Fuel Prices, Interest Rates, FDI, and Inflation

UNCLAS SECTION 01 OF 05 KUALA LUMPUR 000357 SIPDIS SENSITIVE SIPDIS TREASURY FOR OASIA AND IRS STATE FOR USTR - WEISEL AND BRYAN STATE FOR FEDERAL RESERVE AND EXIMBANK STATE FOR FEDERAL RESERVE SAN FRANCISCO TCURRAN USDOC FOR 4430/MAC/EAP/BOYD GENEVA FOR USTR E.O. 12958: N/A TAGS: ECON EFIN EINV EPETPGOV PREL MY SUBJECT: Fuel Prices, Interest Rates, FDI, and Inflation All On The Rise - Malaysia Economic Update - February 2006 ¶1. U) Summary: The biggest news arrived at the end of the month when the government of Malaysia (GOM) announced a 23% hike in gasoline and diesel prices. Earlier in the month, Bank Negara - Malaysia's central bank - announced another overnight policy rate hike to help control inflation and discourage capital outflows. Malaysia's overall FDI increased by 37% in 2005, with the U.S. the top investor at $1.1 billion. The GOM decided to postpone indefinitely the looming Goods and Services Tax because neither government nor industry was ready to implement such a far-reaching change. The 9th Malaysia Plan -- Malaysia's tribute to Soviet era economics -- will be delivered next month. We also include a "man on the street" view of the Malaysian economy to put some of these changes into perspective. End Summary. Fuel Prices Rise 23% -------------- ¶2. (U) On February 28, the government of Malaysia (GOM) raised the price of gasoline, diesel, and liquefied natural gas by RM 0.30 ($.08) per liter or 23%. Gasoline now costs RM 1.92 ($.51) per liter; diesel costs RM 1.58 ($.42) per liter; and liquefied petroleum gas, or household cooking gas, costs RM 1.75 ($.47) per kilogram. ¶3. U) This is the single highest price increase in recent memory and the fifth in the past two years. Gasoline prices are 42% and diesel prices are 102% higher than the levels in May 2004. GOM has promised consumers that this will be the only petroleum price hike this year. Despite the recent increases, Malaysians still pay less at the pump than any other ASEAN nation, with the exception of Brunei. That is due to the remaining high fuel subsidies that the government pays on behalf of its consumers. Prime Minister Abdullah suggested in a press conference that the price would be more than RM 2.50 per liter should the GOM remove all forms of subsidy entirely. ¶4. (U) Although Abdullah tried to downplay the inflationary effects of the price hike, analysts announced that inflation may rise by 3.5% to 3.8% during 2006 due to higher transportation costs and pass through effects to other parts of the economy. For example, Jamarulkan Kader, the President of the Malaysian Muslim Restaurant Owners Association predicted that a plate of fried noodles would rise by RM 0.50 ($0.13) per plate to RM 3.00 ($0.80 -- a 25% increase) at hawker stalls. Although the 2000 members of the groups may wait awhile to increase prices, Kader expects that most will do so over the next few months. Malaysian truckers did not have any such hesitation and announced immediate transportation rate increases. The Pan-Malaysian Lorry Owners' Association enacted a RM 0.15 ($0.04) per kilometer fuel surcharge on March 1. ¶5. (U) Minister of Domestic Trade Shafie Apdal promised that the impact of the fuel increase would only be 0.12 percent. He suggested that he would accomplish this by coming down hard on merchants who hike prices unnecessarily, revoking their licenses if need be. Yet, in the same press conference, Shafie also announced that 285,000 bus operators and taxi drivers would be given cards entitling them to subsidized diesel. ¶6. (U) Abdullah defended the price hike by explaining the GOM will save RM 4.4 billion ($1.2 million) in 2006 by not having to pay fuel subsidies. Due to the rise in global oil prices over the past year, the GOM found itself unable to sustain its program of fuel subsidies, deficit reduction, and public project spending. GOM paid RM 15 billion ($4 billion) last year and expected to pay RM 16 to RM 20 billion ($4.27 to $5.33 billion) this year. Also, with the 9th Malaysia Plan due for roll out in one month, the GOM may be looking for a funding for long-term development programs even though Malaysian consumers seem much more concerned with KUALA LUMP 00000357 002 OF 005 inflation at the moment. ¶7. (SBU) Exxon Mobile's Chief Financial Officer explained to the Economic Counselor that the GOM is actually taking in a small "profit" on gasoline after the latest price hike. The subsidies that the GOM has historically paid out are composed of two pieces: a transfer payment for the consumer (given to the consumers through artificially low prices and repaid to the oil seller by the government) and foregoing sales tax on fuel. In the recent past, the GOM was paying the subsidy and foregoing all of its potential tax revenue. The price increase has now moved gasoline prices into the range where the government will be collecting a small amount of tax on each sale. Diesel fuel, however, will remain at a low enough price that government will still be paying out subsidy support, in addition to foregoing tax revenues. 