VZCZCXRO5950
RR RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHKL #0357/01 0612302
ZNR UUUUU ZZH
R 022302Z MAR 06
FM AMEMBASSY KUALA LUMPUR
TO RUEHC/SECSTATE WASHDC 6051
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHGV/USMISSION GENEVA 1343
RUCNASE/ASEAN MEMBER COLLECTIVE

UNCLAS SECTION 01 OF 05 KUALA LUMPUR 000357 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
TREASURY FOR OASIA AND IRS 
STATE FOR USTR - WEISEL AND BRYAN 
STATE FOR FEDERAL RESERVE AND EXIMBANK 
STATE FOR FEDERAL RESERVE SAN FRANCISCO TCURRAN 
USDOC FOR 4430/MAC/EAP/BOYD 
GENEVA FOR USTR 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV EPETPGOV PREL MY
SUBJECT:  Fuel Prices, Interest Rates, FDI, and Inflation 
All On The Rise - Malaysia Economic Update - February 2006 
 
 
¶1. U) Summary:  The biggest news arrived at the end of 
the month when the government of Malaysia (GOM) 
announced a 23% hike in gasoline and diesel prices. 
Earlier in the month, Bank Negara - Malaysia's central 
bank - announced another overnight policy rate hike to 
help control inflation and discourage capital outflows. 
Malaysia's overall FDI increased by 37% in 2005, with 
the U.S. the top investor at $1.1 billion.  The GOM 
decided to postpone indefinitely the looming Goods and 
Services Tax because neither government nor industry 
was ready to implement such a far-reaching change.  The 
9th Malaysia Plan -- Malaysia's tribute to Soviet era 
economics -- will be delivered next month.  We also 
include a "man on the street" view of the Malaysian 
economy to put some of these changes into perspective. 
End Summary. 
 
Fuel Prices Rise 23% 
------------------------------ 
 
¶2. (U) On February 28, the government of Malaysia (GOM) 
raised the price of gasoline, diesel, and liquefied 
natural gas by RM 0.30 ($.08) per liter or 23%. 
Gasoline now costs RM 1.92 ($.51) per liter; diesel 
costs RM 1.58 ($.42) per liter; and liquefied petroleum 
gas, or household cooking gas, costs RM 1.75 ($.47) per 
kilogram. 
 
¶3. U) This is the single highest price increase in 
recent memory and the fifth in the past two years. 
Gasoline prices are 42% and diesel prices are 102% 
higher than the levels in May 2004.  GOM has promised 
consumers that this will be the only petroleum price 
hike this year.  Despite the recent increases, 
Malaysians still pay less at the pump than any other 
ASEAN nation, with the exception of Brunei.  That is 
due to the remaining high fuel subsidies that the 
government pays on behalf of its consumers.  Prime 
Minister Abdullah suggested in a press conference that 
the price would be more than RM 2.50 per liter should 
the GOM remove all forms of subsidy entirely. 
 
¶4. (U) Although Abdullah tried to downplay the 
inflationary effects of the price hike, analysts 
announced that inflation may rise by 3.5% to 3.8% 
during 2006 due to higher transportation costs and pass 
through effects to other parts of the economy.  For 
example, Jamarulkan Kader, the President of the 
Malaysian Muslim Restaurant Owners Association 
predicted that a plate of fried noodles would rise by 
RM 0.50 ($0.13) per plate to RM 3.00 ($0.80 -- a 25% 
increase) at hawker stalls.  Although the 2000 members 
of the groups may wait awhile to increase prices, Kader 
expects that most will do so over the next few months. 
Malaysian truckers did not have any such hesitation and 
announced immediate transportation rate increases.  The 
Pan-Malaysian Lorry Owners' Association enacted a RM 
0.15 ($0.04) per kilometer fuel surcharge on March 1. 
 
¶5. (U) Minister of Domestic Trade Shafie Apdal promised 
that the impact of the fuel increase would only be 0.12 
percent.  He suggested that he would accomplish this by 
coming down hard on merchants who hike prices 
unnecessarily, revoking their licenses if need be. 
Yet, in the same press conference, Shafie also 
announced that 285,000 bus operators and taxi drivers 
would be given cards entitling them to subsidized 
diesel. 
 
