IMPACT OF RISING FOOD/COMMODITY PRICES - MALAYSIA

UNCLAS SECTION 01 OF 05 KUALA LUMPUR 000357

SENSITIVE

SIPDIS

STATE FOR EEB/TPP/ABT/ATP - JANET SPECK
STATE ALSO FOR EAP/MTS, EAP/EP AND OES
TREASURY FOR OASIA
STATE FOR USTR - WEISEL AND BELL
STATE FOR FEDERAL RESERVE AND EXIMBANK
STATE FOR FEDERAL RESERVE SAN FRANCISCO TCURRAN
USDOC FOR 4430/MAC/EAP/BOYD

E.O. 12958: N/A
TAGS: EAGR EAID ECON ETRD PGOV PREL SENV MY
SUBJECT: IMPACT OF RISING FOOD/COMMODITY PRICES - MALAYSIA

REF: STATE 39410

KUALA LUMP 00000357 001.11 OF 005


Summary and Introduction
--------------


1. (U) Rising global prices for major food commodities so far are
having limited impact on their availability to Malaysian consumers.
Long-standing price controls on many food staples have kept such
items affordable, but have also contributed to some spot shortages.
While it is only about 65% self-sufficient in rice production, the
country's major sources of imported rice (Thailand and Vietnam) as
well as other food crops have remained reliable. However, Malaysia
produces neither wheat nor soybeans, and imports about 87% of its
corn demand. The government is increasingly treating the issue as a
critical problem at the cabinet level, and is devoting significant
additional resources to mitigate its potential impact. The
government has responded to recent global price increases by
announcing an expensive new program to increase domestic rice
production (along with fruit and vegetable cultivation),primarily
in the East Malaysia states of Sabah and Sarawak. The government
claims that new paddy cultivation in those states will not adversely
impact remaining rain forest on Borneo.


2. (SBU) The government's new plans followed its electoral drubbing
in the March 8 national elections. Malaysia's increasing inflation
rate, and widespread concern that the government would be decreasing
subsidies (particularly for fuel, but also for food commodities),
contributed to the ruling coalition's poor showing. The money being
allocated to East Malaysia reflects the large amount of uncultivated
land available there to increase food production; it also rewards
two states that were crucial to maintaining the government's
parliamentary majority. The government is likely to maintain and
even increase its support levels to keep a lid on prices, and its
relatively strong financial situation should allow it to continue
doing so for some time. However, long term subsidies will probably
not be sustainable, especially if the government budget deficit
persists. Malaysia's newly-energized political opposition will keep
the focus on government action to address rising prices. However,
we do not believe rising food prices will result in social
instability or unrest. Although the opposition may try to exploit
the issue, food price inflation will not likely play a major role in
the post election political drama playing out in Kuala Lumpur.

Demand
--------------


3. (U) Rice, wheat, corn and soybeans are the principal agricultural
commodities consumed in Malaysia. Corn is used mostly for feed, and
soybeans are used for both feed and food. Malaysia is a net
importer of these commodities; of the four commodities, only rice is
produced domestically to a significant extent. Malaysia is about
65-70% self-sufficient in rice and about 13% self-sufficient in
corn; neither wheat nor soybeans are grown domestically. There has
been no recent discernable change in consumption patterns in
Malaysia for these commodity crops.


4. (U) Each Malaysian adult consumes an average of 77 kg of rice a
year. Malaysia has long controlled the retail price of standard
grade rice, which currently ranges between RM1.60 (US$0.50) and
RM1.80 (US$0.56) per kilogram. This policy largely shields lower
income Malaysians from the effects of rising global rice prices; the
consumption of this grade of rice is estimated to be around 30% of
the total national consumption. Prices of uncontrolled rice
varieties, consumed by middle and higher income Malaysians, have
risen over the past two years. For example, the price of "Fragrant"
rice rose about 5% in 2007 and another 5% in the first quarter of
2008 and "Basmati" rice rose in price by 15.2% in 2007 and by 11.7%
in the first quarter of 2008. Malaysia has a relatively high per
capita income (USD 6721 in 2007),a result of strong economic growth
over several decades; steadily rising income has not significantly
affected short term food consumption patterns.


