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GENEVA FOR USTR 
 
E.O. 12958: DECL: 01/19/2020 
TAGS: ECON EFIN ENIV EXIM MY PGOV
SUBJECT: MALAYSIA’S NEW ECONOMIC MODEL: ECONOMIC REFORM EFFORTS MAY MEET OPPOSITION 
 
REF: A. 09 KUALA LUMPUR 303 
     ¶B. 09 KUALA LUMPUR 318 
     ¶C. 09 KUALA LUMPUR 887 
 
¶1.  (C) Summary:  Prime Minister Najib Razak (Najib) 
introduced a first wave of limited economic reforms (refs A 
and B) shortly after taking office in April 2009 and has 
promised more substantial economic reforms designed to 
improve Malaysia's competitiveness (ref C).  To accomplish 
this, Najib formed the National Economic Advisory Committee 
(NEAC) to develop a New Economic Model (NEM), an economic 
policy roadmap which he hopes will lead Malaysia from middle 
income to high income country status.  Little has been 
revealed about the contents of the NEM, but government 
officials say it is intended to address Malaysia's 
"stagnating" economy, by improving education, reducing 
corruption, strengthening weak public institutions, 
reconfiguring emigration, cutting back on government 
over-involvement in the private sector, and increasing low 
domestic investment rates.  Leading Malaysian economists 
believe that Najib is sincere in his desire to address these 
problems.  However, they question his ability to make major 
changes in the government's long-standing discriminatory 
Bumiputera preference policies which have discouraged 
domestic investment and new business formation and are 
driving the "brain drain" of  young professional Malaysians 
frustrated with limited opportunities under this  system. 
Economists here expect Najib's effort to establish a policy 
framework that will foster a more gradual move away from 
ethnic preferences to a merit-based economy, but believe that 
may be insufficient.   If PM Najib is unable to deliver on 
NEM reforms, they expect the opposition will seize the reform 
agenda as an issue for possible 2012 elections.   Executing a 
robust NEM, however, will be even more difficult as the PM 
will undoubtedly face steady opposition from within his own 
political party (UMNO), particularly from members who fear 
their parliamentary seats may be lost if the current 
patronage system is dismantled.  End Summary. 
 
The New Economic Model: Reigniting High Growth 
--------------------------------------------- - 
 
¶2.  (C) Since Prime Minister Najib Tun Razak (Najib) took 
office in April 2009, he has called for Malaysia to move from 
a low value-added, manufacturing-for-export oriented middle 
income economy to a knowledge-based service oriented high 
income economy.  He has used the rubric of former Prime 
Minister Mahathir's Vision 2020 goal of reaching "high-income 
country" status by the year 2020 as his call to action to 
justify developing a "New Economic Model" (NEM) to promote 
economic transformation.  PM Najib quickly announced an 
investment liberalization agenda and by April 2009 
implemented a first tranche of reforms aimed at reducing 
bumiputra (ethnic Malays and other non-Chinese or Indian 
ethnicities) ownership requirements in 27 different 
non-influential service sectors (e.g. veterinary services and 
ship salvage and refloatation services) and allow foreign 
controlling ownership interests in some types of financial 
institutions (Ref A).  PM Najib announced a second tranche of 
reforms late in April including reducing bumiputra ownership 
requirements on all listed companies from 30% to 12.5% and 
repealing Foreign Investment Commission guidelines on new 
mergers and acquisitions by foreign firms (Ref B).  In July, 
PM Najib formed the National Economic Advisory Committee 
(NEAC) and charged the new body - made up of high profile 
Malaysian and non-Malaysian economic figures - with 
developing the NEM.  In his October 23 budget speech (Ref C), 
PM Najib promised additional economic reforms. 
 
Financial Crisis and Capital Flight Push GOM to Reform 
--------------------------------------------- --------- 
 
¶3. (C) Najib has been forced to consider a broader reform 
program because the Global financial crisis (GFC) has put 
tremendous pressure on the underpinnings of Malaysia's 
economic growth.  FDI has slowed to a trickle, $15 billion of 
portfolio investment departed in 2009 and has just begun to 
return, and there remain large domestic reverse investment 
outflows as Malaysian conglomerates focus on overseas rather 
than domestic investment.  According to a January 8 UBS 
Securities report, Malaysia experienced net capital out flows 
in excess of $27 billion from mid-2008 to mid-2009.  More 
telling, the UBS report states Malaysia has not experienced 
net capital inflows in any one calendar year since 1997.  UBS 
cites domestic investors investing outside Malaysia as the 
primary source of the outflows.  PriceWaterhouse Coopers 
Consulting Malaysia (PWC) General Manager Pearlene Cheong 
described Western multi-national corporate interest in 
investing in Malaysia as "dormant" and that ethnic Chinese 
Malaysians had been taking their money out of Malaysia ever 
since the Asian financial crisis.  She said that PWC's 
investor advisory business has seen primarily North Asian 
investors working in the extractive industries focused in 
East Malaysia and added, "This is not the knowledge-based 
type of employment that the government is looking for to 
stimulate wage growth." 
 