¶6. (U) Abdullah defended the price hike by explaining 
the GOM will save RM 4.4 billion ($1.2 million) in 2006 
by not having to pay fuel subsidies.  Due to the rise 
in global oil prices over the past year, the GOM found 
itself unable to sustain its program of fuel subsidies, 
deficit reduction, and public project spending.  GOM 
paid RM 15 billion ($4 billion) last year and expected 
to pay RM 16 to RM 20 billion ($4.27 to $5.33 billion) 
this year.  Also, with the 9th Malaysia Plan due for 
roll out in one month, the GOM may be looking for a 
funding for long-term development programs even though 
Malaysian consumers seem much more concerned with 
 
KUALA LUMP 00000357  002 OF 005 
 
 
inflation at the moment. 
 
¶7. (SBU) Exxon Mobile's Chief Financial Officer 
explained to the Economic Counselor that the GOM is 
actually taking in a small "profit" on gasoline after 
the latest price hike.  The subsidies that the GOM has 
historically paid out are composed of two pieces:  a 
transfer payment for the consumer (given to the 
consumers through artificially low prices and repaid to 
the oil seller by the government) and foregoing sales 
tax on fuel.  In the recent past, the GOM was paying 
the subsidy and foregoing all of its potential tax 
revenue.  The price increase has now moved gasoline 
prices into the range where the government will be 
collecting a small amount of tax on each sale. 
Diesel fuel, however, will remain at a low enough price 
that government will still be paying out subsidy 
support, in addition to foregoing tax revenues. 
 
8) (SBU) Another concern for the GOM is its status as a 
net oil exporter.  Deputy Prime Minister Najib, in a 
March 1 television interview, admitted that Malaysia 
could become a net oil importer in as few as 4 years. 
He cited the need for conservation and to change the 
Malaysian lifestyle as another reason to raise the fuel 
prices.  (Comment:  Industry insiders have been aware 
that Malaysian national oil company Petronas scrapes 
the bottom of the wells to pump the 650,000 barrels per 
day required to remain a net exporter.  Najib's 
comments are the first on record statement about this 
looming challenge.  The GOM has long relied on Petronas 
as a cash cow for the nation.  Petronas provides about 
25 percent of the national budget, takes up the slack 
when there is a need for national infrastructure (the 
Petronas Towers are a national symbol of Malaysia), and 
provides heavy subsidies to the state run electrical 
utility, to name a few examples.  End Comment.) 
 
¶9. (SBU) Comment:  Although Malaysia's central bank 
Governor Zeti Aziz and Minister of Finance (II) Nor 
Mohamed Yakhop have both stated that the inflation rate 
this year would be manageable, it is hard to see how 
prices will not rise.  When asked if she would raise 
interest rates again, Zeti exhibited her usual calm 
manner and submitted that she would need to review the 
outlook over time.  In fact, the government of Malaysia 
was anything but calm about this announcement.  Prior 
to releasing this news to the press, they strongly 
urged that the media not refer to the price increase as 
a "hike." The Deputy Minister of International Trade, 
slated to participate in a joint press conference with 
the Ambassador, refused to speak to the media without 
assurances that there would be no questions on the rate 
increase.  It is worth noting that the leading English 
language daily, the New Straits Times, led with the 
banner:  PRICE HIKE PAIN.  Furthermore, the major 
Islamic opposition party, incensed over the hike, has 
announced that it will lead a protest on Friday, March 
3, at the Mosque in central Kuala Lumpur, next to the 
Petronas Towers.  End Comment. 
 
Interest Rates Hike 
-------------------- 
 
¶10. (U) On February 22, Bank Negara announced another 
increase in Malaysia's overnight policy rate by 25 
basis points to 3.25% from 3%.  This is the second time 
the Central Bank has increased the rate in the past 3 
months.  The last increase occurred on November 30, 
2005; during the seven years prior to that increase 
Bank Negara had held the overnight policy rate steady 
at 2.7%. 
 
