Malaysia Inc. - still profitable? Monthly Economic Update

UNCLAS SECTION 01 OF 03 KUALA LUMPUR 001994

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E.O. 12958: N/A
TAGS: ECON EFIN EINV EPET MY

SUBJECT: Malaysia Inc. - still profitable? Monthly Economic Update
for October 2006


1. Summary: Foreign Direct Investment to Malaysia continues to
slide, even as FDI to the region soars, according to an UNCTAD
report. The government's announced strategy is to be "selective" in
an effort to "move up the value chain." While this strategy makes
some sense, based on rising wages and the stability and
infrastructure Malaysia has to offer, the GoM is not taking the
steps needed to attract enough high-end manufacturers to compensate
for those they are losing. While the GoM boasts of a handful of
successes, the numbers tell the real story - the bandwidth of
Malaysia's profitability as a destination for FDI is narrowing.
Meanwhile, Malaysia and other ASEAN countries are increasing their
pressure on Indonesia to resolve the haze problem. End Summary.

Malaysia Slips in FDI Rankings
--------------


2. The UNCTAD World Investment Report released October 16 showed
that Malaysia fell to sixth place among the ASEAN countries last
year in the race to attract foreign direct investment (FDI). FDI
inflows to Malaysia in 2005 declined 14%, while inflows to Southeast
Asia as a whole increased 45%. The poor showing was presaged in the
2005 Investment Confidence Index published by the consulting firm
A.T. Kearney, Inc. This survey asked Global 1000 executives where
they planned to make their investments that year; Malaysia failed to
make the top 25 list of FDI destinations for the first time since

1998.

GOM Seeks Advice, But Will They Take It?
--------------


3. Malaysian policymakers are aware of the need to upgrade the
country's foreign investment regime and have been quietly seeking
advice. Our business contacts report they have been invited to
several meetings to discuss the investment climate with officials up
to and including the Prime Minister, although they add that they
have seen no significant changes as a result. Commenting to the
press on the UNCTAD report, National Economic Action Council (NEAC)
member Datuk Zainal Aznam Yusof defended the government's policies,
including rules that assign a 30% equity share to bumiputeras
(ethnic Malays) in any new venture outside the export manufacturing
sector. However, he also said Malaysia must liberalize its service
and industrial sectors to make them more attractive to foreign
investors. Our business contacts would agree.


4. In a press interview, Mohamed Ariff, Executive Director of the
Malaysian Institute of Economic Research (MIER),attributed the
lower FDI to Malaysia's policy of "selectivity" in approvals,
pointing to Malaysia's targeted greenfield industries and its goal
of attracting manufacturers of high tech and capital intensive
products, rather than low-wage, labor intensive industries.
Ambassador Thierry Rommel, head of EU Commission delegation to
Malaysia, publicly announced that the declining attractiveness of
Malaysia as an FDI destination was due to issues regarding
availability of skilled labor, visa issuance, intellectual property
rights, and lack of transparency and predictability to certain
policies and markets.

Penang Strives to Move Up the Value Chain
--------------


5. Wan Zalina Noordin, CEO of Invest Penang, a state government
agency charged with attracting business investment, told econoff
that the GoM's strategy was to "move up the value chain." She
explained how the government selectively targets hi-tech industries,
renewing tax incentives for those companies it sees as meeting the
appropriate technology and wage levels, and not discouraging
employers of lower skilled workers from moving their manufacturing
to China or elsewhere.


6. Rod Libby, Managing Director for Linear Semiconductor, a San
Francisco-based manufacturer, told econoff that the GoM recently had
renewed the company's tax abatement agreement for another ten years
and approved a large-scale expansion of the factory. At the other
end of the technology spectrum, Mr. Soo Teck Heng, General Manager
for Mattel (Malaysia),explained that Mattel had shifted its
production of Barbie dolls from Penang to China several years ago as
a result of increasing labor costs. The manufacture of toy cars in
Malaysia remained profitable, he explained, because it was highly
mechanized. Cardinal Health Care, formerly Allegiance, no longer
manufactures in Penang after determining that it was no longer
profitable, according to one company representative. The company

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maintains some staff in Penang who are engaged in "outsourcing."
Econoff's taxi driver referred to the shuttered plant as the "rubber
glove factory."


