Identifier
Created
Classification
Origin
07KUALALUMPUR1493
2007-10-05 06:22:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Kuala Lumpur
Cable title:  

Malaysia's Current Economic Performance Masks Need for

Tags:  ECON EFIN EINV MY 
pdf how-to read a cable
VZCZCXRO7464
RR RUEHBC RUEHCHI RUEHDA RUEHDBU RUEHDE RUEHDT RUEHGI RUEHHM RUEHJS
RUEHKUK RUEHLH RUEHNH RUEHPW RUEHROV
DE RUEHKL #1493/01 2780622
ZNR UUUUU ZZH
R 050622Z OCT 07
FM AMEMBASSY KUALA LUMPUR
TO RUEHC/SECSTATE WASHDC 0066
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHGV/USMISSION GENEVA 1516
RUCNASE/ASEAN MEMBER COLLECTIVE
RUCNISL/ISLAMIC COLLECTIVE
UNCLAS SECTION 01 OF 03 KUALA LUMPUR 001493 

SIPDIS

STATE PASS USTR - WEISEL AND JENSEN
STATE PASS FEDERAL RESERVE AND EXIMBANK
STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN
SINGAPORE PASS TO SBAKER
USDOC FOR 4430/MAC/EAP/J.BAKER
TREASURY FOR OASIA AND IRS
GENEVA FOR USTR
SENSITIVE

SIPDIS
E.O. 12958: N/A
TAGS: ECON EFIN EINV MY
SUBJECT: Malaysia's Current Economic Performance Masks Need for
Structural Change


UNCLAS SECTION 01 OF 03 KUALA LUMPUR 001493

SIPDIS

STATE PASS USTR - WEISEL AND JENSEN
STATE PASS FEDERAL RESERVE AND EXIMBANK
STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN
SINGAPORE PASS TO SBAKER
USDOC FOR 4430/MAC/EAP/J.BAKER
TREASURY FOR OASIA AND IRS
GENEVA FOR USTR
SENSITIVE

SIPDIS
E.O. 12958: N/A
TAGS: ECON EFIN EINV MY
SUBJECT: Malaysia's Current Economic Performance Masks Need for
Structural Change



1. (SBU) Summary: Malaysia's central bank Deputy Governor considers
the country's banking sector unexposed to the turmoil in the US
sub-prime mortgage market and believes that the economy remains on
track for six percent GDP growth in 2007. Private sector
economists, however, point out that Malaysia's economy is performing
under its potential growth rate by as much as two percentage points
due to poor government policy. The racial preference policies set
out in the New Economic Policy (NEP) are viewed as the primary
source of growth-restraining distortions which primarily have served
to enrich political cronies. In the process, not only has the NEP
failed to reduce poverty among ethic Malays, it has directly
contributed to greater income inequality and poverty. It continues
to crowd out of healthy private sector investment by government
linked corporations. Perverse education policies have chipped away
at Malaysia's ability to produce a competitive work force for a
global economy. Prime Minister Abdullah Badawi is not perceived as
a politician prepared to make the hard decisions necessary to reform
the policies upon which his political supporters have come to
depend. Middle of the road rates of economic growth prevent a
greater sense of urgency among policy makers, but over time these
structural policy failures are expected to create even stronger
constraints on Malaysia's ability to deliver on robust economic
growth. End summary.

CENTRAL BANK: LOOKING ON THE BRIGHT SIDE
--------------


2. (U) In a meeting with Economic Counselor and Financial Attach
for Southeast Asia, Ooi Sang Kuang, Deputy Governor of Bank Negara,
Malaysia's central bank, expressed confidence that the Malaysian
economy would remain largely on track to reach government forecasts
of 6% growth for 2007, even in light of the U.S. sub-prime lending
problems. Ooi said that, although Malaysia was fairly insulated from
the U.S. sub-prime lending market, he was concerned about how the

"sentimental effect" of a significant reduction in financial markets
could impact the global economy. He described the U.S. Federal
Reserve's decision to lower interest rates by fifty basis points as
having done "wonders" for the global economy.

MANUFACTURING SECTOR MUST IMPROVE


3. (U) Ooi described Malaysia's overall manufacturing sector as "not
robust" and said it would need to become more competitive. The
sector that would suffer the most from an economic downturn in the
U.S. was electrical & electronics (E&E),which was largely dependent
upon U.S. demand for semiconductors, he explained. He said Malaysia
was not moving up the value chain rapidly enough, and that the
country needed to transform its economy, particularly in light of a
strengthening currency that would make Malaysian exports more
expensive.


4. (U) Ooi pointed out that the ringgit's long-term value was
increasing, and said Malaysian manufacturers would be forced to
either "move up the value chain" or relocate if necessary. He said
many Malaysian companies were investing overseas, with
labor-intensive manufacturing moving to Vietnam and Indonesia.

