COUNTRY REPORT

Malaysia Brunei At a glance: 2001-02

OVERVIEW ’s political crisis has deepened further, as opposition to the 75-year- old prime minister, , from within his United Malays National Organisation (UMNO) continues to grow, relations with the Chinese community worsen, and proposed talks with the opposition on Malay unity fail to materialise. The economic slowdown that is expected for this year could trigger social unrest. Key changes from last month Political outlook • Malaysia’s racial harmony is increasingly under threat as the political crisis deepens and the economy begins to turn down. The chances are growing that Dr Mahathir may be forced to retire by the UMNO party elders, concerned about the acute discontent among the grassroots. Economic policy outlook • Additional fiscal stimulation and larger budget deficits can be expected as the government responds to the increasingly evident slowdown in the economy. Economic forecast • Demand for Malaysian exports is expected to be hit as the US economy comes close to recession and the Japanese economy goes back into recession, harming private investment and slowing private consumption growth. Real GDP growth of only 4.1% is forecast for this year, but growth is expected to bounce back to 6.1% in 2002.

March 2001

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ISSN 0269-6703

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Contents

3 Summary

Malaysia

5 Political structure

6 Economic structure 6 Annual indicators 7 Quarterly indicators

8 Outlook for 2001-02 8 Political outlook 9 Economic policy outlook 10 Economic forecast

14 The political scene

18 Economic policy

23 The domestic economy 23 Economic trends 25 Manufacturing 27 Agriculture 28 Infrastructure 30 Financial and other services

31 Foreign trade and payments

Brunei

33 Political structure

34 Economic structure 34 Annual indicators 34 Quarterly indicators

35 Outlook for 2001-02 35 Political outlook 35 Economic forecast

36 The political scene

38 Economic policy and the economy

EIU Country Report March 2001 © The Economist Intelligence Unit Limited 2001 2

List of tables

10 Malaysia: international assumptions summary 11 Malaysia: forecast summary 12 Malaysia: gross domestic product by expenditure 24 Malaysia: real gross domestic product 32 Malaysia: current account

List of figures

13 Malaysia: real gross domestic product 13 Malaysia: Malaysian dollar real exchange rates 19 Malaysia: money supply, M2 23 Malaysia: gross domestic fixed capital formation 24 Malaysia: quarterly gross domestic product 25 Malaysia: consumer and producer prices 26 Malaysia: industrial and manufacturing production 26 Malaysia: exports of electronics and electrical goods 27 Malaysia: sales of passenger cars

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Summary

March 2001

Malaysia

Outlook for 2001-02 Malaysia’s fragile stability will continue to be threatened as pressure on the government to become more democratic intensifies. An expected economic slowdown this year could trigger social unrest, accelerating the pace of change. The 75-year-old prime minister, Mahathir Mohamad, appears determined to carry on in office but opposition to him from within the United Malays National Organisation (UMNO), the dominant component of the ruling (BN) coalition, is growing, and he could be forced out prematurely. Since the previous Country Report, the EIU has sharply reduced its real GDP growth forecast for 2001 from 7.3% to 4.1%, recovering to 6.1% (previously 6.7%) in 2002, largely because of the expected downturn in the US economy and the return of recession to Japan.

The political scene The discontent within UMNO over the leadership of Dr Mahathir has become more overt. A newly-set up Malay Action Front has become a forum for grievances. Malay unity talks have been rejected by the opposition Parti Keadilan Nasional (PKN) while talks with the Parti Islam sa-Malaysia have been called off at the last minute. Ethnic tensions are rising. Dr Mahathir has alienated the Chinese community which had called for an easing of the positive discrimination policies in favour of ethnic Malays. The intimidation of opposition supporters is continuing. The Malaysian Human Rights Commission has held a public inquiry into police brutality.

Economic policy Officials are trying to find ways of limiting the impact of the US slowdown. Fiscal and monetary policies remain stimulative. The government has published “masterplans” for the financial sector and the capital market, which promise stricter corporate governance and the establishment of a single local exchange by 2002. However, the divestment policy has so far remained opaque and changes to the bumiputera policy are unlikely. Malaysia’s foreign investment incentives are no longer adequate. Support for international trade pacts is weakening in Malaysia, where concern about the growing number of free-trade agreements is arousing concern.

The domestic economy Economic growth continues to slow and there has been a sharp deceleration in domestic demand growth. Inflation remains subdued. Sales of manufactured goods slipped in the fourth quarter and there has been a similar weakening of growth in the electronics industry. Malaysia’s manufacturing investment plans may paint too bright a picture of the investment outlook. The government has taken measures to reduce the glut of crude palm oil with new moves under way to boost demand. The government is buying up excess rice stocks. Some of Kuala Lumpur’s light-rail companies have been bailed out and the government is planning to take over some of the KL bus companies. After the government’s

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repurchase of a large stake in MAS there have been yet more accusations of a bailout. Concern is growing about future electricity supply shortages.

Foreign trade and The value of exports declined in the fourth quarter and there was a payments corresponding drop in fourth-quarter imports. The current-account surplus was little changed from the third quarter.

Brunei

Outlook for 2001-02 As Brunei’s economy continues to falter, social control is likely to increase, notwithstanding the government’s calls for openness and transparency. Economic restructuring will be limited in scope. While economic growth will be a respectable 3-3.5% in 2001, weakness in the private sector will hamper a full economic recovery. Brunei’s non-oil external payments position is likely to worsen this year and next.

The political scene The sultan’s visit to a US hospital, for undisclosed medical reasons, went unreported. A defamation ruling by the High Court worried the press. The chief justice pointed out the difficulty of trying to make Brunei an international investment centre while the government is immune from the process of the law. The government published new regulations to control Internet content. Policing of the citizens’ morality has been stepped up as the government banned public musical performances. Complaints about the public healthcare system are increasing.

Economic policy and the Brunei has launched a private-sector stimulus programme to boost small- and economy medium-sized companies. Consumer spending and lending are on the rise. Brunei’s halal food regulations, which raise retail prices, have drawn warnings about the emergence of a black market. The government has promised a new job training programme. Brunei Shell Petroleum has discovered more oil and gas. Brunei’s efforts to develop tourism are facing major obstacles.

