MALAYSIA'S "NEW" AUTO POLICY: A STEP TOWARDS

UNCLAS SECTION 01 OF 05 KUALA LUMPUR 000959

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SUBJECT: MALAYSIA'S "NEW" AUTO POLICY: A STEP TOWARDS
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Ref: 2005 KUALA LUMPUR 4080

Summary
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1. (U) The Malaysian government issued its new National
Auto Policy (NAP) on March 22, 2006, following up on
the NAP Framework issued five months earlier (reftel).
The NAP envisions some significant changes to
development of Malaysia's auto sector, including an
expiration date for its longstanding (and much
criticized) approved permit (AP) system, a revised
customs valuation regime designed to more accurately
assess import values, and a ban on most used car
imports. Key changes to the tax structure include a
significant decrease in excise duties and an immediate
lowering of import duties for vehicles from Malaysia's
ASEAN partners, bringing Malaysia in line with the
ASEAN FTA (AFTA) earlier than expected. Malaysian
officials acknowledge, however, that the NAP remains a
work in progress and that many details remain
unsettled.


2. (SBU) Car dealers took advantage of the NAP by
lowering prices, though their reductions were due in
part to pressure from the government. In addition to
reiterating five key goals from last year's framework,
the NAP includes a sixth goal to safeguard consumer
interests. While the NAP moves the auto sector towards
liberalization, the new policy makes clear that the
government intends to protect "national" cars,
including the troubled Proton. Still Malaysia's
dominant carmaker, Proton continues to explore
alliances with foreign automakers that would give it
access to improved technology and, perhaps, more export
markets. U.S. and other carmakers have been meeting
with government officials on implementing the NAP.
They generally welcome the NAP, but hope that an FTA
with Malaysia would produce faster and deeper reforms,
including import duties for U.S. vehicles that are no
higher than those imposed on ASEAN-origin cars, and an
earlier abolition of the AP system than the NAP
envisions. End summary.

The Government's Current Vision
--------------


3. (U) Malaysia's New Auto Policy envisions the
continued dominance of two strong national auto
manufacturers (Proton and Perodua),but also recognizes
the important role that foreign manufacturers play in
the Malaysian auto sector. The NAP encourages foreign
firms to maximize joint ventures with local partners,
and to upscale their assembly operations into niche
areas where Proton and Perodua have little interest.
The new policy also encourages consolidation within the
auto components sector to create stronger domestic
firms that would be better able to compete for
contracts in the global automotive industry.

Approved Permits - An Expiration Date
--------------


4. (U) The NAP calls for elimination of the AP system
by December 31, 2010, which would end one of Malaysia's
high profile preference programs for ethnic Malays. A
spokesman for the Prime Minister has stated that APs
would be made available in the meantime based on the
contribution made to the local economy. Priority would
be given to manufacturers that have committed to a
significant increase in production volume in a
particular model, with plans for significant exports of
that model, which then seek APs to import other models
to complete their product range in the Malaysian

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market. The spokesman added that a limited number of
APs would also be made available based on the need to
ensure sufficient vehicle choice for consumers. These
criteria make no mention of reserving APs for ethnic
Malays (Bumiputera),leading some analysts to speculate
that the NAP may for the first time give non-Malays the
ability to obtain APs.


5. (SBU) Comment: The setting of a date for the
elimination of the AP system is testimony to the
increasingly negative public opinion it has engendered
in recent years, even among prominent ethnic Malays.
Many high profile Malaysians, including former PM
Mahathir, now criticize the AP system as inimical to
its original goal of giving entrepreneurial Malaysians
greater access to a lucrative sector. Instead, the
system has become a means for a very small group of
connected Malays to enrich themselves with minimal
effort, while contributing to the high costs of
imported vehicles. End comment.

Motor Vehicle Tax Structure Changes Yet Again
--------------


6. (U) The NAP reduces further the excise tax
reductions for passenger cars that came into effect in
conjunction with the NAP framework in October 2005.
The new excise duties, effective March 22, 2006, now
range from 75 to 125 percent. Although these
constitute reductions of between 16 and 69 percent
(depending on the engine size),these new rates are
still higher than those in effect until December 2004.
Nevertheless, most auto manufacturers here, including
Ford Malaysia and Daimler Chrysler Malaysia, used the
new excise rates as a marketing tool, and announced an
immediate reduction in prices for completely knocked
down (CKD) models of up to 11 percent.


7. (U) Of more concern to national carmakers like
Proton and Perodua was the government's decision to
reduce immediately the import duties for ASEAN-origin
completely built up (CBU) vehicles from fifteen to five
percent. This reduction, along with the elimination of
the AP system, is perhaps the most far-reaching step
implemented by the NAP. Malaysia's commitments under
the ASEAN FTA (AFTA) did not require it to lower these
duties until 2008. By acting now Malaysia has
eliminated a contentious issue with its ASEAN partners.
The government is hopeful that the step will promote
greater integration within ASEAN. Imports from the
rest of ASEAN will still be limited until the AP system
is abolished, however. There is no change to the MFN
import duty of 30 percent for non-ASEAN CBU vehicles,
giving ASEAN imports a marked advantage over imports
from the rest of the world, including the U.S. Prior
to the series of tax structure changes initiated in
December 2004, both ASEAN and non-ASEAN CBU imports
were assessed similar import duties.