"MANAGING" FOREIGN EXCHANGE RATES


5. (U) Ooi said Bank Negara continued to intervene in the foreign
exchange market, but only to "smooth it out" and "manage"
volatility, since large volumes could "disturb or excite markets" if
they were not kept within "tolerable levels" of flexibility. He
claimed that the central bank intervened in both directions - to
smooth both the highs and the lows. (Note: when asked about this,
one private sector banking professional responded that this might be
true on a one-to-ten ratio, with the central bank mitigating the
"lows" once for every ten times it intervenes to mitigate the
"highs.")

ECONOMY STILL CHUGGING ALONG


6. (U) In spite of the setback in E&E, strong domestic demand
continued to fuel the economy, explained Ooi. Demand was being
driven largely by higher rural incomes resulting from high commodity
prices, a recent 35% civil service salary increase, and large
government projects being implemented under the Ninth Malaysia Plan.
He estimated that the government projects would remain the primary
driver of domestic demand until mid-2008, by which time he expected
the private sector would strengthen and the government-funded

KUALA LUMP 00001493 002 OF 003


projects taper off. The economy would also benefit by the imminent
opening of the Kikeh oil field, Malaysia's first deepwater
operation.

FINANCIAL SECTOR LIBERALIZATION


7. (U) For its part, the Government of Malaysia (GOM) would continue
to enact financial liberalizations, just as it had been doing for
the Islamic finance sector. According to Ooi, the GOM had been
adhering to the ten-year Financial Sector Master Plan and in some
areas was ahead of schedule. This, coupled with the GOM's recent
announcement that corporate tax rates would be reduced to 25% in
2009, would help boost the Malaysian economy.

AN ANALYST'S VIEW
--------------


8. (U) While Ooi was upbeat about the Malaysian economy's
resilience, Dr. Mohamed Ariff, President of the Malaysian Institute
for Economic Research (MIER),was more willing to discuss the
weaknesses as well as the strengths. He cited similar economic
indicators and pointed to the same strengths - strong domestic
demand, government stimulus, and a reasonable forecast of 5.3 to 6
percent growth. But Malaysia had much more potential than that, he
said. Malaysia would need to "move up the value chain" to position
itself to complement, rather than compete with, China and other
low-wage manufacturing centers in the region. In fact, he said the
GOM had rejected many applications to bring low-tech labor-intensive
manufacturing to Malaysia, some of which had requested bringing in a
few thousand (low-wage) foreign workers. Rather, the GOM was
approving higher-tech manufacturing in the E&E sector, but these
more capital-intensive investments were not bringing in many jobs
for Malaysians, with 20% of new jobs going to foreigners.


REFORMS NEEDED


9. (SBU) To surmount the hurdles and achieve Malaysia's full
potential for economic growth, Ariff argued that the GOM would need
to enact some politically sensitive - and perhaps unlikely -
reforms. First on the list would be to address the "New Economic
Policy" (NEP),a system of race-based preferences for ethnic Malays.
Most benefits were going to cronies; intra-ethnic inequality was
increasing, especially among Malays; and the entire system was
creating a "dependency syndrome," putting low priority on academic
achievement, he said.


10. (U) Education was among Ariff's primary concerns. Ethnic Malays
were poorly prepared for university, he explained, largely due to a
separate one-year "fast track" matriculation which was designed to
enable them to secure a place in college more easily. Non-Malays
were required to complete a more rigorous two-year program and pass
an exam. The end result was that the non-Malays did better once
they entered university. Moreover, separate education before
college led to patterns of self-segregation at the university, and
Ariff observed that the various ethnic groups had little
interaction.


11. (SBU) Government-linked companies were another politically
sensitive issue that would need to be addressed, as they were
crowding out other players in the market, according to Ariff. In
1985 the GOM privatized a number of companies, but these simply went
to cronies, he said. It was time for another round, but this would
need to be done fairly.


12. (SBU) The race-based preferences in general and the poor
educational system in particular were impediments to reaching
Malaysia's full potential, but Malaysians were afraid of change, he
explained. "We need a new NEP," said Ariff, "and a free press not
owned by the Barisan Nasional" (the ruling coalition which has been
in power since independence in 1957).


13. (U) Ariff also was disappointed that the newly released 2008
budget contained no reference to the proposed Goods and Services Tax
(GST) which had been pending since 2004. The GST, similar to a
value-added tax, would be desperately needed in several years' time
when Malaysia was expected to become a net importer of oil.
Currently Petronas, the national oil company, provides 38% of the
federal government's revenue, and the country's tax regime will need
to be restructured to avert a crisis.

KUALA LUMP 00001493 003 OF 003




14. (U) Comment: There is widespread agreement on what to expect in
the near term for the Malaysian economy: not much. The economy will
continue to chug along, growing at five to six percent; cronies will
continue to benefit from the current system; and, despite Malaysia's
greater potential, there will be little demand for change until
things get measurably worse. With elections near, no one expects
the GOM to take actions that are politically difficult - least of
all changes to the NEP, which is the Malays' sacred cow.

KEITH