Editors: Frans Jonkers (editor); Graham Richardson (consulting editor) Editorial closing date: March 13th 2001 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

EIU Country Report March 2001 © The Economist Intelligence Unit Limited 2001 Malaysia 5

Malaysia

Political structure

Official name Federation of Malaysia

Form of state Federated constitutional monarchy

The executive The king appoints a prime minister and, on the prime minister’s advice, a cabinet

Head of state The Yang di-Pertuan Agong (king or supreme sovereign) elected by the Conference of Rulers from one of the nine hereditary rulers

National legislature Bicameral federal parliament. The Senate () has 70 members, 30 of whom are elected from the state legislatures and 40 appointed by the king. The House of Representatives () has 193 directly elected members. The Senate serves a six-year term of office and the House of Representatives a five-year term

State government There are state governments in each of the 13 states, in nine of which the head of state is a hereditary ruler. Each state has its own constitution, a council of state, or cabinet, with executive authority and a legislature that deals with matters not reserved for the federal parliament. There are also three federal territories, Kuala Lumpur, Labuan, and Putrajaya

National elections November 29th 1999; next election due by January 2005

National government The Barisan Nasional (BN), the governing coalition—the main component of which is the United Malays National Organisation (UMNO) Baru—won 148 of the 193 seats in the Dewan Rakyat in the 1999 general election. The BN has the two-thirds majority required to pass constitutional amendments. The cabinet was reshuffled in December 1999

Main political organisations Government—the main parties in the Barisan Nasional are UMNO Baru, the Malaysian Chinese Association (MCA), the Malaysian Indian Congress (MIC), Gerakan, Parti Pesaka Bumiputera Bersatu (PPBB) and the National Party (SNAP) Opposition—Parti Islam sa-Malaysia (PAS), the (DAP), Parti Keadilan Nasional (PKN), Parti Bersatu (PBS) and Parti Rakyat Malaysia (PRM)

Prime minister Dr Mahathir Mohamad Deputy prime minister & home affairs minister

Key ministers Agriculture Defence Najib Abdul Razak Education Energy, communications & multimedia Finance Foreign affairs Housing & local government Human resources Information Khalil Yacoob International trade & industry Primary industries Public works Transport

Central bank governor Zeti Akhtar Aziz

EIU Country Report March 2001 © The Economist Intelligence Unit Limited 2001 6 Malaysia

Economic structure

Annual indicators

1996 1997 1998 1999 2000a GDP at market prices (M$ bn) 253.7 281.9 284.5 299.2 339.4 GDP (US$ bn) 100.8 100.2 72.5 78.7 89.3 Real GDP growth (%) 10.0 7.3 –7.4 5.8 8.5 Consumer price inflation (av; %) 3.5 2.7 5.3 2.7 1.5 Population (m) 21.2 21.7 22.2 22.7 23.3 Exports of goods fob (US$ m) 76,985 77,538 71,883 84,052 99,885b Imports of goods fob (US$ m) 73,137 74,029 54,378 61,404 82,161b Current-account balance (US$ m) –4,461 –5,936 9,529 12,607 8,974b Foreign-exchange reserves excl gold (US$ m) 27,009 20,788 25,559 30,588 29,523 Total external debt (US$ bn) 39.7 47.2 44.8 45.9 48.0b Debt-service ratio, paid (%) 8.9 7.4 7.4 4.8 5.2b Exchange rate (av; M$:US$) 2.52 2.81 3.92 3.80 3.80

March 9th 2001 M$3.80:US$1

Origins of gross domestic product 2000 % of total Components of gross domestic product 2000 % of total Agriculture 8.3 Private consumption 42.5 Mining 9.9 Public consumption 10.7 Manufacturing 34.4 Gross fixed capital formation 25.7 Construction 4.1 Stockbuilding 1.3 Electricity, gas & water supply 3.4 Exports of goods & services 125.7 Services 39.9 Imports of goods & services –105.8 GDP at factor cost 100.0 GDP at market prices 100.0

Principal exports 1999c US$ bn Principal imports 1999c US$ bn Electronics & electrical machinery 51.3 Manufacturing inputs 24.5 Petroleum & LNG 4.1 Machinery 4.7 Palm oil 3.8 Transport equipment 3.5 Chemicals & chemical products 2.9 Metal products 2.8 Textiles, clothing & footwear 2.5 Food 1.8 Wood products 1.8 Consumer durables 1.3 Total incl others 84.5 Total incl others 60.1

Main destinations of exports 1999 % of total Main origins of imports 1999 % of total US 21.9 Japan 20.8 Singapore 16.5 US 17.4 EU 15.7 Singapore 14.0 Japan 11.6 EU 11.6 Taiwan 4.5 Taiwan 5.3 Hong Kong 4.2 South Korea 5.2 South Korea 3.0 Thailand 3.8 a Actual. b EIU estimate. c Customs basis, imports cif.

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Quarterly indicators

1999 2000 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Federal government finance (M$ m) Revenue 11,318 15,498 13,997 17,861 11,219 16,682 15,421 n/a Expenditure 9,198 10,059 12,158 15,285 7,805 12,760 14,662 n/a Balance 2,120 5,440 1,839 2,577 3,413 3,922 759 n/a Output GDP at constant 1987 prices (M$ m) 44,695 48,151 49,491 50,458 49,966 52,201 53,355 53,742 % change, year on year –1.4 5.0 8.6 11.0 11.9 8.5 7.7 6.5 Industrial production index (1993=100) 142.1 155.0 164.1 170.9 175.5 186.2 194.1 197.2 % change, year on year –2.4 6.6 14.2 17.9 23.5 20.1 18.3 15.4 Prices Consumer prices (1995=100) 114.6 114.8 114.9 115.4 116.3 116.4 116.6 117.5 % change, year on year 4.0 2.7 2.3 2.0 1.5 1.4 1.5 1.8 Producer prices (1990=100) 129.0 127.6 129.3 133.1 134.0 134.8 134.6 131.8 % change, year on year –4.1 –5.0 –4.2 0.3 3.9 5.6 4.1 –1.0 Financial indicators Exchange rate M$:US$ (av) 3.80 3.80 3.80 3.80 3.80 3.80 3.80 3.80 M$:US$ (end-period) 3.80 3.80 3.80 3.80 3.80 3.80 3.80 3.80 Interest rates (av; %) Deposit 5.6 3.8 3.8 3.3 3.3 3.3 3.4 n/a Lending 8.0 7.4 6.9 6.8 6.8 6.8 6.8 n/a Money market 5.3 3.1 2.6 2.6 2.6 2.5 2.7 n/a M1 (end-period; M$ m) 56,813 62,876 65,616 75,602 70,132 69,431 69,526 80,884 % change, year on year –17.3 –3.7 16.3 29.2 23.4 10.4 6.0 7.0 M2 (end-period; M$ m) 274,103 298,968 310,000 316,851 324,716 334,515 332,415 348,158 % change, year on year 3.6 13.2 17.1 16.9 18.5 11.9 7.2 9.9 KLSE composite index (end-period; 1977=100) 502.8 811.1 675.5 812.3 974.4 833.4 713.5 679.6 % change, year on year –30.1 78.0 80.8 38.6 93.8 2.7 5.6 –16.3 Sectoral trends Electronic & electrical products index (1993=100) 163.8 189.9 203.4 218.5 237.8 269.8 289.9 286.8 % change, year on year –1.6 10.6 23.1 30.7 45.2 42.1 42.5 31.2 Mining index (1993=100) 124.2 115.0 118.1 121.5 122.2 118.0 116.2 121.1 % change, year on year –1.3 –4.9 –1.9 –4.3 –1.6 2.6 –1.6 –0.4 Foreign trade (M$ m) Exports fob 69,260 77,864 83,649 90,677 84,758 90,968 101,706 95,859 Imports cif –53,696 –59,702 –64,871 –70,450 –68,231 –78,681 –86,756 –78,758 Trade balance 15,564 18,162 18,778 20,227 16,527 12,287 15,950 17,101 Foreign payments Current-account balance (M$ m) 10,798 12,340 14,056 10,708 10,710 7,879 7,654 n/a Reserves excl gold (end-period; US$ m) 27,140 30,571 31,134 30,588 33,626 33,666 31,895 29,523

Sources: Central Bank of Malaysia, Monthly Statistical Bulletin; IMF, International Financial Statistics.

