Iskandar and Slow-Selling Cars: Malaysia Economic Update

UNCLAS SECTION 01 OF 03 KUALA LUMPUR 000787

SIPDIS

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

SIPDIS
E.O. 12958: N/A
TAGS: ECON EFIN EINV MY
SUBJECT: Iskandar and Slow-Selling Cars: Malaysia Economic Update
for April 2007


1. (U) Summary: The GOM unveiled a package of incentives to attract
foreign investors to the Iskandar Development Region, a newly
established special economic zone in southern Malaysia. Incentives
include an exemption from the GOM's usual requirement that ethnic
Malays be given a 30% equity stake in new businesses. The GOM also
announced it would eliminate capital gains taxes on the sale of real
property throughout the country. Meanwhile, Malaysia's automobile
industry remains in a slump, with new and used car sales continuing
to decline, and the GOM still unable to find a strategic partner for
national car company Proton. End Summary.

Malaysia Launches the Iskandar Development Region
-------------- --------------


2. In November 2006, Prime Minister Abdullah Ahmad Badawi launched
an ambitious plan to transform much of Johor state, bordering
Singapore in southern most Peninsular Malaysia, into a special
economic zone and metropolis which Malaysia hopes will rival Hong
Kong and Shenzhen. At 2,217 square kilometers and costing an
estimated RM 17.7 billion (USD 5.14 billion),this project, known as
the Iskandar Development Region (IDR),will cover an area more than
three times the size of Singapore, and incorporate Senai Airport to
the north, the Port of Pelepas to the southwest and Johor Port in
Pasir Gudang to the southeast. Under the Ninth Malaysia Plan
(2006-1010),the GOM has identified IDR as one of the key future
engines of growth for Malaysia and hopes IDR will woo foreign direct
investment (FDI) and compete with Singapore for manufacturing plants
and logistics businesses. The GOM also plans to create within IDR
an "EduCity", a medical hub, a halal products hub, a biofuel hub,
three "cyber cities," a resort area and the world's oldest mangrove
park.

Kick Starting the Project
--------------


3. The government hopes the private sector, especially foreign
investors, will take lead in developing the IDR. Prime Minister
Abdullah said the government will inject RM 4.3 billion (USD 1.25
billion) for infrastructure projects under the Ninth Malaysia Plan
while the state investment agency, Khazanah Nasional, will pump in
RM 3.4 billion (USD 988 million) to kick start the project. The
private sector is expected to provide an additional RM 10 billion
(USD 2.9 billion) in the early phase of the plan. The government is
counting on attracting RM 370 billion (USD 107.5 billion) worth of
direct investments to the IDR over the next 20 years. For the first
five years, the GOM expects IDR to garner RM 47 billion (USD 13.7
billion) in investments, the bulk of which are expected to come from
Middle Eastern and ASEAN countries.

Incentives for Investors
--------------


4. At the Invest Malaysia 2007 conference in March, Abdullah
announced an "initial incentive and support package" to transform
Southern Johor into a more attractive investment destination. These
incentives include an exemption from rules under the GOM's long
running racial preference policy (still referred to here as the "New
Economic Policy" or NEP),that majority ethnic Malays and indigenous
peoples (which the GOM collectively refers to as "bumiputras",
literally "sons of the soil") be given a 30% equity interest in all
new business as part of the NEP's overall goal of lessening the
economic disparity between Malaysia's ethnic Chinese minority and
its Malay majority. Other incentives include freedom to source
capital globally, freedom to employ foreign workers within the
approved IDR zones contingent upon the amount of space occupied in
these areas, and an exemption from corporate taxation on activities
conducted within the IDR zone and outside Malaysia for 10 years from
commencement of operations. In addition, the cabinet is expected to
consider shortly a new competitive investor incentive package that
will be above and beyond the existing incentives and include more
tax holidays, exclusive land deals and even concessions.

Too Good to Be True?
--------------


5. The exemption from the NEP requirement that bumiputras be given
a 30% stake in new businesses was quite surprising because only
months ago policy makers had stood firm for the need to retain this
requirement. However, after the incentives were announced the Prime
Minister's influential son-in-law, Khairy Jamaluddin, was quick to
point out that the incentive package will not apply to all IDR zones
and will be applicable only to certain targeted sectors, such as
creative industries, educational services, financial advisory and

KUALA LUMP 00000787 002 OF 003


consulting, health, logistics and tourism. Moreover, in order to
qualify for the incentives, the companies must conduct their
business activities exclusively within the zones or outside Malaysia
and not compete with Malaysian companies for domestic business.
Analysts said the government may be using IDR as a test case for
gradually doing away altogether with the NEP's 30% bumiputera equity
interest requirement, which many believe has been a deterrent in
attracting FDI to Malaysia.

