MALAYSIAN GOVERNMENT DECIDES PROTON WILL NOT SEEK A FOREIGN

UNCLAS SECTION 01 OF 02 KUALA LUMPUR 001679

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SUBJECT: MALAYSIAN GOVERNMENT DECIDES PROTON WILL NOT SEEK A FOREIGN
PARTNER: POLITICS TRUMPS ECONOMICS
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1. (SBU) Summary: After nearly two years of back-and-forth
negotiations with Volkswagen, the Malaysian government has decided
that government-controlled auto maker Proton would no longer pursue
a strategic partnership with the German auto manufacturer or any
other foreign partner (including General Motors, with which it had
also held discussions). Rather than look to a foreign partner to
help revive the perennial loss-maker, the government announced that
the firm was doing well and should be given a chance to turn around.
Its auto sales were expected to more than double in Asia,
particularly for its new models. Industry experts claim the
government backed off the idea of Proton taking on an international
partner because hundreds of local vendors would be unlikely to
survive the kinds of reforms a world-class partner would demand.
Many of these vendors are owned by ethnic Malays who enjoy protected
status in multicultural Malaysia. Taking action to force Proton to
reform therefore would be unpalatable to part of the government's
key Malay constituency, a particular concern to UMNO now with a
national election on the horizon. End summary.


2. (U) The Malaysian Cabinet has decided that national automaker
Proton would no longer pursue a foreign partner. In announcing the
decision on November 20, Finance Minister (II) Nor Mohamed Yackop
said that recent signs of a financial turnaround by Proton had
convinced the government that Proton could prosper without a foreign
partner. These signs included stronger than expected orders for
Proton's new Persona model. The announcement came as a surprise to
most analysts, given reports that Proton was in the final stages of
negotiations with Volkswagen which would have allowed the German
automaker an equity (though likely not controlling) stake in Proton.
(General Motors reportedly was also still in the running as an
alternative to VW). Malaysian Automotive Association (MAA)
President Aishah Ahmad publicly voiced doubts about the durability
and depth of Proton's supposed turnaround, noting that a partnership
with a foreign manufacturer would have been good for Proton's
branding, and that Proton still needs to develop a sustainable, long
term strategy to reverse its years-long slide from dominating the
Malaysian market.

SMOKE AND MIRROR PROFITS
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3. (U) Boosted by the sale of land and the wrap-up of some project
development costs, Proton posted a million-dollar profit for its
second quarter ending September 30, compared to USD 75 million in
losses in Q2 last year in a long succession of multi-million dollar
losses. Revenue was up 3% over second quarter figures last year due
to a 1.3% increase in auto sales. Although this growth was modest,
Proton Chairman Mohammed Azlan Hashim pointed to it as an indication
that Proton's sales would rise from their current levels of 30,000
to 40,000 units per model to between 100,000 and 150,000 units per
model by 2011, primarily through greater exports to China, India,
ASEAN, and to a lesser extent Iran.

HOPES PINNED ON NEW MODELS, ASIAN DEMAND
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4. (U) Ministry of International Trade and Industry Minister Rafidah
Aziz told the press that Proton had its own strategic plans to
capture regional markets, especially in India, China and Southeast
Asia. She said the American and European automotive markets were
different and "not for us"; rather, the growth market is in Asia.
Proton recently signed partnerships with the Governments of China
and Thailand, including a deal to allow for the export of 30,000
Proton cars to China by the end of the year. At an auto show in
Thailand this week, Proton unveiled its new fuel-efficient model,
the Savvy, its new sportscar the Neo, and its re-designed Gen.2, all
of which Proton expects will help improve its sales in Asia. As
recently as July Rafidah had told the press that the government was
interested in selling its 43 percent stake in Proton that it holds
through government investment arm Khazanah (the government
indirectly controls additional shares of Proton, including 12
percent through the Employee Provident Fund and 8.8 percent through
national petroleum corporation Petronas).

BUT QUALITY AND COMPETITIVENESS A PROBLEM
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5. (U) At a recent panel discussion on Creating Global Champions Mr.
Rameli bin Musa, Executive Vice Chairman for Ingress Corporation, a
tier one vendor for Proton, said that a lot of vendors depended on
Proton. He described some of the challenges Ingress faced when the
company began supplying auto parts for Honda and Toyota, including
much tougher quality standards. Another panelist, Mr. Yong Poh Kon,
President of the Federation of Malaysian Manufacturers, elaborated
on this point, explaining that where Proton capped defective parts
at 200 parts per million, Honda demanded no more than six per
million, and Toyota ten per million. This level of quality was one
reason Malaysian auto parts suppliers were reluctant to venture
beyond Proton for business, he said.


6. (U) Also at the conference, Akifumi Kuchiki, Executive Vice
President of Japan External Trade Organization (JETRO) pointed out
that Thailand quickly was becoming the "Detroit of Asia" and that
Malaysia was being left behind. He suggested that Malaysia could
focus on exporting automatic compact cars, while firms in Indonesia
and Thailand could engage more in exporting pickup trucks and
multipurpose vehicles, respectively. He said some of the constraints
facing the Malaysian auto industry included an insufficient supply
of unskilled labor, a need to upgrade the skills of its skilled
labor, and an inadequate supply of quality parts manufacturers.
Malaysia also needed to liberalize and deregulate national auto
policies if it wanted to attract foreign firms in the support
industries.


COMMENT:
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7. (SBU) Comment: The Malaysian Cabinet's decision to prohibit
Proton from taking a foreign partner surprised most industry
watchers, likely including Proton itself, which had appeared on the
cusp of signing a deal with VW. With the government focused on
upcoming elections, however, politics trumped economic rationality.
Although long a supporter of Proton's efforts to seek a foreign
partner, the government decided in the end that it was not yet ready
to permit a fundamental shift away from a 20-year tenet of Malaysian
industrialization - the promotion of a national car. Given the
political sensitivities surrounding both Proton and its pyramid of
local suppliers, most of which are owned by ethnic Malays, only a
foreign partner could have demanded the kinds of reforms necessary
to make the company competitive. Unfortunately, as long as the
government continues to subsidize Proton's losses, neither the
national automaker nor its vendors will have the incentive to become
globally competitive. In the case of Proton, the GOM's
unwillingness to upset its spoils system has once again undercut its
efforts to rationalize the economy.

KEITH