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Outlook for 2001-02

Political outlook

Domestic politics Malaysia’s contrived and now fragile stability will continue to be threatened as pressure on the government to become more democratic intensifies. An expected economic slowdown this year could trigger social unrest, accelerating the pace of change. With the 75-year-old prime minister, Mahathir Mohamad, apparently determined to carry on for as long as possible and convinced that significant concessions would hasten his departure, he is likely to pursue his strategy of resisting, frustrating and intimidating the reformists. Yet he could be forced out prematurely. Discontent with Dr Mahathir is most acute among the grassroots. The party elders of the United Malays National Organisation (UMNO), the dominant component of the ruling Barisan Nasional (BN) coalition, could ultimately be obliged to give it due recognition by confronting the prime minister and demanding his resignation, to try and restore the party’s battered credibility. Under the present circumstances, it is likely that the increasingly popular opposition would win the next general election, which must be called by end-2004.

There are concerns that the retirement of such a hugely dominant personality could generate more problems than it would resolve, precipitating a wholesale shake-up of the political system he has fashioned and igniting all manner of long-smouldering and potentially explosive animosities. While the deputy premier, Abdullah Badawi, by virtue of his elevation last May to the number two position in UMNO’s hierarchy, is Dr Mahathir’s present heir-apparent, he seems less than qualified to manage that kind of tumultuous transition. Dire warnings by government and opposition leaders about a possible eruption of racial turmoil suggest Dr Mahathir’s determination to hang on is assuming more reckless dimensions. Critics accuse him of stoking racial tensions by antagonising the sizeable ethnic Chinese minority—whose leaders have called for an easing of the government’s long-running affirmative action strategy in favour of Malays—in order to portray himself and beleaguered UMNO as the true defenders of the divided Malay majority. Although the stand-off was defused after a reformist Chinese lobby agreed to shelve particularly sensitive demands, a desperate Dr Mahathir could revive the issue, or stir other potentially destabilising controversies, to try to keep himself in office.

The jailed former deputy prime minister, , is still the joker in the pack. It is possible that the Federal (Supreme) Court, headed by a new chief justice, Dzaiuddin Abdullah, with a reputation for independence and incorruptibility, may quash Mr Anwar’s convictions for corruption and sodomy. Mr Anwar could reasonably expect to be released on bail pending the outcome of his second appeal. His return to the political fray would be a major setback for Dr Mahathir. But it is unclear whether a rehabilitated Mr Anwar would join the opposition Parti Keadilan Nasional, set up following his imprisonment and nominally led by his wife, Wan Azizah Ismail, or return to UMNO. Given the popularity he enjoys on both sides of the political divide,

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his choice would have a significant bearing on the outcome of the next general election.

International relations Slower regional growth will make many Association of South-East Asian Nations (ASEAN) countries less keen to remove internal trade barriers. Malaysia may have seriously harmed the planned creation of an ASEAN Free-Trade Area (AFTA) by 2003 by insisting on the postponement of the lowering of its automotive tariffs, in order to protect its national car company, Proton. Concern about the impact of China’s expected membership of the World Trade Organisation (WTO) has made some ASEAN countries pursue free-trade agreements, usually on a bilateral basis, which could further weaken ASEAN. Japan’s adoption of trade bilateralism could undermine the broadly based trade liberalisation process and discourage foreign direct investment (FDI) inflows from the US and Europe into ASEAN.

Economic policy outlook

Policy trends Developed-nation status by 2020 remains the government’s long-term ambition, requiring the pursuit of a high rate of economic growth. Monetary policy is expected to remain accommodative and fiscal policy stimulative in the next 12 months, as the government tries to reduce the impact of a sudden export slowdown on economic growth. A return to the pre-crisis high-growth path is only possible if investment, which used to contribute two-thirds of GDP growth before the crisis, increases dramatically. Fiscal stimulation, incentives to boost private investment and attract FDI are to be expected. Interventionist policies and exchange controls are likely to continue. The government will set out its economic strategy in the Eighth Malaysia Plan (2001-05) and its social strategy in the revision of the National Development Policy (NDP).

Fiscal policy The government is likely to respond to the increasingly evident slowdown in economic growth by following a stimulative fiscal policy until 2003. This is evident from a sharp rise in the federal government deficit in the fourth quarter of last year. Slower revenue growth will widen the deficit in 2001. The 2001 budget boosts development spending and forecasts a deficit of M$16.1bn (US$4.2bn), equivalent to 4.9% of GNP in 2001, only slightly down from the predicted result for 2000 of M$18bn or 5.9% of GNP. The final outcome may well be a larger shortfall than this. The government has announced it is going ahead with the Bakun hydroelectric dam “mega-project” in Sarawak state, estimated to cost at least M$15bn. Further initiatives are likely to follow.

The government is increasing social spending, supporting those parts of the economy left behind in the recovery. It is boosting education to upgrade skills and productivity. It is also stepping up the development of new growth sectors such as knowledge-based industries, particularly high-technology manufact– uring and high value-added services. The 2001 budget promotes investment in information communications technology, education and retraining of workers. To stimulate domestic consumption, there are tax rebates for low- and middle- income groups.

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Monetary policy The intervention rate of Bank Negara (BN, the central bank), may be cut to 5% from its current level of 5.5%—at which it has remained since the middle of 1999—if economic activity does not pick up in the second half of the year. The expected drop in export demand will keep lending and money supply growth low as private investment is likely to stay sluggish, maintaining the downward pressure on lending rates. Money supply growth will be sluggish in 2001, notwithstanding an encouraging rise in loans disbursed during the final month of 2000. In January the year-on-year increase in total loans outstanding, including loans sold to the national companies, Cagamas and Danaharta, reached 5.9% from 5.4% in December. The forecast acceleration of economic growth in 2002 will induce the central bank to raise the intervention rate as inflation begins to rise.

Economic forecast

International assumptions The major risk to Malaysia’s external outlook remains the possibility of the US downturn developing into a full-blown US recession, which the EIU does not expect to happen, although we suspect the downturn may be sharp enough to call it a “hard landing”. US growth is expected to fall from 5% in 2000 to 1.4% in 2001 but is forecast to recover to 2.9% in 2002, boosted by lower interest rates. Malaysia’s economy is strongly influenced by the performance of the US, its largest export market, particularly for electronic and electrical goods which comprise 59% of Malaysia’s exports. Additional risks to Malaysia come from the expected return to recession in Japan and slower growth in other export-dependent parts of Asia in 2001. However, EU growth is forecast to hold up fairly well at 2.6% in both 2001 and 2002, down from 3.3% in 2000.

