C O N F I D E N T I A L SECTION 01 OF 04 KUALA LUMPUR 000965

SIPDIS

STATE PASS USTR -- WEISEL AND BELL
STATE PASS FEDERAL RESERVE AND EXIMBANK
STATE PAS FEDERAL RESERVE SAN FRANCISCO TCURRAN
SINGAPORE PASS TO SBAKER
USDOC FOR 4430/MAC/EAP/M.HOGGE
TREASURY FOR OASIA AND IRS
GENEVA FOR USTR

E.O. 12958: DECL: 11/03/2018
TAGS: EFIN EINV ECON ETRD PGOV MY
SUBJECT: MALAYSIAN ECONOMY RESILIENT FOR NOW, SAY ECONOMISTS

Classified By: Economic Counselor Matthew J. Matthews for reasons 1.4 (
b) and (d)


1. (C) Summary: In the face of the global economic crisis,
Malaysia,s central bank has adjusted growth forecast for
2009 down to the 3-4 percent range while private sector
economic analysts now expect growth to fall below 3 percent
with a chance of recession in 2009 if U.S. demand for
Malaysia's exports continued to slide. The diversified
Malaysian economy is resilient and banks are well
capitalized, according to our contacts, but they see problems
as slower growth and falling oil prices could drive
Malaysia,s oil-revenue- dependent federal budget deficit to
six percent in 2009, substantially higher than the 3.4
percent figure projected when oil sold for $125 per barrel.
There are also concerns about potential problems at some of
Malaysia,s smaller banks, but these are viewed as
manageable. Views on the appointment of Deputy Prime
Minister Najib as Finance Minister were mixed but on balance
positive for the Malaysian economy, as Najib was perceived as
a more decisive leader than Abdullah with a willingness to
push reforms. Clearly, Malaysia needs to reform its economic
policies if it wants to move forward. However, Najib's level
of commitment to reform is an open question, as is the level
of support he has to carry it out. His first real test will
be his "Economic Stabiliztion Plan" which he is to announce
on November 4. This is expected to include liberalizations of
foreign investment restrictions in the property and services
sectors, but how deep they will go is yet to be seen. End
summary.

ECONOMIC OUTLOOK


2. (SBU) Sanjeev Nanavati, Managing Director for
Citibank,s Malaysia operations, told Econcouns October 30

that Bank Negara Governor Zeti informed foreign bankers in a
morning meeting that it was dropping its estimates for GDP
growth to the 3-4 percent range for 2009 due to concerns
about the impact of the global economic slowdown. Nanavati
said Citi,s internal estimate for GDP growth was below 3
percent for next year. Mohamed Ariff, Executive Director of
the Malaysian Institute for Economic Research, agreed that
Malaysia was headed for a sharp slowdown despite the fact
that export figures for August and September had remained
strong. Those export numbers were due in large part to U.S.
growth rates of 3.3 percent for the second quarter which
helped boost Malaysia's economic growth to 6.7 percent in the
first half of 2008. With the U.S. economy slipping into
recession, however, Ariff expects 3.9 percent growth for
Malaysia in the second half of 2008, resulting in a GDP
growth rate of 5.4 percent for the year as a whole. Malaysia
had a diversified economy with a large domestic sector, he
explained, but it was not completely insulated from the
global economy. The global economic crisis would catch up as
demand for Malaysian exports wilted. In fact, Ariff
predicted a 40 percent chance of a technical recession in
Malaysia in the second quarter of 2009 and a two-year period
of underperformance at less than 6 percent growth.