¶11. (U) Several commercial banks, including foreign 
banks, raised their base lending rates by 25 basis 
points to 6.5% immediately after Bank Negara's 
announcement.  Although the rate hike was generally 
expected, analysts are concerned that banks' loan 
growth could be affected.  In 2005, loan growth in the 
banking system was 8.6%.  Depositors continue to face a 
negative real interest rate return with inflation 
 
KUALA LUMP 00000357  003 OF 005 
 
 
rising at 3.5% year-on-year in December 2005, and 3% 
year-on-year for the whole on 2005.  Inflation for 
January, year-on-year, clocked in at 3.2%.  Analysts 
are now predicting 3.5 - 3.8% for 2006. 
 
¶12. (U) Comment: While Bank Negara has concerns over 
the rate of inflation, it also is worried by the 
difference between Malaysian and U.S. interest rates 
and the possibility of funds flowing out of the 
country.  But even with the increase, the gap between 
Malaysian and the U.S. rates remains wide at 1.25%. 
With current inflation rates (already high for 
Malaysia) almost certain to increase, Bank Negara will 
need to weigh the benefits of fighting inflation 
through further rate hikes against the fear of slowing 
economic growth.  Analysts generally expect Bank Negara 
to raise rates an additional 50 to 75 basis points over 
the coming year.  End Comment. 
 
Malaysia's FDI Surges to 4-year High 
------------------------------------ 
 
¶13. (U) Foreign direct investment (FDI) in Malaysia 
rose 37% to RM 17.9 billion ($4.8 billion) in 2005 from 
RM 13.1 billion ($3.5 billion) in 2004.  The Malaysian 
Industrial Development authority (MIDA) reported that 
2005 saw the highest level of approved FDI in Malaysia 
since 1996.  FDI accounted for 58% of total approved 
investment in the manufacturing sector in 2005.  The 
U.S. topped the list with RM 5.2 billion ($1.4 billion) 
in new FDI for approved projects, followed by Japan 
($987 million) and Singapore ($773 million).  This is a 
major increase over 2004 when there was a mere $293 
million in U.S. FDI. 
 
Goods and Services Tax Implementation Postponed 
--------------------------------------------- -- 
 
¶14. (U) In a move that brought a sigh of relief from 
businesses, both local and foreign, the GOM announced 
on February 22 that it was postponing implementation of 
the new Goods and Services Tax (GST).  While most 
businesses accept that GST is inevitable, there was 
significant concern from groups such as the Federation 
of Malaysian Manufacturers, the Malaysian International 
Chamber of Commerce and Industry, and the American 
Malaysian Chamber of Commerce as to the GOM's ability 
to plan and implement the new tax system.  The GOM also 
may have been worried about the effect of tax increases 
on some of the poorer elements of society who do not 
currently pay income tax but who would be affected by a 
universal GST.  Further, the GOM had yet to produce its 
guidelines for implementation of the GST and businesses 
complained they were not being given sufficient lead 
time to plan for the transition. 
 
¶15. (SBU) Comment:  Although the GOM has not reset a 
date for the GST implementation, observers expect that 
it will not be until after the next election.  That 
would place GST implementation, at the earliest, in 
2008 and likely 2009.  This is good news for the 
possible U.S.-Malaysian Free Trade Agreement (FTA) 
negotiations because the GOM will be able to focus all 
of its attention on the FTA.  Observers have suggested 
to Econoff that the GOM would not be capable of 
handling extensive negotiations on the FTA while 
implementing a complete tax overall.  End Comment. 
 
A "Street Level" View of the Economy 
------------------------------------ 
 
¶16.  (SBU) A recent conversation with a senior 
executive of a local department store that caters to a 
lower and lower-middle class clientele provided a rare 
"street level" view of the economy.  (Note:  this 
conversation took place prior to the February 28 fuel 
hike.)  This retailer is seeing a slight decline in 
sales, which he believes is consistent with the results 
of other retailers operating in his market niche. 
Asked whether this was due to inflation, he said "no." 
He said his customers are feeling some pinch from 
 
KUALA LUMP 00000357  004 OF 005 
 
 
higher transportation costs (the result of cuts in 
government fuel subsidies), but inflation is not biting 
too hard since the government controls the prices of 
most staple goods.  What is holding back his customers, 
he said, is uncertainty, as many depend on construction 
and other low-end jobs that have been drying up as the 
government cuts back on spending. 
 