Malaysia: international assumptions summary (% unless otherwise indicated) 1999 2000 2001 2002 Real GDP growth World 3.5 4.8 3.3 3.9 OECD 3.0 4.0 1.9 2.7 EU 2.4 3.3 2.6 2.6 Exchange rates (av) ¥:US$ 113.9 107.8 119.5 120.0 US$:¤ 1.07 0.92 1.00 1.09 SDR:US$ 0.731 0.758 0.755 0.731 Financial indicators ¥ 2-month private bill rate 0.27 0.24 0.50 0.50 US$ 3-month commercial paper rate 5.18 6.32 4.89 5.39 Commodity prices Oil (Brent; US$/b) 17.9 28.4 23.9 23.0 Gold (US$/troy oz) 278.8 279.3 258.8 255.0 Food, feedstuffs & beverages (% change in US$ terms) –18.6 –6.2 9.0 16.1 Industrial raw materials (% change in US$ terms) –4.2 14.6 0.7 12.6

Note. Regional aggregate GDP growth rates weighted using purchasing power parity exchange rates.

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Economic growth Malaysia’s manufacturing economy is in the middle of a sharp slowdown, which is likely to last two or three quarters, as the effect of much weaker US demand for electrical and electronic goods feeds through. From November 2000 to January 2001, manufacturing production declined by 3.6% from the preceding three months. Signs of the output fall had first been picked up by a sharp drop in business confidence in the third quarter, as foreign and domestic orders slowed and stocks began to pile up. A sudden year-on-year 10.9% plunge in December exports—the first fall for almost two years—also suggests that further export weakness is to be expected.

The loss of momentum was also evident in fourth-quarter real GDP figures which barely increased from the preceding quarter, although the year-on-year growth rate reached a respectable 6.5%, after 7.7% in the third quarter. Exports are likely to fall in the first half of 2001 but will begin to recover in the second half. The fall in export revenue will reduce corporate incomes, limit household income growth, and lead to greater caution in private consumption and gross fixed investment.

Malaysia: forecast summary (% unless otherwise indicated) 1999a 2000b 2001c 2002c Real GDP growth 5.8 8.5 4.1 6.1 Industrial production growth 9.1 18.0 5.3 7.9 Gross agricultural growth 3.3 0.4 2.0 1.0 Unemployment rate (av) 3.4 3.0 3.5 3.4 Consumer price inflation Average 2.7 1.5 1.8 2.2 Year-end 2.5 1.4 2.0 2.8 Short-term interbank rate 7.3 6.8 6.8 7.3 Government balance (% of GDP) –3.2 –3.6 –4.1 –2.8 Exports of goods fob (US$ bn) 84.1 98.5 103.6 115.5 Imports of goods fob (US$ bn) 61.4 79.8 88.9 101.4 Current-account balance (US$ bn) 12.6 9.0 4.7 3.8 % of GDP 16.0 10.2 5.1 3.8 External debt (year-end; US$ bn) 45.9 48.0 51.6 55.2 Exchange rates M$:US$ (av) 3.80 3.80 3.80 3.80 M$:¥100 (av) 3.34 3.53 3.18 3.17 M$:¤ (year-end) 3.82 3.57 3.99 4.29 M$:SDR (year-end) 5.22 4.95 5.12 5.28

a Actual. b EIU estimates. c EIU forecasts.

Growth-sustaining influences in 2001 will be private consumption, slower imports and public spending. Consumer confidence is still high and, although it is likely to be eroded by rising unemployment, no serious deterioration is expected in 2001. A steep decline in import growth—imports of intermediate goods are closely linked to exports—will reduce the negative impact of lower exports on overall GDP growth. Public spending is likely to be boosted should the slowdown turn out to be prolonged. During the past three months we have

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sharply revised down our real GDP forecast and now expect growth to reach 4.1% in 2001 and recover to 6.1% in 2002, after an outcome of 8.5% last year.

We expect gross fixed investment growth to be relatively firm, owing mainly to public-sector investment (part already planned, and part made up of additional works to compensate for the slowdown in GDP growth). Private-sector investment, apart from residential investment, has remained depressed, standing at about half the level attained in 1997. However, if global demand for electronic and electrical products continues to grow at a moderate rate, production facilities are likely to be expanded in the next two years. Total gross fixed capital formation, which rose by a remarkable 24.1% in 2000, is forecast to increase by 9.1% in 2001 and 12% in 2002 but may again surprise on the upside. Our forecast assumes that private consumption growth, boosted by a sharp rise in disposable incomes from higher wages and increased tax allowances in the 2001 budget, will hold up fairly well. After the spending recovery which raised real consumption by 12.5% in 2000, private consumption growth is expected to amount to 4.2% in 2001 and 5.4% in 2002.

Malaysia: gross domestic product by expenditure (M$ m at constant 1987 prices; % change year on year in brackets unless otherwise indicated) 1999a 2000b 2001c 2002c Private consumption 84,068 94,492 98,461 103,778 (3.1) (12.4) (4.2) (5.4) Public consumption 23,905 24,311 24,992 25,742 (16.3) (1.7) (2.8) (3.0) Gross fixed investment 51,897 64,404 70,265 78,697 (–6.1) (24.1) (9.1) (12.0) Final domestic demand 159,870 183,208 193,718 208,217 (1.6) (14.6) (5.7) (7.5) Stockbuilding 219 1,174 1,100 500 (0.2)d (0.5)d (0.0)d (–0.3)d Total domestic demand 160,089 184,382 194,818 208,717 (1.9) (15.2) (5.7) (7.1) Exports of goods & services 212,484 247,034 260,127 280,677 (14.3) (16.3) (5.3) (7.9) Imports of goods & services 179,778 222,242 237,132 258,236 (11.8) (23.6) (6.7) (8.9) Foreign balance 32,706 24,792 22,995 22,440 (4.2)d (–4.1)d (–0.9)d (–0.3)d GDP 192,795 209,174 217,813 231,157 (5.8) (8.5) (4.1) (6.1)

a Actual. b EIU estimates. c EIU forecasts. d Contribution to real GDP growth.

Inflation A slower economy, growing spare capacity and a less tight labour market will keep prices and wages down in 2001. Inflation, which began to resurface by early 2000, was already fading by the end of that year. Consumer price inflation fell to 1.4% year on year in December 2000 from 1.9% in November, as year-end price increases remained moderate, and reached 1.5% in January 2001. Despite an oil price-related autumn inflation rise, consumer price inflation averaged only 1.5% in 2000 and non-food inflation even less at 1.3%.

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Utility price rises will raise inflation slightly this year. Consumer prices are expected to rise by an average of 1.8% this year and by 2.2% in 2002. Producer price inflation, which peaked at 7.3% year on year in June 2000, should continue the decline which began towards the year-end.