GOVERNMENT DEFICIT LIMITS FSCIAL OPTIONS


3. (SBU) Unfortunately, Ariff said, there was a limit to
what the GOM could do on the fiscal side to jump-start the
economy. The government had been running a fiscal
expansionary policy for the past ten years so most of the
projects with good economic multipliers already had been
done, other than a few that remained on hold in
opposition-controlled states. Moreover, the federal
government faced the need for increasing expenditures at a
time of decreasing revenues. Describing the GOM as
"oil-drunk," Ariff said the federal budget deficit could
increase to 6 percent or more over the next year with the
decrease in oil prices. Budget projections of a 3.4 percent
deficit for 2009 were based on an average price of $125 per
barrel. With approximately 40 percent of federal revenue
coming from Petronas, the national oil company, Ariff said

KUALA LUMP 00000965 002 OF 004


the recent oil price decline to around $60 per barrel would
translate to significantly lower federal government revenues
during a time when greater federal expenditures are needed to
boost the ailing economy. A 6 percent deficit level would
weigh heavily on Malaysia's sovereign rating, he said,
placing a real limit on fiscal policy space.

MALAYSIAN BANKING SECTOR HOLDING UP, FOR NOW


4. (SBU) Malysia's financial sector was essentially sound,
Ariff said, as it was well capitalized and had a low average
level of non-performing loans (NPLs) across the system.
However, the level varied widely from bank to bank, with
Public Bank and HSBC holding 1.6 and 1.8 percent NPLs
respectively and Affinbank and Ambank hovering at around 8
percent, and this was creating problems. As a result, Bank
Negara was closely monitoring banks, Ariff explained, calling
on the non-executive directors of boards in private to ask
how the banks really were doing and whether they had any
concerns. To date, Ariff said, the key test facing Bank
Negara has been managing the fact that depositors were moving
money from the weaker to the stronger banks, leaving the
weaker banks cash-strapped and the stronger ones awash with
more money than they knew what to do with. The central bank
had decided not to force them into further mergers, Ariff
said, because the bigger Malaysian banks had "not yet
digested" the last round of consolidations in 2000-02. Dr.
Yeah Kim Leng, Managing Director and Chief Economist for
Rating Agency Malaysia, agreed. It was much more likely that
Bank Negara would prop up the weaker banks than let them
fail. At present, Yeah said Bank Negara has deemed it
sufficient &to encourage8 inter-bank lending, offering
&assurances8 to the highly liquid banks but not outright
guarantees. While banks were cautious, Malaysia was not
suffering from some of the inter-bank lending problems of
some other countries. Citi,s Nanavati also felt Malaysia,s
banking system was fundamentally sound, although he did not
exclude the possibility that there would be a few
&stumbles8 for Bank Negara to handle in the coming year.

WEAKEST LINK: PROPERTY SECTOR


6. (SBU) For now, property was the most vulnerable sector
in the economy and, with real estate representing much of the
collateral backing loans, a property-induced spike in NPLs
could weigh heavily on the banking sector, according to
Ariff. The property sector had not crumbled yet, Ariff said,
but could cave in, especially commercial properties. Landed
properties would fare much better than condos where years of
overbuilding had left much unsold space. During the 1997-98
Asian Financial Crisis the GOM established special purpose
vehicles to buy up properties to keep the sector from
collapsing; these had since been disbanded but the GOM could
recreate them if necessary. Yeah noted that several listed
corporations had come under pressure

GOVERNMENT RESPONSE ONGOING


7. (C) The Economic Council, established by Prime Minister
Abdullah in August primarily to deal with the spike in
inflation, has shifted its focus to dealing with the global
economic slowdown, according to Yeah. It established
subcommittees to address capital markets, services,
manufacturing, logistics, and several other areas. Yeah said
several major measures were under consideration by the
Council, including liberalization of the services sector as a
means of stimulating private investment. Several weeks ago
Dr. K Govindan, Head of the Private Sector Development Center
located in the Economic Planning Unit (EPU) of the Prime
Minister's Department, explained that the full council met
monthly, including Ministers and a contingent from the
private sector, but smaller executive committee meetings were
held weekly, and these were where the real decisions were
made. EPU staff and other interested parties presented
various studies and papers on various issues such as
subsidies, government procurement, education, controlling

KUALA LUMP 00000965 003 OF 004


government expenditures, energy security, and tax reform.
However, only a handful of Ministers were "supportive of good
ideas," Govindan said. When pressed, he named Domestic Trade
and Consumer Affaires Minister Shahrir Samad, Deputy Prime
Minister Najib, Minister of International Trade and Industry
Muhyiddin, and his own boss, Minister in the Prime Minister's
Department Amirsham Abdul Aziz.