5. (U) Rice imports to Malaysia are sourced primarily from Thailand
and Vietnam, and average between 650,000 and 700,000 tons annually.
BERNAS, a government-linked corporation, regulates the rice industry
in Malaysia under authority granted to it by the government. BERNAS
is the "buyer of last resort" for paddy farmers as well as the sole
importer of rice for the country. BERNAS handles about 40 - 50% of
Malaysia's total rice supply. The government is considering a
proposal to give it sole authority to monitor and ensure that paddy

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land is used only for planting rice.

Supply
--------------


6. (U) Although Malaysia is not experiencing major shortages of
commodities yet, higher input costs have narrowed profit margins,
especially for crops like rice that are subject to price controls.
The government has announced plans to increase the country's rice
production to meet possible future shortages, however, including a
RM 4 billion (USD 1.3 billion) plan to plant rice and vegetables in
East Malaysia.


7. (U) Wheat is not produced in Malaysia. The Malaysian government
controls certain domestic wheat prices; it last allowed price
increases for retail general-purpose wheat flour in May 2007 (the
first increase in a decade). That price hike, and price increases
for wheat types not subject to control, has not impacted wheat
consumption, although millers and commercial bakers have complained
about narrow margins and losses.


8. (U) Malaysia imports about 87% of its corn supply. Soybean is
not cultivated in the country. Malaysia depends heavily on feed
imports for its livestock sector. While the cost of feed has risen
some 20% in the past year, prices of pork and poultry have also
risen, mitigating the effect of higher feed costs on farmers.


9. (U) Products derived from oil palm cultivation constitute
Malaysia's most significant agricultural export commodity (rubber
and cocoa also are important export commodities). Not surprisingly,
oil palm is the only Malaysian crop that has experienced significant
growth as a result of increased global prices. Malaysian palm oil
exports in the first quarter of 2008 were up 23% from the first
quarter of 2007.

Political Impact
--------------


10. (SBU) It is unlikely that higher food process will lead to
social instability or unrest, but rising food prices come at an
extremely inconvenient time for the ruling UMNO party, still reeling
from its shocking setbacks in the March 8 elections. Although
opposition sources privately have told us they understand the
government's no-win situation, we do not doubt that the resurgent
opposition will try to make political hay by allowing the government
to take the blame for rising prices. The GOM may be aware that new
subsidies are probably not sustainable over the long term, but, with
public confidence already at a low point, the leadership will be
anxious to prevent further erosion of support due to perceived
inaction on the price increases.

Economic Impact
--------------


11. (U) Prices of food and other commodities are rising in Malaysia.
The consumer price index (CPI) rose to a 13-month high of 2.8%
year-on-year in March from a low of 1.4% in June 2007. For January
to March, the CPI increased 2.6% year-on-year. Food and
non-alcoholic beverages recorded the most significant increase of
4.9%. The index including housing, water, electricity, gas and
other fuels rose 1.3%, and the transport index rose 0.9%.
Malaysia's inflation rate remains relatively low compared to some of
its neighbors, such as Singapore and Vietnam.


12. (U) As Malaysia's inflation is cost-pushed, the pass-through of
global prices into domestic prices was somewhat mitigated by several
factors including the strengthened ringgit, which has appreciated by
5.3% to RM 3.15 against the dollar since the beginning of 2008.
Also, food accounts for 31.4% of the basket of goods for measuring
price increases in the CPI, which includes price-controlled food
items such as cooking oil, chicken, bread, flour, sugar, salt,
preserved fish and locally produced rice. In 2007, the government
spent RM 53 billion (USD 17 billion) to subsidize oil and gas, which
helped to alleviate the cost of production and transportation. That
amount ended up being much higher than the preliminary forecast of
RM 40 billion for 2007, and the figure is believed to be climbing
still in response to global crude oil price increases (though more
recent statistics are unavailable). After its poor showing at the
polls in March, the government has delayed its plan to cut subsidies
on domestic fuel, though it is considering a plan to reallocate fuel

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distribution so that the subsidies are tilted towards lower income
consumers.