Exchange rates There is a real possibility that the renewed weakness of the Asian economies most closely linked to the US may trigger unrest in the currency market in 2001. Malaysia’s response is likely to be to stick firmly to the US dollar peg and the remaining capital controls, even though the official belief in the benefits of stability against the US dollar is increasingly being questioned and the disadvantages of an inflexible currency regime have been pointed out. The expected weakening of the US dollar, to which the ringgit is fixed at a level of M$3.80:US$1, is likely to bring some relief to Malaysian competitiveness, which the rise of the US dollar had reduced during 2000. Much of the competitive gain from the sizeable ringgit depreciation in 1997-98 has disappeared. Should there be a sharp fall in the currencies of the Asian regional competitors, domestic pressure for a ringgit devaluation is likely to increase. However, we expect the fixed currency regime to continue this year and next.

External sector Export and import growth will slow sharply in the next 12 months but domestic demand is expected to hold up. This will be apparent in a continued decline of the current-account surplus, from an estimated outcome of 10.2% of GDP in 2000 to 5.1% in 2001 and 3.8% in 2002. The impact of the downturn in trade will be very different from the Asian crisis: neither a surging current- account surplus or a collapse of imports, as in 1998, nor a surge in exports, as in 1999 and 2000, are to be expected. Some recovery in export and import growth is expected to follow in 2002. The trade surplus expanded in the second half of 2000, initially because of surprisingly firm exports, then later because of unusually weak imports. The trade surplus will remain high during the forecast period, reaching US$14.7bn in 2001 and US$14.1bn in 2002, after US$18.7bn in 2000.

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The political scene

UMNO grassroots challenge Simmering discontent within the United Malays National Organisation Dr Mahathir (UMNO) over the leadership of Mahathir Mohamad has become more overt in recent weeks, intensifying the already considerable pressure on the veteran prime minister to stand aside. This was graphically illustrated during a February 4th rally in Kuala Lumpur organised by the newly created Malay Action Front (MAF), essentially a grouping of once high-flying politicians of the ruling Barisan Nasional (BN) coalition’s dominant party, UMNO. Intriguingly themed “Malays will not perish from the Earth” and attended by some 3,000 people, the gathering heard speaker after speaker roundly condemn the government and some of its key policies. The implementation of the affirmative action strategy in favour of bumiputeras (Malays and other indigenous groups) was singled out for special treatment, with critics denouncing it as a vehicle for the enrichment of a small coterie of cronies rather than the advancement of the community generally. The government was repeatedly advised to attend to concerns being ever more vocally expressed by grassroots UMNO members on issues such as corruption, transparency and injustice.

MAF: a new forum for The former justice minister, Ibrahim Ali, the driving force behind the event, grievances defended the public airing of the grievances, arguing that opposition parties alone could not be seen to be capitalising on them. Yet opposition parties sought to extract as much mileage as possible from the thinly veiled attacks on the prime minister by UMNO stalwarts. Harakah, a newspaper published by Parti Islam sa-Malaysia (PAS), declared that the MAF had “openly challenged the legitimacy of Dr Mahathir to remain in office”. The prime minister was apparently initially under the impression that the forum would merely echo his calls for unity among the Malays. After belatedly realising it would prove less than supportive, he launched a damage-limitation exercise, urging members of his party not to attend and contriving to change the venue to the UMNO-run World Trade Centre. Subsequently, Dr Mahathir accused the MAF of effectively creating a breakaway party, and decreed that it be given no further meeting permits.

Malay unity talks are Official efforts to reverse the polarisation of ethnic Malays—triggered by the rejected by the PKN controversial September 1998 ouster and imprisonment of the former deputy prime minister, Anwar Ibrahim—intensified following the BN’s surprising defeat in an end-November by-election in Dr Mahathir’s native state of . In early January, after UMNO’s management committee endorsed a recommendation by a local academic that the party’s president hold “unity talks” with his counterparts from other Malay-based parties, invitations were duly issued to Fadzil Noor of the PAS and Wan Azizah Ismail of Parti Keadilan Nasional (PKN). The latter—who is Mr Anwar’s wife—promptly turned down the offer. Questioning the rationale for such talks, she asserted that the large- scale shift in allegiance among Malays from UMNO to the opposition stemmed from a crisis of confidence in the government and was being fuelled by perceived misuse of power, corruption, police brutality, weak economic

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management and judiciary subservience. Characterising the PKN as a multiracial party, she said ethnic Chinese and Indians were victims of official oppression as well as Malays, and that unity talks should encompass all races.

Talks with PAS called off at PAS, while echoing PKN’s advocacy of talks on national rather than just Malay the last minute unity, nonetheless said it would take up UMNO’s invitation. But it too was clearly suspicious of Dr Mahathir’s motives and intentions, demanding that there be prior agreement on the agenda and that this incorporate broad issues of concern to all members of the four-party opposition Barisan Alternatif, which comprises PAS, PKN, the Democratic Action Party (DAP) and Parti Rakyat Malaysia. During preliminary “technical” discussions on February 8th between representatives of the two parties, PAS insisted that the government’s controversial decision last September to stop paying Terengganu state— controlled by the opposition Islamic party since November 1999—a 5% royalty on offshore oil and gas production also be included. Two days later, Dr Mahathir announced that formal talks would begin on February 19th. But on February 18th PAS declared otherwise, citing UMNO’s refusal to reconsider the royalty issue and recent heavy-handed police break-ups of gatherings of opposition supporters. On March 8th Terengganu state filed a suit in the Kuala Lumpur High Court alleging that the federal government and its wholly owned hydrocarbons corporation, Petroliam Nasional, were in breach of contract by failing to make royalty payments.

Dr Mahathir alienates the UMNO’s attempts to portray itself as the true defender of Malay interests Chinese community prompted renewed condemnation by Dr Mahathir of members of the Chinese community favouring a dilution of policies underpinning pro-bumiputera affirmative action. The prime minister had begun his attacks last August, targeting a respected umbrella grouping of Chinese lobbies, known as Suqiu, that issued an 83-point memorandum prior to the November 1999 parliamentary elections calling, inter alia, for the abolition “in all respects of the bumiputera/non-bumiputera distinction”. Ironically, the grouping’s recommendations were “approved in principle” at the time by the UMNO-led government. Dr Mahathir was then angered by Chinese educationalists’ rejection of a proposed pilot project to partially integrate some Malay, Chinese and Indian schools on the single campuses—the so-called Vision School initiative. His harsh criticism of opponents of the Vision School scheme and of Suqiu was a key factor in the BN’s defeat in the November 2000 Kedah by- election. The prime minister alienated even more Chinese by declaring in parliament on December 11th that the government’s earlier acquiescence to Suqiu’s appeals was a political expedient necessitated by the looming elections. That admission prompted Lim Kit Siang, the chairman of the predominantly Chinese DAP, to accuse him of “deliberate and cynical deception”. The solid backing of the main minority community at the polls had helped give the BN another two-thirds majority in the federal parliament.

