VZCZCXRO7464
RR RUEHBC RUEHCHI RUEHDA RUEHDBU RUEHDE RUEHDT RUEHGI RUEHHM RUEHJS
RUEHKUK RUEHLH RUEHNH RUEHPW RUEHROV
DE RUEHKL #1493/01 2780622
ZNR UUUUU ZZH
R 050622Z OCT 07
FM AMEMBASSY KUALA LUMPUR
TO RUEHC/SECSTATE WASHDC 0066
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC
RUEHGV/USMISSION GENEVA 1516
RUCNASE/ASEAN MEMBER COLLECTIVE
RUCNISL/ISLAMIC COLLECTIVE

UNCLAS SECTION 01 OF 03 KUALA LUMPUR 001493 
 
SIPDIS 
 
STATE PASS USTR - WEISEL AND JENSEN 
STATE PASS FEDERAL RESERVE AND EXIMBANK 
STATE PASS FEDERAL RESERVE SAN FRANCISCO TCURRAN 
SINGAPORE PASS TO SBAKER 
USDOC FOR 4430/MAC/EAP/J.BAKER 
TREASURY FOR OASIA AND IRS 
GENEVA FOR USTR 
SENSITIVE 
 
SIPDIS 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV MY
SUBJECT: Malaysia's Current Economic Performance Masks Need for 
Structural Change 
 
 
¶1. (SBU) Summary:  Malaysia's central bank Deputy Governor considers 
the country's banking sector unexposed to the turmoil in the US 
sub-prime mortgage market and believes that the economy remains on 
track for six percent GDP growth in 2007.  Private sector 
economists, however, point out that Malaysia's economy is performing 
under its potential growth rate by as much as two percentage points 
due to poor government policy.  The racial preference policies set 
out in the New Economic Policy (NEP) are viewed as the primary 
source of growth-restraining distortions which primarily have served 
to enrich political cronies.  In the process, not only has the NEP 
failed to reduce poverty among ethic Malays, it has directly 
contributed to greater income inequality and poverty.  It continues 
to crowd out of healthy private sector investment by government 
linked corporations.  Perverse education policies have chipped away 
at Malaysia's ability to produce a competitive work force for a 
global economy.  Prime Minister Abdullah Badawi is not perceived as 
a politician prepared to make the hard decisions necessary to reform 
the policies upon which his political supporters have come to 
depend.  Middle of the road rates of economic growth prevent a 
greater sense of urgency among policy makers, but over time these 
structural policy failures are expected to create even stronger 
constraints on Malaysia's ability to deliver on robust economic 
growth. End summary. 
 
CENTRAL BANK: LOOKING ON THE BRIGHT SIDE 
---------------------------------------- 
 
¶2. (U) In a meeting with Economic Counselor and Financial Attach 
for Southeast Asia, Ooi Sang Kuang, Deputy Governor of Bank Negara, 
Malaysia's central bank, expressed confidence that the Malaysian 
economy would remain largely on track to reach government forecasts 
of 6% growth for 2007, even in light of the U.S. sub-prime lending 
problems. Ooi said that, although Malaysia was fairly insulated from 
the U.S. sub-prime lending market, he was concerned about how the 
"sentimental effect" of a significant reduction in financial markets 
could impact the global economy.  He described the U.S. Federal 
Reserve's decision to lower interest rates by fifty basis points as 
having done "wonders" for the global economy. 
 
MANUFACTURING SECTOR MUST IMPROVE 
 
¶3. (U) Ooi described Malaysia's overall manufacturing sector as "not 
robust" and said it would need to become more competitive.  The 
sector that would suffer the most from an economic downturn in the 
U.S. was electrical & electronics (E&E), which was largely dependent 
upon U.S. demand for semiconductors, he explained.  He said Malaysia 
was not moving up the value chain rapidly enough, and that the 
country needed to transform its economy, particularly in light of a 
strengthening currency that would make Malaysian exports more 
expensive. 
 
¶4. (U) Ooi pointed out that the ringgit's long-term value was 
increasing, and said Malaysian manufacturers would be forced to 
either "move up the value chain" or relocate if necessary.  He said 
many Malaysian companies were investing overseas, with 
labor-intensive manufacturing moving to Vietnam and Indonesia. 
 
"MANAGING" FOREIGN EXCHANGE RATES 
 
¶5. (U) Ooi said Bank Negara continued to intervene in the foreign 
exchange market, but only to "smooth it out" and "manage" 
volatility, since large volumes could "disturb or excite markets" if 
they were not kept within "tolerable levels" of flexibility. He 
claimed that the central bank intervened in both directions - to 
smooth both the highs and the lows.  (Note:  when asked about this, 
one private sector banking professional responded that this might be 
true on a one-to-ten ratio, with the central bank mitigating the 
"lows" once for every ten times it intervenes to mitigate the 
"highs.") 
 