13. (U) Mohamed Ariff, executive director of the Malaysian Institute
of Economic Research, recently warned that food prices would
continue rising if recent trends towards cultivation of biofuel
crops, and conversion of rice fields to other uses, continued.
However, the Institute recently revised downwards the inflation
forecast from 3.5% to 3% for 2008 as the government has indicated
that it will not substantially reduce its oil subsidy. Bank Negara
expects inflation to be contained at between 2.5 to 3% this year.


14. (U) Bank Negara is expected to keep its policy intervention rate
unchanged at 3.5%. Despite the recent upturn in inflation, the
banking system is flush with excess liquidity as the economy shows
signs of slowing growth. Bank Governor Zeti Akhtar Aziz has
indicated reluctance to increase interest rates to discourage food
price increases; rather, she has said Malaysia and other countries
need to increase supply, improve distribution, and improve the
incentive structure for food producers.


15. (U) Malaysia enjoys a strong current account surplus, amounting
to RM99.4 billion (USD 31.6 billion) in the balance of payments in

2007. The higher costs of importing wheat, rice, sweet corn and soya
bean, which accounted for 5.3% of total imports in 2007, is not
likely to have a significant impact on the goods account and the
balance of payments. Moreover, increased exports of palm oil due to
rising prices and a stronger ringgit should offset somewhat the
higher costs of imports.

Increasing Rice Production in Eastern Malaysia
-------------- -


16. (U) To reduce Malaysia's partial dependency on imported rice,
the government of Malaysia (GOM) recently announced plans to
identify suitable land for large-scale rice cultivation in the East
Malaysia states of Sabah and Sarawak. Sabah Department of
Agriculture Senior Research Officer Datin Elizabeth Malangkig
explained to ESTHoff that Sabah will identify for new rice
production idle land that is already earmarked for agricultural
production. Sabah is currently just 35% self-sufficient in rice
production, but hopes to be 60% self-sufficient by 2010. In
addition to encouraging increased acreage under rice cultivation,
the state government also plans to install irrigation systems in
existing rice paddies to increase rice yield to two or three
harvests a year; most such paddies now are cultivated only during
the rainy season. For instance, in Sabah's four main rice paddy
districts (Kota Belud, Tuaran, Papar and Penampang),10,000 out of
13,854 acres only produce rice during the rainy season.


17. (U) Though it is Malaysia's largest state, Sarawak is thinly
populated and has greater agricultural potential in comparison to
much of peninsular West Malaysia. Sarawak Land Development Minister
Datuk Seri Dr. James Masing has emphasized that no trees will be
felled nor forests cleared for paddy planting. He claimed that
forests do not exist on the flat land that has been identified for
new paddy cultivation. Sarawak currently has five million hectares
identified for rice cultivation, located in the coastal areas of
Paloh in central Sarawak, the Rajang River delta, and in parts of
Limbang and Lawas in northern Sarawak. In a recent trip to the
state, MOA Minister Mustapa Mohamad noted Bintangor as having the
greatest potential for big farming projects.


18. (U) Developing Sarawak into a rice cultivation center poses many
challenges, as its geography includes a mix of swampy coastal areas,
narrow and hilly rural areas and a mountainous interior.
Nevertheless, on April 27 Sarawak Chief Minister Taib Mahmud
announced plans to combine large parcels of state land with nearby
private land to create large paddy estates, which will provide
Malaysia with "total food security in the long-run." Taib claims
that the move to estate rice farming would benefit current
landowners, who would become shareholders in the larger estates, as
well as corporate investors and the government.

Environmental Impact
--------------


19. (U) Both Sarawak and Sabah's rice cultivation plans have raised
concern among environmentalists. Increasing rice production in East
Malaysia could impact the world's second largest rainforest. In

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early April, the governments of Malaysia, Indonesia, and Brunei
Darussalam agreed to a tri-national Heart of Borneo (HOB) strategic
plan of action to preserve this fragile ecology from further
deforestation and fragmentation due to logging and palm oil
plantations. A major increase in rice cultivation through large
paddy estates constitutes another potential threat to the HOB.