8) (SBU) Another concern for the GOM is its status as a net oil exporter. Deputy Prime Minister Najib, in a March 1 television interview, admitted that Malaysia could become a net oil importer in as few as 4 years. He cited the need for conservation and to change the Malaysian lifestyle as another reason to raise the fuel prices. (Comment: Industry insiders have been aware that Malaysian national oil company Petronas scrapes the bottom of the wells to pump the 650,000 barrels per day required to remain a net exporter. Najib's comments are the first on record statement about this looming challenge. The GOM has long relied on Petronas as a cash cow for the nation. Petronas provides about 25 percent of the national budget, takes up the slack when there is a need for national infrastructure (the Petronas Towers are a national symbol of Malaysia),and provides heavy subsidies to the state run electrical utility, to name a few examples. End Comment.) ¶9. (SBU) Comment: Although Malaysia's central bank Governor Zeti Aziz and Minister of Finance (II) Nor Mohamed Yakhop have both stated that the inflation rate this year would be manageable, it is hard to see how prices will not rise. When asked if she would raise interest rates again, Zeti exhibited her usual calm manner and submitted that she would need to review the outlook over time. In fact, the government of Malaysia was anything but calm about this announcement. Prior to releasing this news to the press, they strongly urged that the media not refer to the price increase as a "hike." The Deputy Minister of International Trade, slated to participate in a joint press conference with the Ambassador, refused to speak to the media without assurances that there would be no questions on the rate increase. It is worth noting that the leading English language daily, the New Straits Times, led with the banner: PRICE HIKE PAIN. Furthermore, the major Islamic opposition party, incensed over the hike, has announced that it will lead a protest on Friday, March 3, at the Mosque in central Kuala Lumpur, next to the Petronas Towers. End Comment. Interest Rates Hike -------------- ¶10. (U) On February 22, Bank Negara announced another increase in Malaysia's overnight policy rate by 25 basis points to 3.25% from 3%. This is the second time the Central Bank has increased the rate in the past 3 months. The last increase occurred on November 30, 2005; during the seven years prior to that increase Bank Negara had held the overnight policy rate steady at 2.7%. ¶11. (U) Several commercial banks, including foreign banks, raised their base lending rates by 25 basis points to 6.5% immediately after Bank Negara's announcement. Although the rate hike was generally expected, analysts are concerned that banks' loan growth could be affected. In 2005, loan growth in the banking system was 8.6%. Depositors continue to face a negative real interest rate return with inflation KUALA LUMP 00000357 003 OF 005 rising at 3.5% year-on-year in December 2005, and 3% year-on-year for the whole on 2005. Inflation for January, year-on-year, clocked in at 3.2%. Analysts are now predicting 3.5 - 3.8% for 2006. ¶12. (U) Comment: While Bank Negara has concerns over the rate of inflation, it also is worried by the difference between Malaysian and U.S. interest rates and the possibility of funds flowing out of the country. But even with the increase, the gap between Malaysian and the U.S. rates remains wide at 1.25%. With current inflation rates (already high for Malaysia) almost certain to increase, Bank Negara will need to weigh the benefits of fighting inflation through further rate hikes against the fear of slowing economic growth. Analysts generally expect Bank Negara to raise rates an additional 50 to 75 basis points over the coming year. End Comment. Malaysia's FDI Surges to 4-year High -------------- ¶13. (U) Foreign direct investment (FDI) in Malaysia rose 37% to RM 17.9 billion ($4.8 billion) in 2005 from RM 13.1 billion ($3.5 billion) in 2004. The Malaysian Industrial Development authority (MIDA) reported that 2005 saw the highest level of approved FDI in Malaysia since 1996. FDI accounted for 58% of total approved investment in the manufacturing sector in 2005. The U.S. topped the list with RM 5.2 billion ($1.4 billion) in new FDI for approved projects, followed by Japan ($987 million) and Singapore ($773 million). This is a major increase over 2004 when there was a mere $293 million in U.S. FDI. Goods and Services Tax Implementation Postponed -------------- -- ¶14. (U) In a move that brought a sigh of relief from businesses, both local and foreign, the GOM announced on February 22 that it was postponing implementation of the new Goods and Services Tax (GST). While most businesses accept that GST is inevitable, there was significant concern from groups such as the Federation of Malaysian Manufacturers, the Malaysian International Chamber of Commerce and Industry, and the American Malaysian Chamber of Commerce as to the GOM's ability to plan and implement the new tax system. The GOM also may have been worried about the effect of tax increases on some of the poorer elements of society who do not currently pay income tax but who would be affected by a universal GST. Further, the GOM had yet to produce its guidelines for implementation of the GST and businesses complained they were not being given sufficient lead time to plan for the transition. ¶15. (SBU) Comment: Although the GOM has not reset a date for the GST implementation, observers expect that it will not be until after the next election. That would place GST implementation, at the earliest, in 2008 and likely 2009. This is good news for the possible U.S.