8. (U) Proton and Perodua now face the near elimination
of the import duties (on ASEAN-origin vehicles) that
were the prime means of protection for both companies.
Senior GOM officials, including Finance Minister (II)
Nor Mohamed Yakcop, were quick to criticize both firms
for not reacting quickly to the increased competition
from imported (CBU) models due to the lower import
duties. Though they initially announced only modest
discounts of two to four percent on most of their
models, both companies quickly gave in to the political
pressure by increasing their discounts substantially.

Effective Valuation of Car Imports
--------------


9. (SBU) Despite losing the protection of high import
duties, national carmakers should benefit from another
NAP reform designed to assess a more accurate value on

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CBU imports in order to determine customs duties.
Under the new policy, the government gazette will
publish the values of imported CBU cars as determined
by a government committee, using Singapore CIF values
and market studies that include back calculation from
retail prices. By steering away from prior importer
declared values, the government hopes to significantly
cut the incidence of tax under-declaration. One study
suggests that most CBU imports would increase in price
from 10 to 40 percent, given the widespread under-
declaration of vehicle values.


10. (U) If this new provision is enforced it should
decrease CBU demand and increase the attractiveness of
Malaysian-built cars, either by the national carmakers
or by imported CKD models. The new provision would
also help level the playing field for importers that do
not abuse the current system, such as U.S. firms.
Demand for such cars should also be stimulated by
another NAP provision that phases out most used-car
imports by 2010.

Dreaming of a Regional Auto Hub
--------------


11. (U) One of the six broad goals of the NAP is to
develop a regional automotive manufacturing hub in
Malaysia. Bringing Malaysia's import duty in line with
the rest of ASEAN is one means of stimulating the
development of such a hub, by easing Malaysia's ability
to export within ASEAN with few tariff barriers. The
government will also nurture such a hub by using its
licensing authority to control the development of new
foreign manufacturing facilities. Under the NAP new
manufacturing licenses would not be issued until after
domestic over-capacity had been resolved. The NAP also
prohibits current excess capacity being used to
assemble new makes or models that compete directly with
those produced by national car manufacturers.


12. (U) Just days after announcing the NAP, however,
Malaysia demonstrated that its overall goal of creating
a regional auto manufacturing hub trumped its over-
capacity concerns. On March 29 Chinese automobile
manufacturer Geely announced that it would open an
assembly plant in Malaysia to produce two low cost
models, 80 percent of which were destined for export.
Geely reportedly will become the first Chinese auto
company to assemble vehicles overseas. Malaysian
approval of this new manufacturing capacity, producing
models that would seem perfect competitors to Proton,
reportedly was forthcoming only through Geely's
commitment to export most of its production.

The Future of Proton
--------------


13. (U) Proton's future as Malaysia's dominant
"national" carmaker remains uncertain. Automobile
sector analysts here agree Proton needs to conclude an
alliance with a foreign partner that can provide
significant technology and marketing expertise to
enable Proton to remain competitive domestically.
Proton's lengthy courtship with Volkswagen ended
abruptly in early 2006 when VW pulled out of talks to
form an alliance, apparently unhappy with Proton's
reluctance to give VW an equity stake. The two
companies continued lower-profile cooperation,
including the supply by VW to Proton of a limited
number of components. Press reports indicate the two
companies recently have resumed high-level negotiations
on forming an alliance that would create a separate
corporate entity to produce Proton-branded cars, based
on VW platforms, for sale throughout ASEAN and India.
In the meantime VW has decided to enter the Malaysian
market in full force, with plans to introduce nine new
models here and to establish twelve new dealerships

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over the next two years. If it does not end up in
alliance with Proton, VW could become another
significant competitor.


14. (U) Proton also reportedly is in talks with both
French carmaker Peugeot Citroen, and with its old
partner Mitsubishi, which previously played a big role
in Proton's development. In both cases Proton is
believed to be seeking looser, more technical alliances
than it had contemplated with VW. These types of
alliances would be more politically palatable in
Malaysia as they would involve little, if any, equity
sharing. But some analysts believe Proton can only be
saved through a deeper alliance, which would provide
Proton with economies of scale, access to advanced
technologies, and connections to an established global
distribution and supply network. VW or another foreign
partner likely would not be willing to provide such
substantial benefits without a significant equity share
in Proton.


