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RR RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHKL #0930/01 1420947
ZNY CCCCC ZZH
R 220947Z MAY 06
FM AMEMBASSY KUALA LUMPUR
TO RUEHC/SECSTATE WASHDC 6688
INFO RUCNASE/ASEAN MEMBER COLLECTIVE
RUEATRS/DEPT OF TREASURY WASH DC
RUCPDOC/DEPT OF COMMERCE WASHDC

C O N F I D E N T I A L SECTION 01 OF 04 KUALA LUMPUR 000930

SIPDIS

STATE PASS USTR FOR B. WEISEL AND J. JENSEN
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E.O. 12958: DECL: 05/21/2016
TAGS: ETRD ECON EINV EFIN MY
SUBJECT: THE BUMIPUTERA POLICY:  IMPLICATIONS FOR THE FTA

REF: A. KUALA LUMPUR 0797 B. KUALA LUMPUR 0613 C. KUALA LUMPUR 0331 D. 2005 KUALA LUMPUR 4080

Classified By: Ambassador Christopher J. Lafleur for reasons 1.4 b & d.

¶1. (C) Summary: Malaysia's bumiputera policy provides socioeconomic support for ethnic Malays and other indigenous groups with the goal of raising the "bumi" share of national equity ownership to 30% from the current official figure of around 19%. Over the 35 years of its existence, the policy has evolved into a pervasive system of government interventions designed to tilt the playing field in favor of the bumis. These interventions extend into practically every corner of the economy, from banking regulation to the ownership of individual restaurants. The bumiputera policy targets persistent differences in racial income shares. Official figures indicate the poverty rate for bumis in 2004 was 8.3%, compared to 0.6% for Malaysia's Chinese population; and while many analysts believe the 19% figure substantially understates bumi share ownership, no one thinks their piece of the equity pie approaches their 66% percent share of the population. The policy has fostered a propensity for government micromanagement and blurred the lines between official favoritism and illegal corruption.

¶2. (C) The bumiputera policy will be a critical factor in our upcoming negotiations on a free trade agreement (FTA) with Malaysia. The new Ninth Malaysian Plan (9MP) sets targets that will extend the policy through 2020, so formally dismantling the bumi preference system would not be a realistic goal. Malaysian officials recognize the need to improve the country's economic performance, both to meet national development goals and to keep pace with regional competitors. However, it is not yet clear the extent to which the GOM will be willing to compromise on the Bumiputera Policy to obtain an FTA that would increase Malaysia's growth and competitiveness. The best approach for U.S. negotiators is not to tackle the policy head on, but to deal with the preferences it creates on a case-by-case basis. Disaggregating the bumi package, linking changes where possible to Malaysia's WTO obligations and pre-existing policy initiatives, and minimizing discussion of the bumiputera policy by name, will help produce a deal that meets U.S. negotiating objectives, but is salable in Malaysia

The New Economic Policy - Now 35 Years Old
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¶3. (U) In 1969, Malaysia experienced racial riots that became a watershed in the country's political and social development. In 1971, in response to the riots and to shore up Malay support for his government, then-Prime Minister Tun Abdul Razak launched the New Economic Policy (NEP). The NEP set a national goal "to correct economic imbalances so as to reduce and eventually eliminate the identification of race with economic function." More specifically, it established the objective that Malays would own and operate at least 30% of the commercial and industrial activities of the country by 1990. At that time, ownership as measured by share capital of private limited companies (the benchmark measurement chosen in the NEP and still used today) was divided as follows: Malays 2%; non-Malays 37%; and foreigners 61%. The NEP set targets to reduce the foreign share to 30%, increase the non-Malay share to 40% and allocate the remaining 30% to Malays. By 1990, the government could claim that it had succeeded in reducing the foreign share to the target level, but only thanks to government acquisition of foreign assets. Private Malay ownership remained at a very low level.

¶4. (U) An important characteristic of the NEP was that it was a government policy statement, not a piece of legislation. The Second Malaysia Plan (1971-1975) and succeeding five-year Malaysia plans were the formal means of implementing the NEP, but numerous independent measures taken as the government pursued its economic, regulatory, education and other policies supplemented and expanded the program. This pattern continues to this day. The five-year Malaysia plans provide budget resources and set policy targets that put muscle on the bones of the bumiputera skeleton, while politicians and bureaucrats strengthen and expand bumi preferences in their individual areas of responsibility.

¶5. (U) In 1991, the National Development Policy (NDP) replaced the NEP, and in 2000 the National Vision Policy (NVP; also known as Vision 2020) replaced the NDP. These new policy statements expanded on the goals of the NEP, and also expanded the beneficiary population to include all "bumiputera" or "sons of the soil." This formally added the Orang Asli (indigenous peoples of the Malaysian Peninsula, who lived here before the Malay migration), and the Dyak, Iban, Dusun and other indigenous inhabitants of Sabah and Sarawak, as potential beneficiaries. In practice, Malays continued to receive preference above all because they controlled the levers of political and bureaucratic power.

