The annual oil royalties amount to more than RM2.5 billion (S$1.05 billion) and are earned from oil and gas deposits pumped from the seas that are within the state's borders.

They will now be paid directly to the state instead of a special fund run by the federal government.

'The federal government decided to return the oil royalty to Terengganu, and the details, procedure and other measures to be taken will be determined after discussions with the Terengganu government are held,' Prime Minister Abdullah Badawi was quoted as saying by the Malaysiakini news website yesterday.

He made the long-awaited announcement after meeting Terengganu Umno leaders during a one-day working visit to the state.

Umno MPs in the oil-rich state had pressured the PM to return control of the oil royalties.

The federal government has an agreement with Terengganu to pay the royalties to the state, but it started channelling them to a special fund it administered after Terengganu fell to the opposition in 1999.

Although the ruling Barisan Nasional coalition regained control of the state in 2004, the federal government did not change the arrangement and continued to disburse what it termed wang ehsan (goodwill money) to fund development projects in the state instead.

Unhappy Terengganu politicians claimed that the oil royalties were abused. They cited as an example the hosting of the Monsoon Cup yacht competition by the state.

They also said that while the funds were meant for development in the state, they saw little evidence of that happening.

Newly appointed Terengganu Menteri Besar Ahmad Said further fuelled the unhappiness over the issue when he said the state government did not know how the money was being spent.

He asked Prime Minister Abdullah last month to return the royalties.

Parliament was told recently that RM7.364 billion had been channelled to Terengganu between March 2004 and March last year, reported Malaysiakini.

Opposition politicians have also pushed for higher royalties to be paid to Malaysia's oil-producing states.

Yesterday, Datuk Seri Abdullah urged the Terengganu state government to spend the royalties prudently.

'I'm confident it can be done. If we have the money, manage it wisely because we will face various situations that will require expenditure that may sometimes exceed our projection,' he was quoted as saying.

The Prime Minister yesterday also appointed Mr Ahmad Said as the new state Umno liaison chief in Terengganu.

Malaysiakini said the move was likely to further smoothen ties between the state and the federal governments following the March general election.

The post has been vacant as a result of bitter infighting within the state's Umno division, as well as differences between the federal government and the state palace, over the choice of menteri besar after the election.

The two decisions yesterday were expected to burnish Mr Abdullah's image among Umno members in the oil-rich state ahead of upcoming party polls.