While the outcome of the Jan 17 poll will not significantly alter the balance of power in parliament, it is a key test for Najib Razak, the man who will become Malaysia's prime minister in March, and for Anwar Ibrahim's opposition.
A recent poll showed the opposition slightly ahead, although informal polls show that advantage may be narrowing after a high-octane campaign from the government featuring Mr Najib and other top ministers.
Mr Najib has declared it a 'must win' seat and it will signal whether he can rebuild the multi-ethnic National Front coalition that has run Malaysia for 51 years The government has 137 seats in parliament, Anwar's coalition has 82 and there are two independents who quit the government.
Why is Kaula Terengganu important?
The by-election is widely viewed as a proxy battle between Mr Anwar and Mr Najib, before the later assumes the premiership in April.
Although Mr Najib will stand unopposed in Umno party polls in March, there are still battles for other top posts and Mr Najib needs a big win to silence his critics in Umno. If he does not win the by-election by a large margin, his premiership could be undermined before it starts.
Terengganu is home to the biggest oil reserves in Malaysia with giants such as Exxon Mobil Corp. operating there, yet it remains one of the poorest states in the country.
The state is part of the 'Malay heartland' and in that sense can reveal trends. Ethnic Malays account for 87.4 per cent of the 80,326 voters in the constituency. The main government party, the United Malays National Organisation (Umno) won the seat in the 2008 general election by a slender majority of 628 votes, despite a massive national swing to the opposition.
Will the Chinese vote matter?
The ethnic Chinese community, comprising 11.6 per cent of the voters, could be the key swing vote in the election. Some polls show the Malay vote is about evenly split between PAS and the National Front.
Chinese and Indian voters deserted the National Front in droves in the 2008 election and it lost power in five of 13 states as well as its once iron-clad two-thirds parliamentary majority.
The opposition maintained that momentum with a huge by-election win for Anwar in August 2008 when he was returned to parliament for the first time in a decade.
The vote is taking place against the background of slowing economic growth . Even a narrow win for the opposition would be enough for Anwar to claim the momentum of public support is still with him.
What does the Islamic party want?\
Malaysia's Islamic party, the Pan-Malaysian Islamic Party (PAS), one of the three members of Anwar's coalition, is contesting the seat and has chosen a popular and combative local politician, Abdul Wahid, as its candidate.
PAS wants an Islamic state and its comments on implementing Islamic criminal and civil law have in the past upset the secular parties in Anwar's coalition, especially the ethnic Chinese party, the Democratic Action Party.
In the past, rural Chinese have never really endorsed PAS, even in 2008. If PAS does win over the ethnic Chinese vote, it will show they have lost their fear of the Islamic party.
Even among rural Malays, PAS' push for an Islamic state is not that popular. It is their clean government and the neglect of the rural poor by Umno that boosts the Islamic party's appeal.
While PAS vies with Umno for the Malay Muslim vote, it usually only performs well when it is a member of a national coalition.
And what of Anwar?
Mr Anwarr lost political traction when he failed to win over government MPs to take power on Sept 16.
A resounding win would re-establish his momentum and keep his fractious alliance of PAS, urban reformers and the DAP together. Anwar, a former Muslim activist, is popular among Muslim voters, despite his imprisonment for sodomy and corruption in the late 1990s and new charges of homosexuality that are in the courts.
The Kuala Terengganu by-election will provide an important reading on his popularity with rural Malays, a key voter segment whose support will be required if the opposition is to win Malaysia's next general election, scheduled for 2013.
While economists have praised Anwar's policies, particularly his anti-corruption stance and plans to remove a system of economic and social preferences for ethnic Malays, he also has a populist message. Anwar opposed moves to end fuel subsidies that cost the budget 18.1 billion ringgit in 2008. -- REUTERS