Malay students fuel ethnic Mr Lim and other opposition luminaries likewise expressed outrage at the tensions government’s apparent acquiescence when Gabungan Pelajar Melayu Semenanjung (GPMS–the Federation of Peninsular Malay Students) announced in mid-December that it would issue a list of demands to counter those of

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Suqiu. This advocated that the post of prime minister be reserved for a Malay, that Malays be guaranteed 70% and 60% respectively of the places in public and private universities, and that passports be issued only to Malay-speaking Malaysians. The GPMS also threatened to organise demonstrations across the country unless Suqiu withdrew its appeal by mid-January. In his New Year address on December 31st, Dr Mahathir claimed that bowing to demands for more egalitarian policies would aggravate existing imbalances and lead “inevitably” to race riots. In a clear reference to the prime minister, Mr Lim warned that “those who cynically play with communal fire can end up putting their entire political legacy to flames”.

The situation was defused on January 6th when Suqiu, under intense pressure and citing the “prevailing ethnic tension”, agreed to shelve its most sensitive demands. But it was a hollow victory for Dr Mahathir. While the controversy was raging, the DAP chairman also accused Ling Liong Sik, the president of the Malaysian Chinese Association (MCA), the BN’s second biggest party, of pandering to the GPMS. Although the ruling coalition’s defeat in the Kedah by- election had prompted Dr Ling and other Chinese members of the government to call meekly for a re-evaluation of its attitudes towards the main minority community, they preferred to be seen professing loyalty to the prime minister than indulging their reformist constituents.

Factionalism within the Barely concealed factionalism within the MCA erupted into a bitter war of MCA flares up words in February between supporters of Dr Ling and those of his deputy, . It was sparked by claims in a Chinese-language newspaper that Mr Lim had asked Dr Ling to specify when he would step down as party president. The MCA’s two top office-bearers have long been grooming protégés to assume the leadership of the party upon their retirement. Once the best of friends, they fell out after the 1999 parliamentary elections when Dr Ling supposedly reneged on a promise to ensure the appointment of Mr Lim’s protégé, , as a full minister, promoting his own, Ong Ka Ting, instead. The bad blood stirred by that episode provoked a mid-2000 threat by Dr Ling to resign as transport minister, ostensibly to make way for Mr Chan. Suspicions that this was a tactical manoeuvre to silence his critics and to reassert his authority over the party were reinforced by apparently well- orchestrated displays of support that culminated in Dr Ling’s withdrawing his resignation threat.

Negotiations between Dr Ling and Mr Lim on a succession formula resumed, reportedly resulting in an agreement early in February that Mr Chan would take over the deputy presidency of the MCA before internal elections next year, thus becoming the top contender to head the party once its president bows out. But newspaper claims of an ultimatum by Mr Lim to his boss again exposed the strained relations between them, a situation exacerbated by Dr Ling’s refusal to endorse his deputy’s denial that such a demand had been made and vocal pledges of support for each by respective loyalists. With the rift deepening ominously, party elders prevailed on both sides to end the public slanging match.

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Intimidation of the Notwithstanding UMNO’s overtures to PAS and PKN, the judiciary and law opposition continues enforcement agencies remain ill-disposed towards dissenting opposition party luminaries and supporters. On February 9th a former PKN vice-president, Marina Yusof, was found guilty of sedition by a court in state and given the maximum fine of M$5,000 (US$1,315). She had been charged in January 2000 with “provoking racial discord” during a speech prior to the 1999 elections by urging voters not to support UMNO because, she alleged, it had started the massacres of ethnic Chinese following closely contested polls in 1969. Human rights groups have called for the repeal of the Sedition Act, a colonial-era law that criminalises any speech deemed to have a “seditious tendency”, regardless of its veracity. In mid-February anti-riot police used tear- gas and chemical-laced water to break up three rallies by PKN supporters, one in Kuala Lumpur and two in Kedah. The third gathering coincided with the preliminary hearing of a court case against nine PKN members on charges of interfering with the November by-election. They were said to have intercepted several buses believed to be filled with would-be BN voters from outside the constituency. Defendants said the charges were baseless, politically motivated and designed to intimidate opponents of the government.

Human Rights Commission A landmark public inquiry by the Malaysian Human Rights Commission, holds a public inquiry known as Suhakam, into allegations of police brutality during a PKN-organised rally near Kuala Lumpur in early November got under way in mid-December. Witnesses, who included Wan Azizah, testified that the police fired tear-gas canisters straight at members of the crowd after organisers had instructed it to disperse, beat up both participants and bystanders at the site, and assaulted several of the 120-odd people taken into custody. The police were reluctant to send representatives to the Suhakam hearings, ostensibly because court cases against some of those detained—on charges of involvement in an illegal demonstration and failure to disperse—were still pending, but eventually relented. Officers who testified in mid-February denied all the allegations, claiming that any force used was legitimate and wholly justified given the “provocation” by certain members of the crowd. After the inquiry had begun Dr Mahathir urged a gathering of senior police officers not to be disheartened by the proceedings. He said the government realised that when confronted by demonstrators who turned violent, their subordinates sometimes had to use force. Suggesting that the allegations of police brutality were politically motivated, the prime minister declared that his administration would not be easily influenced by any recommendations the commission might make. Suhakam, set up by the government to temper criticisms of its human rights record, has no power to prosecute.

Mr Anwar is said to need On February 23rd the Federal (Supreme) Court upheld rulings by lower courts surgery overseas that a M$100m (US$26m) defamation suit by Mr Anwar against Dr Mahathir was frivolous, and refused to hear his plea. The former deputy prime minister, now serving jail sentences totalling 15 years after being convicted of corruption and sodomy, had accused the prime minister of slandering him during a press conference two days after his arrest in September 1998 by graphically describing the alleged sexual misconduct. Dr Mahathir argued that the statements were not calculated to disparage the detained politician, but

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had been necessary to explain his dismissal. The hearing of Mr Anwar’s appeal to the Federal Court against the corruption conviction was postponed indefinitely in December following his hospitalisation the previous month for a slipped disc. His lawyers said the least painful and risky treatment was endoscopic microspinal surgery, which is not available in Malaysia, and asked that he be allowed to undergo it abroad. The government turned down the request, but agreed in early February to allow a Munich-based doctor, Thomas Hoogland, to examine Mr Anwar and, if necessary, operate on him locally. One of several conditions imposed was that local doctors be absolved of any blame that might arise from the treatment. Dr Hoogland told a press conference in Kuala Lumpur on March 11th that Mr Anwar should undergo surgery overseas.

Economic policy

Officials mull how to limit There has been little change in the general thrust of policy during recent the impact of US slowdown months, with the authorities essentially reiterating their faith in the expansionary strategy adopted in mid-1998 to propel the economy out of the then looming downturn and sustain growth thereafter. To limit the adverse repercussions of the nascent slowdown in the US, Malaysia’s biggest market and source of investment, officials have been stressing the need to broaden the export base and identify new overseas markets; to boost domestic demand, inter alia by encouraging banks to lend and their customers to borrow, and by facilitating access to non-bank sources of funding; to attract more foreign investment in manufacturing and other sectors; and to ensure public sector outlays are utilised speedily.