ECONOMY STILL CHUGGING ALONG 
 
¶6. (U) In spite of the setback in E&E, strong domestic demand 
continued to fuel the economy, explained Ooi.  Demand was being 
driven largely by higher rural incomes resulting from high commodity 
prices, a recent 35% civil service salary increase, and large 
government projects being implemented under the Ninth Malaysia Plan. 
He estimated that the government projects would remain the primary 
driver of domestic demand until mid-2008, by which time he expected 
the private sector would strengthen and the government-funded 
 
KUALA LUMP 00001493  002 OF 003 
 
 
projects taper off.  The economy would also benefit by the imminent 
opening of the Kikeh oil field, Malaysia's first deepwater 
operation. 
 
FINANCIAL SECTOR LIBERALIZATION 
 
¶7. (U) For its part, the Government of Malaysia (GOM) would continue 
to enact financial liberalizations, just as it had been doing for 
the Islamic finance sector.  According to Ooi, the GOM had been 
adhering to the ten-year Financial Sector Master Plan and in some 
areas was ahead of schedule.  This, coupled with the GOM's recent 
announcement that corporate tax rates would be reduced to 25% in 
2009, would help boost the Malaysian economy. 
 
AN ANALYST'S VIEW 
----------------- 
 
¶8. (U) While Ooi was upbeat about the Malaysian economy's 
resilience, Dr. Mohamed Ariff, President of the Malaysian Institute 
for Economic Research (MIER), was more willing to discuss the 
weaknesses as well as the strengths.  He cited similar economic 
indicators and pointed to the same strengths - strong domestic 
demand, government stimulus, and a reasonable forecast of 5.3 to 6 
percent growth.  But Malaysia had much more potential than that, he 
said.  Malaysia would need to "move up the value chain" to position 
itself to complement, rather than compete with, China and other 
low-wage manufacturing centers in the region.  In fact, he said the 
GOM had rejected many applications to bring low-tech labor-intensive 
manufacturing to Malaysia, some of which had requested bringing in a 
few thousand (low-wage) foreign workers.  Rather, the GOM was 
approving higher-tech manufacturing in the E&E sector, but these 
more capital-intensive investments were not bringing in many jobs 
for Malaysians, with 20% of new jobs going to foreigners. 
 
 
REFORMS NEEDED 
 
¶9. (SBU) To surmount the hurdles and achieve Malaysia's full 
potential for economic growth, Ariff argued that the GOM would need 
to enact some politically sensitive - and perhaps unlikely - 
reforms.  First on the list would be to address the "New Economic 
Policy" (NEP), a system of race-based preferences for ethnic Malays. 
 Most benefits were going to cronies; intra-ethnic inequality was 
increasing, especially among Malays; and the entire system was 
creating a "dependency syndrome," putting low priority on academic 
achievement, he said. 
 
¶10. (U) Education was among Ariff's primary concerns.  Ethnic Malays 
were poorly prepared for university, he explained, largely due to a 
separate one-year "fast track" matriculation which was designed to 
enable them to secure a place in college more easily.  Non-Malays 
were required to complete a more rigorous two-year program and pass 
an exam.  The end result was that the non-Malays did better once 
they entered university.  Moreover, separate education before 
college led to patterns of self-segregation at the university, and 
Ariff observed that the various ethnic groups had little 
interaction. 
 
¶11. (SBU) Government-linked companies were another politically 
sensitive issue that would need to be addressed, as they were 
crowding out other players in the market, according to Ariff.  In 
1985 the GOM privatized a number of companies, but these simply went 
to cronies, he said.  It was time for another round, but this would 
need to be done fairly. 
 
¶12. (SBU) The race-based preferences in general and the poor 
educational system in particular were impediments to reaching 
Malaysia's full potential, but Malaysians were afraid of change, he 
explained.  "We need a new NEP," said Ariff, "and a free press not 
owned by the Barisan Nasional" (the ruling coalition which has been 
in power since independence in 1957). 
 
¶13. (U) Ariff also was disappointed that the newly released 2008 
budget contained no reference to the proposed Goods and Services Tax 
(GST) which had been pending since 2004.  The GST, similar to a 
value-added tax, would be desperately needed in several years' time 
when Malaysia was expected to become a net importer of oil. 
Currently Petronas, the national oil company, provides 38% of the 
federal government's revenue, and the country's tax regime will need 
to be restructured to avert a crisis. 
 
KUALA LUMP 00001493  003 OF 003 
 
 
 
¶14. (U) Comment:  There is widespread agreement on what to expect in 
the near term for the Malaysian economy: not much.  The economy will 
continue to chug along, growing at five to six percent; cronies will 
continue to benefit from the current system; and, despite Malaysia's 
greater potential, there will be little demand for change until 
things get measurably worse.  With elections near, no one expects 
the GOM to take actions that are politically difficult - least of 
all changes to the NEP, which is the Malays' sacred cow. 
 
KEITH