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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