watching signals that Beijing and Kuala Lumpur exchange.

First, Kuala Lumpur is increasingly unsure about how to respond to growing Chinese activities in the South China Sea, particularly in Malaysia’s exclusive economic zone. Malaysia and China are two of the six countries that are formally disputing territorial claims in the South China Sea. Malaysian officials, while still stressing the use of quiet diplomacy in addressing tensions among claimants in the South China Sea disputes, understand that it will become harder to keep a low-key stance should China continue to assert itself in this area. A key test awaits Malaysia over how to address the ruling in the China-Philippines arbitration case expected under it chairmanship of ASEAN.

At the core of the South China Sea challenge lies a question posed by many Malaysians: Does China regard its ties with Malaysia as equally special?

For Malaysia, finding the answer to this question will have a fundamental impact on its view of and policy toward China.

A second area to watch is how Malaysia will perceive China’s desire to exercise greater leadership in the regional architecture.

Malaysia has actively supported China’s membership in regional groupings centered on ASEAN. Former prime minister Mahathir Mohamad made no secret of his belief that ASEAN countries should invest further in the ASEAN Plus Three (China, Japan, South Korea) mechanisms, an idea that also found strong support in Beijing.

However, under Xi’s leadership, China has become much more confident in promoting its own initiatives for regional integration such as the Asian Infrastructure Investment Bank, and Belt and Road strategy. This means that while Beijing continues to take part in existing ASEAN-led regional platforms, it is intent on building a regional order or web of interdependence with China at its center. While Malaysia welcomes a greater role for China in the Asia Pacific, as strong proponents of the centrality of ASEAN and balance of power in the region, it is unclear whether and to what extent its leaders welcome the idea of a China-led regional order.

There are few other countries in Asia with which China enjoys such warm and comprehensive ties. Without exaggeration, the China-Malaysia friendship has to this date been a model relationship for the region. But at 40, it remains to be seen whether this special relationship can weather the fast-changing geopolitics in Asia in coming decades.

Mr. Ernest Z. Bower is Senior Adviser and holds the Sumitro Chair for Southeast Asia Studies at CSIS. Follow him on twitter @BowerCSIS. Ms. Phuong Nguyen is a Research Associate with the Sumitro Chair. Follow her on twitter @PNguyen_DC.