20. (U) The GOM's call for increased rice production has spurred
current rice-producing states in West Malaysia to find ways to meet
this demand. The Kemubu Agricultural and Development Authority
(Kada) in the northern state of Kelantan recently requested RM18
million (USD 5.7 million) from the Ministry of Agriculture (MOA) to
buy fertilizer and lime to treat the soil and improve yields, which
the MOA has approved. In Kota Bharu near the Thai border, paddy
farmers cultivate rice on land with high soil acidity, which
prevents high rice yields. By treating the soil before the next
planting season, farmers hope to boost their yields by as much as 20
per cent. The long-term environmental impact increased
fertilization will have on the local ecology represents an area for
environmentalists to monitor in the future.

Government Policy Response
--------------


21. (U) The GOM has announced that the ceiling retail price of
standard grade rice will remain at current levels in order to ease
the burden on lower income Malaysians. Although the government does
not directly subsidize locally-grown rice, it spends a considerable
amount on fertilizer and other concessions to rice farmers to help
control prices. This type of government support for rice farmers
increased from RM800 (US$250) million in 2006 to RM900 (US$281)
million in 2007.


22. (U) The Cabinet Committee on Inflation, which includes all
relevant ministries, has been meeting regularly to consider possible
approaches to mitigating the impact of inflation, in particular
regarding food (though the committee is also addressing other
sectors such as steel, where import restrictions are contributing to
higher prices). Domestic and Consumer Affairs Minister Shahrir
Abdul Samad recently stated that the government soon would adopt new
measures to tackle rising food prices. Shahrir said the government
is working on raising production of and narrowing subsidies on
locally produced basic foodstuffs. He ruled out for now the
introduction of a special subsidy on imported rice, which is not
subject to price controls (though import prices are managed through
BERNAS' monopoly). Sharir has also indicated that Malaysia is
considering a direct subsidy for domestic rice production. Such a
subsidy would be in addition to the RM 4 billion recently announced
by the Prime Minister to increase rice production in Sarawak and
Sabah, which by itself represents a significant increase in
government funding (though such new production would not have an
impact in the short term).


23. (U) On May 6 Minister of Agriculture Datuk Mustapa Mohamed
announced that BERNAS had been instructed to raise by 9000 tons (to
20000 tons) the monthly supply of standard grade rice. He added that
the price of this rice variety will remain the same. Mustapa added
that Malaysia has a stockpile of 550,000 tons of such rice
(sufficient for three months). To counter the increased temptation
to smuggle this relatively-low priced rice to Thailand and other
countries, the Ministry of Domestic Trade and Consumer Affairs is
stationing more enforcement offers at border crossings.


24. (U) Second Finance Minister Nor Mohamed Yakcop has expressed
concern about the increasing cost to the government of subsidies,
for both fuel and food. He has noted that the increased government
spending on subsidies makes it more difficult to achieve the
targeted fiscal deficit reduction to 3.1% of GDP, which would be a
reduction from the 2007 fiscal deficit of 3.2%.

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


25. (SBU) Reliable suppliers, the appreciation of the ringgit, and
Malaysia's relative wealth compared to its neighbors has insulated
the population somewhat from rising global food prices. Wealthier
Malaysians have so far been able to absorb rising prices, while
lower-income Malaysians have benefited from price controls on staple
food items. Much more attention has been focused in Malaysia on
long-expected changes to government subsidies on fuel, which receive

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significantly more funding than food subsidies. However, the
government's budget deficit means that large subsidy increases will
not be sustainable over time. The government's imposition of price
controls has caused in the past occasional shortages of such
products as sugar and cooking oil (shortages that were due in part
to smuggling to Singapore and Thailand). It is probably only a
matter of time before rice shortages appear as well. But given the
close attention Malaysia's newly-energized opposition is giving to
the issue, the government will find it difficult to enact more
fiscally-responsible policies in the near term.


KEITH