Ringgit Rises as Proton Flounders: Malaysia Economic Update for May 2007

UNCLAS SECTION 01 OF 03 KUALA LUMPUR 000964

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E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD EPET MY
SUBJECT: Ringgit Rises as Proton Flounders: Malaysia Economic Update for May 2007



1. Summary:

- Malaysia's currency continued its gradual rise against the U.S.
dollar to reach a near 10 year high.

- The Malaysian cabinet, reacting to loud protests from non-Malays,
ordered the country's largest commercial bank to withdraw a
requirement that law firms conducting business with the bank have at
least one Malay partner with at least a 50% equity interest.

- Malaysia has proposed building a trans-peninsula crude oil
pipeline to ease congestion in the Straits of Malacca and to provide
an alternative route for getting Middle East oil to buyers in East
Asia.

- At the 4th Malaysian International Halal Showcase Prime Minister
called on Malaysian producers of halal food to improve their
practices in order to boost the country's goal of becoming a "halal
hub".

- A GOM official said the government will not bail out Proton,
Malaysia's national carmaker, which continues to bleed cash as it
searches for a foreign strategic partner.

End Summary.

The Ringgit Strengthens to 10-year High
--------------


2. The Malaysian ringgit rose to a near 10-year high of 3.388 to
the U.S. dollar on May 21, appreciating 0.13% soon after China
raised interest rates and widened the yuan trading band to a range
of 0.5% from 0.3% previously. The currency also broke the
psychological barrier of 3.4 to the dollar. Since early January,
the ringgit has gained 4.1% against the U.S. dollar but has
depreciated 2% against the yuan and most of other regional
currencies. The Malaysian currency had been pegged at a rate of 3.8
to the dollar from September 1998 (in the wake of the Asian
financial crisis) to July 2005, when the GOM announced that it would
allow the currency to appreciate by switching to a managed float
system.


3. Bank Negara Governor Zeti Akhtar Aziz rushed to clarify that the
ringgit was moving in line with the Malaysian economy and not in
tandem with the yuan. However, many traders and speculators thought
otherwise, saying that as long as the yuan strengthened they would
rush to buy ringgit in anticipation of the ringgit's appreciation.
Governor Zeti said on May 29 that the central bank is not targeting
the ringgit to appreciate to any specific level but to move in an
orderly manner in line with market conditions.


4. Analysts generally expect the ringgit to continue strengthening,
possibly to between 3.35 and 3.3 against the U.S. dollar by
year-end, and at a pace tempered by Bank Negara's cautious
intervention. Many local analysts also believe that the ringgit
remains competitive with other regional currencies, though Rating
Agency Malaysia's (RAM) chief economist Yeah Kim Leng said the
government's current strong ringgit policy encourages speculators to
enter the currency market. For the first two weeks in May alone,
Malaysia's foreign reserves rose by nearly USD 3 billion to USD 94.5
billion, equivalent to 8.6 months of retained imports and 9.6 times
the short-term external debt.

Largest Local Bank Withdraws Race-Based Lawyer Rule
-------------- --------------


5. The Malaysian Cabinet has ordered Maybank, the country's largest
commercial bank, to withdraw a requirement that law firms conducting
business with the bank have at least one bumiputera partner and that
bumiputera partners collectively hold at least a 50% equity stake in
the firm ("bumiputera", literally "sons of the soil", is a term the
GOM uses to describe majority ethnic Malays and Malaysia's minority
indigenous tribe people, mainly as means of distinguishing this
group from Chinese-Malaysians and Indian-Malaysians). Following the
Cabinet's order, Maybank issued a statement saying that with
immediate effect all solicitor firms, whether with bumiputera or
non-bumiputera equity ownership, are eligible for consideration to
do business with the bank.


6. Maybank had earlier sent letters to lawyers demanding compliance
with the bumiputera equity requirement if they wanted to be or
remain on its legal panel, generating much controversy and criticism
from the non-bumiputera community as being discriminatory. After
loud protests from the Malaysian Chinese Association (a component
party of the ruling Barisan Nasional, or National Front, party) as
well as the Associated Chinese Chamber of Commerce and Industry and
the Malaysian Bar Council, the Cabinet decided at its weekly meeting
on May 9 to order Maybank to withdraw the policy. The opposition
party Democratic Action Party (DAP) took the opportunity to call for
the public's support for a boycott of the bank. Senior government
officials from the Central Bank and the Ministry of Finance denied
the government had anything to do with the race-based requirement
issued by Maybank, a government linked corporation (GLC) that is
2/3rds owned by other GLCs.