¶6. (SBU) Today at the beginning of the Ninth Malaysia Plan (9MP; see Ref A), the goals of the NEP remain unmet. According to 9MP statistics, ownership of share capital in 2004 was: bumiputera 18.9%; Chinese 39.0%; Indian 1.2%; and foreigners 32.5%. The remaining 8.4% are held as nominee shares, with ownership unclear but deemed by the government to be non-bumiputera. Many analysts question whether these statistics provide a good picture of who owns the nation's wealth. For example, they exclude shares held by Federal and state government entities (including a sizeable share held by Khazanah, the Federal investment agency). But however the data is massaged, it is clear that bumi share ownership remains significantly less than would be expected given their 66% share of the population (ethnic Malays alone account for about 54% of the total population). In addition, 9MP statistics indicate that bumiputeras experience much higher poverty rates than other population groups. The poverty rate for bumis in 2004 was 8.3%, compared to 0.6% for Malaysia's Chinese population and 2.3% for Malaysia's Indian population. Chinese incomes in 2004 averaged 64% higher than bumiputera incomes, while Indian incomes averaged 27% higher. Many analysts also dispute these income statistics, noting in particular that the Indian community suffers from some of the most persistent poverty in the country. Malaysian policymakers say they cannot ignore a situation in which the majority group is perceived to be at such an economic disadvantage, or fail to be seen to be taking steps to address these disparities.

The Not-So-New Ninth Malaysia Plan
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¶7. (SBU) Prime Minister Abdullah announced the new Ninth Malaysia Plan (9MP) at the end of March 2006. As reported Ref A, 9MP largely carries forward existing socioeconomic programs, including those supporting the bumiputera policy. Most significantly for U.S. economic interests, in particular the FTA, 9MP reaffirms the goal of increasing bumi share ownership to 30% with a target date of 2020. This means the bumiputera policy probably will be in place for at least the next fifteen years. 9MP also adds a target of increasing Indian share ownership to 3% and reaffirms the NEP doctrine "to correct the identification of race with economic function." In addition, 9MP plans a multitude of bumiputera support measures, from ensuring that privatized government entities are sold to bumi owners, to funding for R&D projects for bumi researchers, to a goal of creating 100 new bumiputera direct sales companies.

¶8. (SBU) The third of the five "thrusts" of the Ninth Malaysia Plan is "to address persistent socio-economic inequalities constructively and productively." While this 9MP element also addresses rural-urban disparities, its predominant aim is to support bumiputera advancement. It sets specific targets for balancing income distribution, restructuring employment, and redistributing the ownership of the nation's wealth, and enjoins "all government agencies ( to ensure that their policies and programs take into account the implications on (sic) distribution." This last requirement sets the stage for continued micromanagement of the economy to ensure the advancement of bumiputera policy goals.

The Business - As Usual
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¶9. (C) As noted in paragraph 4 above, much of the implementation of the bumiputera policy is carried out through the day-to-day work of Malaysian ministries and agencies in their individual areas of responsibility. This has led to a wide variety of approaches in how it is applied. Some bumi preferences are a matter of law, but others take the form of regulations, or informal guidelines. Even the Ninth Malaysia Plan does not provide a comprehensive list, but following are examples from key sectors.

¶10. (C) For example, when Bank Negara Malaysia (BN; the central bank) audits foreign financial institutions in its role as a regulator, it checks employment rolls to see whether bumiputeras are receiving an appropriate share of the jobs at each level of the company. In conducting these audits, BN officials characterize their recommendations as "best practices." We are not aware of any formal legal requirement for racial hiring quotas, but few firms would be willing to jeopardize their relationship with their regulator by ignoring its recommendations. Bank Negara also presses new university graduates on foreign financial firms, which are expected to hire a certain number and provide them with training and experience. Many of these young professionals move on to jobs in domestic financial institutions after a few years, so foreign banks are forced to train up their local competition. (See Ref B for more details on the financial services sector.)

¶11. (C) On a broader level, when the Ministry of Domestic Trade and Consumer Affairs (MDTCA) drafted new regulations governing the distributive trade sector (note: defined as activities that channel goods and services to intermediaries or to final buyers) it incorporated bumiputera support measures throughout the new guidelines. Its draft required hypermarkets to reserve 30% of their shelf space for bumiputera-made products and stipulated that 30% of all sales receipts must come from bumiputera products. It required restaurateurs to increase their share capital to at least one million ringgit (about $275,000) and reserve 30% for a bumi partner. Initially, MDTCA planned to instruct manufacturers who maintained their own distribution division to spin it off as a separate company and allocate 30% of the equity to a bumi partner. This idea caused such an uproar, however, that MDTCA appears to have dropped it. (See Ref C for more details on the distributive trade guidelines.)