Fiscal and monetary policy Fiscal policy has remained expansionary. Net development expenditure remain stimulative reached M$11.75bn (US$3.1bn) in October-December 2000, up from M$5.34bn in July-September and M$7.79bn in the fourth quarter of 1999. The government has long been adamant that pump-priming will remain essential until the private sector fully recovers from the 1998-99 recession. The abundance of export-generated liquidity presently in the system means that the government can use domestic borrowings to finance a higher deficit without crowding the private sector out of the credit market. Monetary policy continues to be stimulative. The average lending rate of commercial banks declined to 7.45% by end-December, from 7.6% at end-September. The downward trend was dictated by the sizeable liquidity surplus, the persistent slackness of demand for funds, and the weakness of inflationary pressures. Such pressures are likely to remain subdued given the US slowdown. Recent cuts in US interest rates have narrowed differentials between the two countries, discouraging the outflow of monies from Malaysia. The M$3.80:US$1 exchange-rate peg and residual capital controls allow the monetary authorities more freedom than their counterparts elsewhere in the region to keep interest rates low. The downside of the government’s determination to maintain rates at low levels is that it props up borrowers less than deserving of such support, thereby impeding, for example, the much-needed restructuring of the corporate sector.

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The financial sector On March 1st Bank Negara, (BN, the central bank), unveiled a ten-year masterplan is unveiled masterplan for the financial sector. This is broadly aimed at developing a “more resilient, competitive and dynamic” system and facilitating the emergence of a core of “strong and forward-looking” domestic institutions capable of facing the challenges of liberalisation and globalisation. During the first phase of its implementation, 2001-03, the focus will be on enhancing the competitive capacities of locally owned banks and insurance companies. Impediments to competition among such institutions are to be progressively lifted during the second stage, 2004-07, paving the way for a fully liberalised market, and the licensing of more foreign players thereafter.

Bank integration is likely The ongoing consolidation of the banking industry should eventually lead to to be fraught with hazards greater efficiency and lower costs. It will also spur improvements in risk management capabilities—the recent economic crisis stemmed in no small measure from banks’ earlier profligacy—and in the range of products and services on offer. Fifty of the country’s 54 domestic banks met an officially imposed end-2000 deadline to legally merge into ten groups. However, the actual integration process is likely to be fraught with hazards. Management strains are inevitable given differences in corporate culture and procedure, and this is bound to have an adverse affect on day-to-day operations in the short term. Lending activities, which are already slack owing to a still hefty bad debt overhang, seem set to recover only slowly. Customers will be tempted to transfer deposits to locally incorporated foreign banks perceived as more efficient. One danger implicit in the ten-year masterplan is that the protective instincts which impelled the government to oblige domestic banks to merge could become protectionist ones, delaying the transition to full- blown foreign competition.

A capital market On February 22nd the Securities Commission presented a ten-year masterplan masterplan is presented for the capital market, essentially designed to render it more attractive for borrowers and investors. The plan promises measures to lower the cost of fundraising, and to facilitate more innovative methods of doing so. Much of the focus is on accelerating the development of the corporate bond market, inter alia, by fostering greater liquidity, establishing benchmark yield curves, encouraging asset securitisation, promoting bond derivatives and bond funds,

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and permitting regulated short-selling. A phased programme to encourage international financial institutions and multinational corporations to issue ringgit bonds should be considered, the plan said. Another key thrust is the development of the venture capital market, not least by encouraging the participation of foreigners and local institutional investors in such funds. The plan acknowledges that the private pension fund sector needs to be promoted, and recommends that the management of government-controlled investment institutions such as the Employees’ Provident Fund, a mandatory national pension scheme, be outsourced. Foreign majority ownership of unit trust companies is to be permitted from 2003.

The plan promises stricter Strengthening corporate governance is a major priority. The plan promises to corporate governance improve avenues for minority shareholders to exercise and enforce their rights. In late January the Kuala Lumpur Stock Exchange (KLSE) unveiled stricter governance and disclosure rules as part of ongoing efforts to boost investor confidence in the lacklustre share market. They were partly a response to minority shareholders’ concerns about dubious restructuring and other initiatives, undertaken in recent months by politically well-connected listed companies, that contributed to a substantial outflow of foreign funds. The changes prescribed minimum standards of disclosure to encourage the timely provision of material information to the market. They allow the KLSE to take action against the directors of listed companies, and against their advisers. Quoted firms are, inter alia, required to detail in annual reports the extent of their compliance with corporate governance best practices; to have independent directors constitute at least one-third of their boards, up from the present minimum of two such members; to send directors on KLSE-approved governance training programmes; and to oblige auditors to review a wider range of activities, including possible conflicts of interest.

A single local exchange to The February 22nd masterplan pledges to implement a range of measures to be established by 2002 speed up the development of the fledgling derivatives market, including entitling foreign firms to act as clearing agents. As part of its campaign to ensure a liquid, efficient, secure and transparent trading environment, the Securities Commission advocates consolidation of market institutions and intermediaries. This is expected to lead to the establishment of a single local exchange by 2002, and to the emergence of a core group of competitive brokerages offering a wide range of products and services. Regulation is to become increasingly market-based, with enhanced incentives to promote greater compliance. While industry players welcomed the masterplan, many pointed out that its success depends heavily on the sort of effective enforcement which the authorities have hitherto been unwilling to impose.

MAS experience is Expectations that the problems afflicting key “privatised” companies— instructive graphically exposed by the 1998-99 recession—would yield a more cautious and transparent divestment policy have not been borne out. Not only has the government continued to award development contracts to favoured but less than experienced entrepreneurs without competitive bidding, it has also bailed out more troubled groups. In December it bought back the controlling 29% stake in loss-making Malaysian Airline System (MAS) held by Tajudin Ramli, a

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prominent Malaysian businessman. The government also assumed responsibility for two bankrupt light-rail companies in Kuala Lumpur, controversially agreeing to reward the assets’ owners handsomely for what many regarded as their poor management (see The domestic economy: Infrastructure). The MAS buy-back is instructive in many respects. Mr Tajudin’s executive chairmanship, which began in 1994, was characterised by big losses, bigger debts, mounting customer dissatisfaction and plunging staff morale. Yet the government agreed to pay him M$1.79bn, or M$8 a share, for his stake, more than double the market value of the stock. Weak stewardship at MAS and the recent economic crisis, which inflated costs and eroded revenue, are a large part of the company’s problem. But the limited freedom to act independently of the government—a burden that it has in common with most privatised companies—also dragged it down. The government has the last word in all MAS decision-making, meaning that it can impose its will regardless of the commercial implications. The many unprofitable local routes the carrier must serve, for example, are a big drain, because domestic fares have been frozen since 1992. The tightness of the rein and the hefty premium paid to Mr Tajudin suggest that the government’s hopes of divesting a sizeable stake of MAS equity to a strategic overseas carrier will be difficult to realise.