7. While these developments seem entirely consistent with the
strategy described by Invest Penang of moving up the value chain,
econoff observed a number of vacant factories in the area, many of
which reportedly have remained empty since the 1997 currency crisis.



8. Although Invest Penang has been criticized widely in the press
for not doing enough to promote the opportunities in the island
state, the real problem cited by many businessmen is more a matter
of fundamental business climate than advertisement. The most common
complaint manufacturers in Penang mentioned to econoff was the poor
enforcement of intellectual property rights. A representative of
one Penang manufacturer pointed out that his company was resolved to
keep manufacturing its more sensitive technology in Singapore,
despite higher costs, specifically because of the risk of piracy.
Only its basic assembly is done in Malaysia. He said bringing
research and development to Malaysia - a stated goal of Invest
Penang - was out of the question for his company. Labor costs in
Malaysia have increased steadily over the past five years, but
improvements in the business climate, including IPR protection, have
not kept up.

Despite Declining FDI, Economic Forecasts Are Up
-------------- ---


9. Economic think tank the Malaysian Institute of Economic Research
(MIER) has revised its GDP forecast for Malaysia for this year to
5.6% from 5.2% on better-than-expected increase in Malaysian exports
to the U.S., EU and Japan. The institute maintains its earlier
forecast of 4.8% for 2007 on an expectation of declining demands for
exports. MIER executive director Mohamed Ariff said the 4.8%
forecast for next year is based on a comparison with expected
performance of other countries in the region. The government has
projected the Malaysian economy would grow 5.8% in 2006 and 6% in

2007.

Indonesia's Smoke Blankets Malaysian Sky
--------------


10. Malaysia is in the thick of haze season as smoke blankets the
sky, blowing in from Indonesian forest fires and plantations
practicing slash-and-burn agriculture. Kuala Lumpur has escaped the
worst of the haze this year; the southern area of the Peninsula and
Sabah and Sarawak in Borneo have borne the brunt of the problem. To
help clear the air over Sabah and Sarawak, the Malaysian government
has tried to stimulate rain through cloud-seeding at a cost of RM
50,000 per flight (about USD 16,600),but so far with little result.


Effect of Haze on Tourism
--------------


11. A representative from the Ministry of Tourism Promotion Board
told EconFSN that the Board set up an ad hoc division to consider
the effect of haze on tourism. While the Board has not received any
reports of inbound cancellations from overseas travel agents,
Southeast Asia is becoming known for this annual problem.
Nevertheless, she remains optimistic that Malaysia will benefit from
increased tourism from Middle Eastern countries which have declared
two-week holidays for Eid Fitri, which marks the end of the fasting
month.

This Year's Haze is Small Potatoes -- Literally
-------------- --


12. A representative from the Malaysian Vegetable Growers'
Association told EconFSN that the haze -- produced largely by
agricultural practices in Indonesia -- is hurting agriculture in
Malaysia, as the prolonged lack of sunlight is inhibiting
agricultural production, particularly the growth of green vegetables
and chilies. He expects the effects of longer maturation times and
smaller sizes to result in a shortage, causing prices to increase by
as much as 20 per cent. However, this remains small potatoes
compared to last year, which saw closures of airports due to poor
visibility, and lengthy suspensions of operations at high-tech
factories requiring "clean rooms," as the smoke overwhelmed their
filtration systems. A manager at one local factory observed that

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they did not have to close during the even more severe haze event of
1997 (reputed to be the region's worst year for haze),but today's
clean rooms operate at much higher standards and thus are more
sensitive to the quality of the ambient air supply. So far this
year, we have heard no reports of factories or other facilities
having to close due to haze, although the Malaysian government
issued a maritime traffic warning due to poor visibility in portions
of the Straits of Malacca.

Indonesia Announces It Will Fight Haze
--------------


13. At an ASEAN meeting in Pekanbaru last week, the Government of
Indonesia apologized to haze-affected countries, and announced its
intention to sign the 2002 ASEAN Transboundary Haze Agreement.
According to press reports, Malaysian Foreign Minister Hamid Albar
expressed frustration over ASEAN's ability to resolve the haze
problem, asking for concrete results, not just sweet words.


LAFLEUR