NEW LEADERSHIP AT MOF


8. (C) Minister of Finance II Nor Yakcop tended to be
among those most opposed to any kind of reform, Govindan
said, but according to Yeah, Najib sidelined Yakcop after he
took over as Finance Minister I. When Najib became Prime
Minister he would hold onto the Finance Minister portfolio,
Yeah said, and likely would play a much more active role than
the current PM. When asked whether Najib was likely to
follow through on his recent promises to review Malaysia's
restrictions on foreign investment in the property and
commercial sectors and to liberalize the services sector,
Yeah was much more optimistic than Ariff. Yeah said Najib
would have to do so if he wanted to be anything more than a
transitional Prime Minister. Ariff, on the other hand,
expected Najib to accomplish little in the way of serious
economic reform, as he would face intense opposition from
vested interests within his party and even Yeah noted that
Najib's reputation for corruption could undermine his
credibility as a force for reform. Najib will have his first
chance to strengthen his credibility as a reformer when he
announces a package of economic measures on November 4.
Alluding to the package in a press interview last week, Najib
suggested that the services sector should be liberalized and
that the Foreign Investment Committee guidelines on the
"proprty and commercial sectors" should be "reviewed." Mr.
Phang Ah Tong, Director for the Americas at the Malaysian
Industrial Development Authority's Foreign Investment
Promotion Division told Econoff that he believed Najib would
lower foreign investment thresholds for the residential and
commercial property sectors, but that liberalizing the
services sector would be more complex and probably would be
implemented in stages.

FIXING THE RACE-BASED ECONOMIC POLICIES


9. (C) Ariff was even more skeptical about Najib's comments
during an interview with Bloomberg that he supported "gradual
liberalizations" of the New Economic Policy (NEP) with
implementation of "elements in the not-too-distant future."
(Note: The NEP is a system of race-based economic
preferences that pervade all aspects of the Malaysian
economy. End note.) A day after his first statement to
Bloomberg, Najib began to backtrack, telling Malaysian
reporters that "elements would not be abolished" but that
there would be some "liberalizations in stages." Ariff said
there were too many hardliners within the party who saw these
race-based preference policies as the foundation of their
power. A Najib/Muhyiddin team as PM/DPM would accomplish
little and would be short-lived, with the opposition winning
the next election, Ariff said. Yeah was a bit more
optimistic, believing that Najib and Muhyiddin both knew that
if they did not become a transformational team they would be
only a transitional team. Malaysia could not move forward
without fixing the NEP, he said, which formed a glass ceiling
on Malaysia's economy. He pointed out that, since Najib's
father had been the one to implement the racial preferences,
the son was the appropriate person to undo them, and that
Najib "had the guts to do it." Sharing Yeah,s more
positive view, Govindan said what the Malaysian economy
needed first was an open consultation process which included
the private sector, unhindered by the Official Secrets Act.
Second, Malaysia needed a "decisive executive" who would make
sure the bureaucracy delivered and he described Najib as
"decisive." He added that Najib would be supported by
Amirsham, former CEO of Maybank, who also favored
liberalization of the private sector.


KUALA LUMP 00000965 004 OF 004


COMMENT:


10. (C) Malaysia spent the first several months of the
economic crisis constantly stating how it was insulated and
unaffected. However, Bank Negara privately has acknowledged
that the economy would face a sharp downturn in 2009. Its
revised estimates will likely be made public after November

4. The GOM also has taken measures to provide precautionary
stabilization for the banking sector through the expansion of
deposit insurance as well as its intention to move on a set
of liberalization measures to be announced on November 4. If
the government puts together a proper package of reforms, it
will send a positive signal that it understands the need to
take a proactive approach to the global slowdown. This will
be a key early test for Najib in his role as Finance
Minister.
KEITH