¶12. (C) The effort to comprehensively implement bumiputera priorities has fostered government micromanagement that penetrates almost every nook and corner of the economy, increasing costs and discouraging entrepreneurship and investment. As one private analyst observed to econoff, "Why would you want to do all the work of setting up a business in Malaysia only to have to turn 30% of it over to someone else?" It also blurs the line between official favoritism and illegal corruption. The government designed Malaysia's "approved permit" system for the importation of foreign cars as a means to encourage the creation of bumiputera car dealerships. But the program devolved into a "middleman" operation where influential individuals acquired the permits from the government and sold them to auto importers and dealers. The rampant corruption in the program became a public scandal, threatening the job of MITI Minister Rafidah and forcing the government to reform the national auto policy, which now calls for the elimination of the AP system for motor vehicles by 2010. (Ref D reports on the government's framework for the planned new national automobile policy. Septel will provide an update. The special case of government procurement also will be covered septel.)

Exceptions Prove the Rule
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¶13. (C) There are honest business people, including foreign investors, who are not discouraged by the need to deal with the bumiputera policy. As the Malaysian head of a multinational consumer products company told econ counselor, "You can get anything you need here, so long as you do not require the government to be too obvious about it. You need contacts, but if you have good ones you can always get an exception." Similarly, the head of a high tech manufacturing facility explained that, unlike many foreign manufacturers, he has no problems getting labor permits for foreign engineers to work in his factory. He has a former senior immigration official on his payroll, who arranges for as many labor permits as he needs.

¶14. (SBU) It is significantly easier for export oriented and high tech firms to do business in Malaysia. Export oriented manufacturers can work through the Malaysia Industrial Development Agency (MIDA), which exempts them from many restrictions and can help clear bottlenecks with other government agencies. There also are other government programs such as the Multimedia Super Corridor (MSC) that provide a lighter system of regulation. But even in the mainstream economy, many foreign investors are satisfied with the status quo, even though it is far from transparent.

Why Rock the Boat?
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¶15. (C) Given the over-riding political importance of the bumiputera policy, why would Malaysian leaders agree to enter into FTA negotiations, knowing they would lead to pressures for change? Responding to this question at a May 9 industry seminar on the FTA, MITI Deputy Secretary General Ooi Say Chuan said, "The NEP has an important role. The government believes it has contributed to economic growth by developing a bumiputera middle class. However, we need to consider Malaysia's global competitive position. We believe the FTA will help us be competitive, but we look for flexibility from the U.S."

¶16. (C) The Ninth Malaysia Plan also cites growing competitive pressures: "The core NEP, NDP and NVP objectives ( remain. However, the circumstances and environment in which the country operates have changed significantly. Malaysia is now an open trading economy participating in an extremely competitive and fast-moving global marketplace. The opening up of China and India has changed the economic landscape dramatically for developed and developing countries alike." Malaysia's leadership clearly recognizes the need to improve the country's economic performance, both to meet national development goals and to keep pace with regional competitors, but not if it means scrapping the bumiputera policy. They suggest that it is essential to raise the productive capacity of bumiputeras, since they represent the majority of the population. They also note that abandoning the bumiputera policy would be political suicide.

Let's Make A Deal
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¶17. (C) The bumiputera policy will be a critical and omnipresent factor in our upcoming negotiations on a free trade agreement with Malaysia. The challenge for the U.S. team will be to devise solutions that meet our bottom line needs for improved market access, and greater fairness and transparency in decision making, while leaving the Malaysian government able to claim publicly that the final deal protects bumiputera interests. This means avoiding attacks on the bumiputera policy head on and by name, and instead adopting case-by-case approach to clearing the obstacles it creates to trade and investment.

¶18. (C) Bank Negara's racial hiring quotas in the financial services provide an example. So long as the central bank continues to use its influence as a regulator to promote the government's bumi objectives, it will be difficult to put a complete stop to this type of practice. It would be addressed to some extent by standard U.S. FTA language prohibiting restrictions on the nationality of senior management and boards of directors. An expansion of the scope of this language might be desirable to address the deeper penetration of Bank Negara's affirmative action policies. However, given the central bank's strong desire to promote bumiputera advancement, it may only be possible to insulate the highest executive levels. Even so, local financial firms would welcome our securing a more transparent and rules based approach to affirmative action in employment, as well as in other applications of Bank Negara's regulatory authority.

¶19. (C) Where feasible, U.S. requests for changes should be linked to Malaysia's obligations under the WTO and other international agreements, as this will permit Malaysian officials to deflect criticism that they conceded to U.S. pressure. Similarly, linking changes to existing Malaysian plans for liberalization, such as the Financial Sector Master Plan (Ref C), will make it easier for Malaysian negotiators to agree. Disaggregating the bumi preference package, linking necessary changes to Malaysia's international obligations and existing domestic plans, and minimizing discussion of the bumiputera policy by name, will help create the impression that the policy is not under attack. This will help produce a deal that meets U.S. negotiating objectives, but is salable in Malaysia.

LAFLEUR