Certain Restrictions Lifted on Property Transactions
-------------- --------------


6. In a move to encourage purchases of Malaysian property,
especially in the IDR and high-cost condominium units in the city
center, Abdullah announced simultaneously that the government would
remove the real property gains tax (RPGT) throughout the country
beginning April 1. Under existing rules, foreign investors must pay
a property gains tax of 30% on the sale of property if the sale is
made within the first five years of the acquisition of the property.
In addition, Bank Negara lifted the limit on the number of credit
facilities a non-resident could use to fund the purchase or
construction of residential and commercial properties in Malaysia.
Previously, a non-resident was limited to three credit facilities
from local financial institutions for the purchase or construction
of property.


7. Analysts welcomed the announcements although they questioned
whether the relaxed rules will help correct the current over-supply
of property on the Malaysia market though they do believe these
moves will help promote investment in the IDR. In 2006, the number
of residential overhang was 25,645 units with a total value of RM
4.18 billion (USD 1.2 billion. Though the number of overhang has
increased, the overhang rate declined from 20.5% in 2005 to 17.7% in

2006. A Citigroup Research report noted, "We believe the latest
move sends a clear signal to the world that the government is aware
of rising competition and willing to take proactive steps to
compete. Judging from the series of initiatives ranging from tax
incentives to the lifting of employment restrictions for companies
in the IDR, it does appear that the political will is strong to
ensure its successful development".

New Car Sales Continue Their Decline
--------------


8. Meanwhile, sales of new vehicles in Malaysia, Southeast Asia's
largest passenger car market, fell 17% in March compared to the same
month last year, the 14th straight month that sales have declined.
Last year, new vehicle sales declined 11% to 490,768 units.
According to the Malaysian Automotive Association (MAA),it is
becoming harder for car owners to purchase new automobiles because
of the difficulties they are having selling their existing vehicles.
Nevertheless, the MAA said sales volume is expected to be
maintained for April as carmakers introduce new models and
incentives. Last year, the association had predicted car sales
would recover this year.


9. Econ FSN spoke with an automobile analyst who said vehicle sales
will likely be negative throughout this year. The analyst pointed
out that the government's National Auto Policy (NAP),which aims to
boost competitiveness in the domestic markets by cutting import
duties every year, is part of reason for the downward sales in
addition to costlier fuel, high tolls and difficulty that some
buyers experience in obtaining financing.

Glut of Used Cars
--------------


10. Another factor behind the slump in new car sales is the glut of
used cars on the market. According to one estimate, more than
600,000 used cars remain unsold in Malaysia, forcing almost one in
five used car dealerships to go out of business, scale down their
operations, or switch to other businesses. The situation has become
so dire that several car dealers' associations have called for the
GOM to consider giving car owners cash incentives to voluntarily
scrap old vehicles and purchase new ones. Under the proposal,
owners of cars more than 15 years old would be asked to exchange
these vehicles for a RM 5,000 (USD 1,461) voucher that could be used
as a down payment on a new car.

Proton Still Searching for Strategic Partner
--------------


11. The GOM missed its self-imposed March 31 deadline to name a

KUALA LUMP 00000787 003 OF 003


strategic partner for its ailing national car company, Proton
Holdings Bhd. Proton, which faces shrinking market share in an
increasingly competitive domestic market, has been reported to be in
talks with US-based GM Motors and German carmaker Volkswagen. Local
automotive companies like DRB-Hicom, Naza Group and Mofaz Group have
also expressed an interest in the partnership. Prime Minister
Abdullah, met with Volkswagen officials recently, said the talks
with VW are still on. Khazanah Nasional Bhd, the GOM's investment
arm, owns around 43 percent of Proton. Meanwhile, Proton adviser
and former Prime Minister Mahathir Mohamad commented that Proton's
new partner should be a local company, otherwise Proton will no
longer be a national car.

LAFLEUR