¶17.  (SBU) On the other hand, the executive said that 
middle and upper income earners are experiencing 
inflation that he estimated as being much higher than 
the government's stated figure of around 3.5%.  He 
claimed that the "market basket" for the government's 
inflation index is over-weighted toward price- 
controlled items.  The fixed price items act as a drag 
on the index and hold down the official inflation rate. 
(Comment:  This also could explain Malaysians' current 
thirst for consumer credit borrowing.  Interest rates, 
which typically are set at the official government 
basis plus a couple of percent, are probably well into 
the negative zone these days for upper income 
borrowers.  End Comment.) 
 
¶18.  (SBU) But while sales are down, this retailer said 
his store's bottom line is up because it has been 
"getting more value for its dollar."  Asked to explain, 
he noted that the Malaysian ringgit has been riding up 
in value with the U.S. dollar against many South and 
Southeast Asian currencies.  Since he sources many 
simple manufactured goods from India, Thailand and 
other neighboring countries, he has been able to 
increase his profit margin while holding his ringgit 
prices constant. 
 
9th Malaysia Plan To Be Unveiled March 31, 2006 
--------------------------------------------- - 
 
¶19. (U) The GOM is furiously working to finalize the 
9th Malaysian Plan, which will set both economic growth 
targets and strategic development priorities for the 
coming five years.  This will be the first plan 
developed under the leadership of Prime Minister 
Abdullah.  Although held closely, indications are that 
the plan will focus on Abdullah's stated goal of 
transforming Malaysia into a knowledge-driven economy. 
The 9th Plan should state what programs and projects he 
intends to fund (high tech education) and identify how 
much and where the funds will be found.  Malaysia has 
been developing these five-year plans since 1966. 
 
¶20.  (U) At the Eight Malaysian Strategic Outlook 
Conference, in January, Deputy Prime Minister Najib 
stated that the GOM would foster equitable distribution 
of wealth and a fairer approach to ethnicity in 9th 
Malaysia Plan.  Specifically, there will be three main 
thrusts, none of which are surprising.  They include: 
more incentives for the private sector in crucial areas 
such as agriculture, life sciences, information and 
communications technology, tourism, health and 
education; greater effort to put human capital 
development as the number one priority and build a 
knowledge-based economy driven by innovation and ideas; 
and, improvement of the public service delivery system 
and cutting cost of doing business in Malaysia. 
 
¶21. (SBU) Comment:  Ethnic Malays are eagerly looking 
forward to the 9th Plan because, historically, this is 
how some of the nation's wealth is spread around. 
Former Prime Minister Mahathir used the plans to launch 
his new infrastructure projects, large and small, and 
pass out contracts.  Abdullah had cut back much of the 
pork in the 8th Plan that he inherited and there has 
been grumbling over the lack of development projects, 
especially among the small Bumiputera (Bumiputera are 
literally 'sons of the soil" but, in practical terms, 
this refers to the government's affirmative action 
policies favoring the majority Malay race) Class F 
contractors.  There are 38,000 Class F contractors and 
only they are allowed to bid on small contracts (less 
than RM 200,000 or about $53,000) specifically set 
aside for them.  As Abdullah's government only 
 
KUALA LUMP 00000357  005 OF 005 
 
 
announced RM 2.4 billion ($640 million) worth of 
construction projects last year, this politically 
important group is looking for projects.  A few weeks 
after the unpopular fuel increase would be a 
politically astute time to announce such Bumiputera set- 
asides. 
 
¶22. (SBU) Comment continued:  For the ethnic Chinese 
and ethnic Indian Malays, Najib's mention of equitable 
distribution of wealth and a fairer approach to 
ethnicity raises shades of the New Economic Program of 
old.  This policy was set in place to transfer money 
and equity in business investment from the minority 
races to the majority.  Only the release of the plan, 
however, will confirm whether it is a step back in 
time, or a path to the future. End Comment. 
 
LAFLEUR