Bold Statements Calling for Change 
---------------------------------- 
 
¶4. (C) The Najib administration has identified several areas 
of the economy needing reform and has announced its 
intentions to carry out reforms through the NEM.  In a 
December 1 speech to the Malaysian Institute of Economic 
Research, Finance Minister II Husni said Malaysia's economy 
was "stagnating" and highlighted Malaysia's most pressing 
economic issues needing to be addressed by the NEM as 
education, corruption, GOM economic over-management, weak 
public institutions, emigration, and low domestic investment 
rates. 
 
Education: Husni said, "Our universities are a 
disappointment." He cited Malaysia as having its highest 
unemployment rate for recent college graduates while adding 
that there is a severe shortage of skilled workers, implying 
that large numbers of Malaysian recent college graduates are 
unskilled.  Malaysian sovereign wealth fund Khazanah reported 
that skilled labor shortages and the poor quality of 
Malaysian graduates costs Malaysian competitiveness 15% of 
GDP annually. 
 
Corruption and Cronyism: He cited the recently released 
Transparency International 2009 Corruption Perception Index, 
in which Malaysia fell to number 56 of 180 countries, its 
lowest rating in over 20 years, and continuing a fall from 
number 26 in 2004.  Husni promised wholesale reform in 
government procurement practices, controlled by the Ministry 
of Finance, and an end to sole source contracts, except for 
the military. 
 
GOM Over-involvement in the Economy: Husni called for the 
transparent divestiture of GOM interests in government-linked 
corporations (GLCs) and the restoration of the private 
sector's role as the primary engine for growth.  He also 
cited that the GOM needs to discontinue open-ended protection 
of domestic industries, allow market driven resource 
allocation including greater precision in subsidy allocation, 
and foster better competition policies to spur innovation. 
 
Weak Public Institutions: Husni criticized the lack of 
diversity in the civil service and proposed strengthening 
public institutions through greater ethnic participation. 
 
Brain Drain: He noted barriers to non-bumiputras in the job 
market, starting and growing businesses, purchasing housing, 
and educational opportunities began a move of many well 
educated non-bumiputra Malaysians to emigrate.  The fact that 
800,000 young Malaysians are now working abroad, 300,000 
having emigrated in the past 18 months, including increasing 
numbers of ethnic Malays was recently noted in Parliament. 
Malaysia's "brain drain" has begun to get the attention of 
policy makers, according to Husni. 
 
Low Domestic Investment: Since 1997, domestic investment 
rates halved from 20-25% of GDP annually to roughly 10% and 
have remained at reduced levels for the past decade.  Husni 
said that the 1Malaysia concept is intended to introduce 
competition and move Malaysia to a more performance-based 
culture like Japan, Korean, and Singapore, promoting an 
attractive investment and working environment for all 
Malaysians. 
 
NEM to be Broad and Wide-Ranging 
-------------------------------- 
 
¶5.  (C) The government and our contacts have released few 
details of the upcoming NEM.  However, PM Najib announced 
December 22 at the Finance Ministry's "Media Night" that he 
had approved the NEM direction, and that the final model will 
be presented to the Cabinet and made public by the end of 
February 2010.  The NEM will "set the direction of the 
economy and make the economy more resilient", according to 
Najib.  NEAC Acting Director of Research Tong Yee Siong, said 
the NEAC met the week of February 1-5 to finalize its 
recommendations to the Cabinet for approval and public 
release by the end of February.  Tong told Econoffs that the 
NEAC will produce goal papers and an economic model 
framework.  Tong expected the recommendations to be very 
broad, and would propose a policy framework to address the 
most significant economic issues facing Malaysia and improve 
its economic competitiveness.  Nicholas Zefferies, the 
president of AmCham, and the only "foreign" member of the 
NEAC, told Econ Counselor January 13 that NEAC reform 
recommendations to PM Najib would be wide-ranging.  Zefferies 
said that Najib was planning to give NEAC powers similar to 
the Prime Minister's Special Task Force to Facilitate 
Business (Pemudah), to enforce the planned economic reform 
program on government Ministries. 
 
Economic Reform Versus Ethnic Preferences 
----------------------------------------- 
 
¶6.  (C) Tong told us that the NEAC is focused on removing 
disincentives to domestic investment established in the New 
Economic Policy (NEP) as a key to reinvigorating domestic and 
foreign investment.  He added that any basis for serious 
economic and investment reform efforts in Malaysia involves 
dismantling old entrenched Bumiputra ethnic preferences 
established since the Mahathir regime in the NEP.  Finance 
Minister II Husni's speech was important for connecting 
Najib's 1Malaysia slogan to real economic reform, according 
to Malaysian Institute for Economic Research Managing 
Director and long-time UMNO economic advisor Mohamed Ariff. 
However, as Husni criticized Malaysia's longstanding ethnic 
preference policies, he qualified his statements by asserting 
that "the government is not abandoning bumiputras" and that 
the government will pursue reform in "a prudent and cautious 
method" in an effort to allay bumiputra fears of economic 
displacement.  Ariff told us that the Husni speech angered 
some senior UMNO members who complained that Najib was 
opening the economy too much and moving too fast toward 
reform.  Opposition parliament members praised the speech, 
according to Ariff. 
 