-Malaysian Free Trade Agreement (FTA) negotiations because the GOM will be able to focus all of its attention on the FTA. Observers have suggested to Econoff that the GOM would not be capable of handling extensive negotiations on the FTA while implementing a complete tax overall. End Comment. A "Street Level" View of the Economy -------------- ¶16. (SBU) A recent conversation with a senior executive of a local department store that caters to a lower and lower-middle class clientele provided a rare "street level" view of the economy. (Note: this conversation took place prior to the February 28 fuel hike.) This retailer is seeing a slight decline in sales, which he believes is consistent with the results of other retailers operating in his market niche. Asked whether this was due to inflation, he said "no." He said his customers are feeling some pinch from KUALA LUMP 00000357 004 OF 005 higher transportation costs (the result of cuts in government fuel subsidies),but inflation is not biting too hard since the government controls the prices of most staple goods. What is holding back his customers, he said, is uncertainty, as many depend on construction and other low-end jobs that have been drying up as the government cuts back on spending. ¶17. (SBU) On the other hand, the executive said that middle and upper income earners are experiencing inflation that he estimated as being much higher than the government's stated figure of around 3.5%. He claimed that the "market basket" for the government's inflation index is over-weighted toward price- controlled items. The fixed price items act as a drag on the index and hold down the official inflation rate. (Comment: This also could explain Malaysians' current thirst for consumer credit borrowing. Interest rates, which typically are set at the official government basis plus a couple of percent, are probably well into the negative zone these days for upper income borrowers. End Comment.) ¶18. (SBU) But while sales are down, this retailer said his store's bottom line is up because it has been "getting more value for its dollar." Asked to explain, he noted that the Malaysian ringgit has been riding up in value with the U.S. dollar against many South and Southeast Asian currencies. Since he sources many simple manufactured goods from India, Thailand and other neighboring countries, he has been able to increase his profit margin while holding his ringgit prices constant. 9th Malaysia Plan To Be Unveiled March 31, 2006 -------------- - ¶19. (U) The GOM is furiously working to finalize the 9th Malaysian Plan, which will set both economic growth targets and strategic development priorities for the coming five years. This will be the first plan developed under the leadership of Prime Minister Abdullah. Although held closely, indications are that the plan will focus on Abdullah's stated goal of transforming Malaysia into a knowledge-driven economy. The 9th Plan should state what programs and projects he intends to fund (high tech education) and identify how much and where the funds will be found. Malaysia has been developing these five-year plans since 1966. ¶20. (U) At the Eight Malaysian Strategic Outlook Conference, in January, Deputy Prime Minister Najib stated that the GOM would foster equitable distribution of wealth and a fairer approach to ethnicity in 9th Malaysia Plan. Specifically, there will be three main thrusts, none of which are surprising. They include: more incentives for the private sector in crucial areas such as agriculture, life sciences, information and communications technology, tourism, health and education; greater effort to put human capital development as the number one priority and build a knowledge-based economy driven by innovation and ideas; and, improvement of the public service delivery system and cutting cost of doing business in Malaysia. ¶21. (SBU) Comment: Ethnic Malays are eagerly looking forward to the 9th Plan because, historically, this is how some of the nation's wealth is spread around. Former Prime Minister Mahathir used the plans to launch his new infrastructure projects, large and small, and pass out contracts. Abdullah had cut back much of the pork in the 8th Plan that he inherited and there has been grumbling over the lack of development projects, especially among the small Bumiputera (Bumiputera are literally 'sons of the soil" but, in practical terms, this refers to the government's affirmative action policies favoring the majority Malay race) Class F contractors. There are 38,000 Class F contractors and only they are allowed to bid on small contracts (less than RM 200,000 or about $53,000) specifically set aside for them. As Abdullah's government only KUALA LUMP 00000357 005 OF 005 announced RM 2.4 billion ($640 million) worth of construction projects last year, this politically important group is looking for projects. A few weeks after the unpopular fuel increase would be a politically astute time to announce such Bumiputera set- asides. ¶22. (SBU) Comment continued: For the ethnic Chinese and ethnic Indian Malays, Najib's mention of equitable distribution of wealth and a fairer approach to ethnicity raises shades of the New Economic Program of old. This policy was set in place to transfer money and equity in business investment from the minority races to the majority. Only the release of the plan, however, will confirm whether it is a step back in time, or a path to the future. End Comment. LAFLEUR