15. (U) The NAP makes clear that Malaysia is not ready
to abandon the concept of a national car. Even
Malaysia's top leaders acknowledge that change is
necessary, however. Deputy Prime Minister Najib Rezak
said on May 23 that further government support for
national carmakers would be "targeted, finite and
transitional, not open-ended and unconditional," and
added that these firms would never be able to offer a
full line up of vehicles to satisfy all segments of the
market. Although Najib stressed that Proton needs a
strong foreign partner, especially to give the firm a
decent shot at competing abroad, and said that the firm
would allow the foreign firm to take an equity stake in
Proton, he also noted that the GOM would not permit a
foreign firm to take a controlling interest in the
company.


16. (U) Proton's new president, Syed Zainal, has
commented the company welcomes the competition that
will be created by the NAP. He admitted that Proton
needs to become a true competitor to foreign
manufacturers, and reportedly commented that Proton
"cannot be a national car forever." Tengku Mahaleel,
who was pushed out as Proton CEO last year after more
than a decade on the job, reportedly has expressed
doubts about the NAP's ability to reach its goals, in
particular Malaysia's hope to become a regional
manufacturing hub. Although Mahaleel praised the
government's goals, he observed that Malaysia's past
implementation of auto sector policy was lackluster and
incomplete. He pointed in particular to previous
industrial master plans over the last two decades,
which he claimed contained similar auto sector goals
that were never realized. Mahaleel also blamed
Proton's ills in part on Malaysia's banks, deriding
their long-term, low-interest loans as depressing new
car sales, since car resale values drop below
outstanding loan balances well before the loans are
paid off. Such loans have been key to Malaysians'
ability to purchase imported cars rather than the
(generally cheaper) national cars. (Rising interest
rates in the last four months have curbed demand
somewhat, with new auto sales in 2006 expected to grow
at their slowest rate in three years.)

The Auto Sector and the FTA
--------------


17. (SBU) U.S. auto industry representatives in
Malaysia generally are satisfied with the direction of
GOM policy on auto sector liberalization. However,
they have identified several areas for U.S. trade
officials to focus on during the FTA negotiations. The
significant difference in import duties for ASEAN-
origin CBU vehicles compared to non-ASEAN imports is a
prime concern. U.S. firms seek an agreement containing

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import duties on U.S. CBU vehicles that are no higher
than those Malaysia imposes on similar ASEAN-origin
imports. U.S. firms also are concerned about the
government's new policy on determining the import
values for CBU vehicles. Although the new valuation
guidelines should have little impact on law-abiding
importers, U.S. automakers have identified this
provision as non-compliant with the WTO, and have
indicated that they will ask U.S. trade negotiators to
push Malaysia to accept franchise importer declarations
of commercial value for taxation purposes.


18. (SBU) U.S. carmakers welcome the government's
efforts to create a more transparent AP system that
would allow the firms' Malaysian partners to directly
obtain APs, and substantially eliminate the role of
other rent-seeking intermediaries in importing cars.
Nevertheless, U.S. firms continue to complain that the
AP system creates unnecessary costs that disadvantage
imported vehicles, and that it also continues to impose
a quota on imported cars. Given that the AP policy
does not appear to be WTO-compliant, U.S. firms will
push for an FTA that would accelerate the complete
phase-out of APs earlier than 2010.


19. (SBU) Ford's senior representative here tells us
that government officials have admitted that the NAP
needs to be fleshed out significantly. He is pleased
that the government is consulting more with industry as
the NAP moves forward, but he also noted that GOM
officials have indicated there will be still more
changes to the auto policy. The government has
indicated that its early priorities will be
implementing the provisions related to customs
valuation of imports, and the abolition of used car
imports. The government reportedly has given overall
responsibility for implementing the NAP to the
Malaysian Industrial Development Authority (MIDA),the
government's investment promotion agency.

Comment
--------------


20. (SBU) Like the framework issued last fall, the
National Auto Policy is short on details. An accurate
assessment of its effectiveness in genuinely opening up
the auto sector to broad competition may not be
possible for many months, if not years. The reportedly
enhanced role for MIDA in implementing the NAP is
encouraging, given that agency's pro-foreign investment
outlook. It's also a bit surprising, since MIDA is an
arm of the Ministry of International Trade and Industry
(MITI),which was discredited by scandal last year over
the misallocation of APs, to the point that the
ministry was even stripped of its authority to issue
APs.


21. (SBU) Malaysia's commitment to reform may be tested
soon, as some auto analysts here predict a contraction
of the market, with sales declining by as much as ten
percent in 2006 compared to 2005. Demand has been over
fulfilled in recent years, but increasing interest
rates are making long-term loans less attractive. The
lower end models of both Proton and Perodua may benefit
from this changing market, while expensive imported
cars could suffer declining market shares.
Strengthened national carmakers could encourage the
government to maintain its commitment to reform. If
Proton's share of the market were to continue to
diminish significantly, however, the GOM could be
expected to seek yet more changes to the NAP to help
preserve the company's viability. In such a scenario
the challenge would be for the government to maintain
its commitments under the AFTA and, eventually, under a
potential U.S.-Malaysia FTA.

LAFLEUR