PM Najib Seeks Incremental Reform 
--------------------------------- 
 
¶7.  (C) Our economic contacts close to PM Najib said they 
were convinced he is sincere about wanting economic reform. 
Economic Planning Unit Deputy Director General K. Govindan, 
who briefs PM Najib and the cabinet weekly on Malaysian 
economic performance and economic policy, told us he believes 
PM Najib understands in general terms the reforms needed to 
improve human capital and productivity, increase trade and 
investment, and reduce corruption.  Nevertheless, Govindan 
said he does not make specific economic policy 
recommendations at those meetings for fear of offending other 
Ministers in the meeting who oppose the reform agenda.  Ariff 
also believes PM Najib legitimately seeks economic reform. 
Ariff told us PM Najib's words to him were "change or be 
changed" when referring to economic reform.  But Ariff also 
said he expected PM Najib to slowly pick away at the NEP 
without causing too much economic and political disruption. 
This will require regularly announcing small reforms rather 
than the sweeping reforms required to transform the economy. 
Ariff offered the February NEM release and the June 2010 
release of the 10th 5-year Malaysia Plan as two upcoming 
opportunities for Najib to roll out more economic reforms. 
 
Safe Won't Work 
--------------- 
 
¶8.  (C) In the view of our economist contacts, PM Najib's 
"politically friendly" incremental strategy to economic 
reform may end up being too little too late.  Tong projected 
that for reform to work, the PM will need to make a bold 
announcement on major reforms and then rally public support 
for change.  Tong said that NEAC members are advocating that 
PM Najib announce significant structural changes to 
Malaysia's economy as a part of the NEM.  Govindan agreed 
that major structural changes are needed for sustained 
economic growth.  He added that a series of small reform 
programs will eventually limit Malaysia to an unacceptably 
low 3-4% annual growth rate that will keep the country 
trapped in middle income status until "politics are removed 
from education and the economy."  The critical point, Ariff 
said, was that while Malaysia continued taking baby steps on 
economic reform, its competitors for investment such as 
Indonesia, Thailand, and Vietnam would be overtaking Malaysia 
as the first choice for foreign direct investment. 
 
Ruling Party May Block Aggressive Reform 
---------------------------------------- 
 
¶9.  (C) Each of our contacts agreed that political will is 
the key to reform, but none are convinced all of the coming 
announcements of plans to reform Malaysia's economy will be 
backed by substantially broad concrete measures.  Ariff told 
us that after early enthusiasm for economic reform,  some 
UMNO insiders do not want reform that would take away the 
economic rents and patronage system they have relied on to 
maintain the party's power base for over a generation.  Ariff 
predicted that UMNO would not survive in power by moving to 
an open and transparent system and that UMNO insiders would 
challenge Najib if he moved too strongly on government 
reform.  Govindan sees Malaysia's huge and largely ethnic 
Malay civil service, completely loyal to UMNO, but 
increasingly incompetent, as PM Najib's largest obstacle.  He 
commented that the civil service has a very narrow world view 
and will oppose, even refuse to implement, reforms perceived 
as damaging ethnic Malay interests, even if convinced of the 
long-run gains for Malaysia.  Tong told us that achieving any 
of the goals developed by the NEAC will require significant 
political buy-in to operationalize the policy changes 
necessary to reinvigorate investment and spur additional 
growth.  However, Tong commented that NEAC members are 
frustrated with a lack of high-level political commitment 
outside of PM Najib as well as the slow responses from 
Ministries which impeded progress on the NEM.  He added that 
some NEAC members are concerned that the NEM maybe merely a 
public relations exercise that will have no real long-term 
policy impact.  Zeffries told us that he was not confident 
that PM Najib has a sufficiently strong political position to 
pursue the NEAC's upcoming proposals.  Liew described the 
opposition closely watching economic reform, offering that an 
inability of the ruling coalition to implement promised 
economic reforms will provide powerful political ammunition 
for use in upcoming federal elections in 2012. 
 
Ethnic Minorities Support Reform 
-------------------------------- 
 
¶10.  (C) Cheong sees her Malaysian private sector business 
clients as highly supportive of the type of economic opening 
she believes PM Najib will announce in the NEM and commented 
that ethnic Chinese, Indian, and urban Malays not directly 
benefitting from UMNO patronage will strongly support 
economic reform efforts, but that rural Malays, a strong UMNO 
constituent base, will fear changes labeled as detrimental to 
Bumiputra interests.  However, Cheong observed that 
Non-Bumiputras have successfully competed in the open economy 
at a disadvantage to Bumiputra and government linked 
businesses for over 30 years and that Malaysians would 
patiently wait for change.  She added that the lack of 
investment is so obvious that the government is practically 
being forced to take action. 
KEITH