Malaysia's Ambitious Oil Pipeline Project
--------------


7. Malaysia has proposed building a 320 km trans-peninsula crude
oil pipeline from Yan, in Kedah state in northwestern peninsular
Malaysia, to Bachok, a town in Kelantan state in northeastern
peninsular Malaysia. The project is expected to kick-off with a USD
2.3 billion pipeline with a capacity to transfer two million barrels
of oil per day. The project eventually would include three
pipelines with a total cost of USD 7 billion. Syed Izhar Al-Idrus,
the director of the project's promoter, Trans Peninsula Petroleum
Sdn Bhd (TPP),said the pipeline will provide an alternative route
for transporting crude oil from Middle East suppliers to buyers in
East Asia. It is also expected to help ease congestion in the busy
Straits of Malacca. Kuala Lumpur-based construction giant Ranhill
Berhad announced on May 28 that its subsidiary, Ranhill Engineers
and Constructors Sdn Bhd, has entered into an agreement with TPP and
Jakarta-based P.T. Tripatra Engineers and Consultants for the
design, engineering, procurement, construction and testing of the
project, which is expected to begin in 2008 and be completed in

2014.
PM Exhorts Halal Industry to Achieve Best Practices
-------------- --------------


8. Prime Minister Abdullah has called on Malaysian producers and
manufacturers of halal food (i.e., food prepared in accordance with
or permitted under Islamic law) to meet the GOM's best practice
requirements in safety, health and quality in order for Malaysian
halal brands to achieve premium status. Abdullah, who attended the
May 10 opening of the 4th Malaysian International Halal Showcase
(MIHAS 2007),said achieving these requirements will boost
acceptance and marketability of halal food to non-Muslim markets.
Malaysia's commitment to become a "Halal Hub", which was set forth
in the Ninth Malaysia plan and the Third Industrial Master Plan,
includes engaging local universities to develop and offer academic
programs in halal related areas.


9. The organizer of MIHAS 2007 said exhibitors at this year's
convention recorded RM 213.9 million (US 63 million) in immediate
sales as a result of their participation compared with RM 168
million (US 49.4 million) in sales at last year's convention,
prompting many exhibitors to place bookings for next year's event.
The official said MIHAS is planning to pull together resources from
the government and private sector to cover a wider span of economic
activities related to halal products, from farming, manufacturing,
and processing to the importing and exporting of commodities and
finance.

Proton Desperately Seeking Savior
--------------


10. On May 22 Second Finance Minister Nor Mohamed Yakcop said the
Malaysian government will not bail out Proton Holdings Bhd (Proton),
creating even more pressure for the ailing carmaker to find a
strategic partner. Proton, which has been engaged in talks with a
number of potential foreign players including General Motors,
Volkswagen and, PSA Peugeot Citroen, saw its cash reserves dwindle
from RM 3 billion ringgit ($882 million) at year-end 2004 to an
estimated RM 500 million at present with some analysts predicting
that the company will be cashless by 2008 if not sooner. On May 31
Proton announced a loss for the quarter ending March 31, the fourth
straight quarterly loss. Also on May 31, Prime Minister Abdullah
Badawi announced the effective end of talks between Volkswagen and
Proton, reportedly due to Volkswagen's lack of interest in the
equity terms Proton was willing to offer.


11. The brainchild of former Prime Minister Mahathir Mohamad,
Proton has seen its market share slide to 32% from 60% at the start
of the decade and shrinking almost 10% in 2006 alone. This is
having a devastating effect on Malaysia's major Proton dealerships,
93% of whom did not break even in the first quarter of 2007,
according to Proton Edar Dealers Association Malaysia president Wan
Ahmad Sepwan. According to industry insiders here, Proton, which is
43%-owned by the GOM via Khazanah Nasional Bhd, is hamstrung when it
comes to major decision making due to lack of direction at the top.
Corporate management does not feel it has government support to make
policy changes, while the government appears to be afraid of a
political backlash if it pushes for cost reducing layoffs or appears
to give too many concessions to potential foreign partners.


12. A manufacturing executive who supplies the industry said
Proton purchasing agents cannot even get approval to make major
parts buys in a timely fashion. Both executives cited quality
control as a pervasive and intractable problem for Proton. The
industry representative told us how he once saw two Proton quality
control inspectors wearing full tool belts lean over the hood of a
finished vehicle. One inspector subsequently tossed a clipboard
across the hood of the vehicle to his partner, thereby scratching
the paint. The executives reported that both of their firms have
offered quality control training to Proton in the past, but the
lessons never seem to make it from the classroom to the factory
floor.

LAFLEUR