Some strategic sectors are On more than a few occasions during the past several months it has seemed as opened up if the government was about to cast off the protective cloak that restricts foreign investors’ access to big chunks of the economy. Hopes of a significant opening up of the previously no-go “strategic” sector were stirred last August by the sale of a 30% interest in ’s Tanjung Pelepas port to Danish shipping giant Maersk Sealand, and of a similarly sized slice of Port Klang’s Westport to Hong Kong-based Hutchinson International Terminals. They were subsequently heightened by official admissions that negotiations were under way with potential overseas partners on the disposal of equity in three of the most jealously guarded symbols of corporate national pride: MAS, the national carmaker Proton, and Telekom Malaysia. In January the government announced the rollover of a waiver introduced at the height of the Asian crisis effectively allowing foreigners to set up wholly owned manufacturing plants of almost any kind, and broadened its scope to include investments for the expansion and diversification of existing operations. In the same month the finance minister, Daim Zainuddin, promised “instant” satisfaction for would- be investors in need of tailor-made incentives.

Bumiputera policy remains Yet a close look at these developments, and a plethora of discouraging news unchanged stories over the same period, reveals that the government’s attitude to foreign capital remains acutely ambivalent. The perceived need to continue protecting the bumiputera majority (ethnic Malays and other indigenous groups) means it is still unwilling to allow unfettered competition among businesses. Not even the supposedly good news is that encouraging. The pledge of prompt gratification for foreign companies keen on customised concessions, while doubtless welcomed by some, reinforces the general perception that a level playing field for all is still a long way off. Egalitarians also wonder why the 100% foreign ownership entitlement was not extended to activities other than manufacturing, such as services. Nor, because of the government’s apparent

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reluctance to relinquish enough management control, have the mooted sales to outsiders of equity in the three prized state-run companies materialised.

Foreign investment Executives of established foreign-owned companies, such as those in the vital incentives are inadequate electronics sector, say the tax and other investment incentives on offer are now generally inadequate, having been bettered by competitor countries in the region. Regulations governing the setting up of new firms, and their implementation, are onerous, and seem set to remain so. Laws to safeguard intellectual property rights—no small issue given Malaysia’s ambition to become a “knowledge” economy—tend to be poorly enforced, even if they appear admirable on paper. Many Malaysians share Dr Mahathir’s resistance to greater openness. Some believe the government is being too generous already. Ramon Navaratnam, an influential author, consultant and former senior official at the Ministry of Finance, argued in January that giving free rein to foreign firms to establish wholly owned manufacturing plants cannot but retard the “build-up of Malaysia’s technological capacity and [its] participation in modern industries”. The same day, the prime minister called on Asian countries to “examine liberal democracy and the unfettered market in a borderless world and determine what we should accept, reject and modify”.

Support for international The government’s reservations about the potentially adverse impact on local trade pacts weakens businesses of global and regional trade pacts have also been enjoying greater domestic support, increasing the possibility of its reneging on more commitments already made and being a reluctant participant in future negotiations. In December a group of prominent non-governmental organisations (NGOs) endorsed the government’s concerns about plans for a new round of multilateral negotiations under the auspices of the World Trade Organisation (WTO), which the US wants to begin this year. They called on it to resist outside pressure for the launch of a new round and introduction of “new issues” on the agenda, which, they claimed, would result in the “domination” of the economy by “big foreign firms”. The international trade and industry minister, Rafidah Aziz, had earlier said that it would be “ridiculous” to launch a new round without setting an agenda first, reiterating the government’s view that priority be given to the resolution of outstanding problems relating to the implementation of the Uruguay Round rather than to new business.

Free-trade agreements Members of the House of Representatives have likewise expressed misgivings arouse concern about the entry into force of the ASEAN Free-Trade Area (AFTA) on January 1st 2003, when six of the group’s ten members, including Malaysia, are to have cut duties on most industrial products to between zero and 5%. Last May the government controversially prevailed on its ASEAN counterparts to allow Malaysia to defer until 2005 the scheduled reduction in duties on motor vehicles produced elsewhere in the ASEAN area—American and Japanese manufacturers have built up capacity ahead of liberalisation—reportedly threatening to abandon AFTA if the concession was not granted. It presently levies tariffs of 140-300% on imported vehicles, and of 42-70% on imported kits and components, to protect national carmakers Proton and Perodua. Dr Mahathir’s admission that he was having “second thoughts” about the AFTA

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process generally fuelled speculation that the government might seek delays for other products too. China’s expected entry into the WTO later this year and its offer in November to consider a free-trade agreement (FTA) with ASEAN are also a concern to the government, especially in view of the negative implications of the US slowdown for Malaysian exports. So too are FTAs that Singapore has signed with New Zealand and is negotiating with the US, Japan, Australia and other countries. Dr Mahathir has insisted that Malaysia would not accord duty-free access to goods redirected by Singapore from such third countries.

US dollar peg is near its Noting that the ringgit’s appreciations in 2000 against key regional currencies equilibrium caused by the relative strength of the US dollar had been somewhat reversed, the central bank asserted in late February that the pegged exchange rate of M$3.80:US$1 was close to its equilibrium value and would remain unchanged. A devaluation would give exporters only a temporary competitive advantage and involve “significant costs”, including higher inflation, the central bank argued. It also pointed out that by facilitating the pricing and planning decisions of manufacturers, importers and exporters, the fix continues to enjoy strong private sector support. But the likelihood of further downward pressure on the US currency, and therefore the ringgit, in the months ahead, and the higher import costs that implies, could render more vocal lobbies advocating that the ringgit be pegged to a basket of currencies—those of Malaysia’s main trading partners—as a prelude to an eventual free float.

The domestic economy

Economic trends

Economic growth Real GDP expanded by 6.5% year on year in the fourth quarter of 2000, continues to slow bringing growth for the full year to 8.5%, in line with the EIU’s forecast of 8.4%, according to data released by the Department of Statistics on February 28th. On the supply side, the manufacturing sector was again the main contributor to growth in October-December, registering a 16.4% year-on- year rise in output. However, owing to a slowdown in external demand, particularly for electronic goods, the sector’s growth rate was significantly slower than the 20.3% recorded in July-September 2000 and the 24.2%

achieved in the fourth quarter of 1999. Thanks to a sharp increase in the production of crude palm oil and logs, agricultural output expanded by 4.4% year-on-year in October-December, more than reversing the 1.1% contraction experienced in July-September. A continued decline in crude oil production resulted in the output of the mining sector, which had eased by 3.3% in the third quarter, shrinking by another 1.8%. Bolstered by government spending on infrastructure projects and ongoing housing developments, value added in the construction sector increased by 1%, up from 0.5% in the third quarter. Value added in the services sector rose by an unchanged 4.1%, notwithstanding the slowdown in trade-related activities.

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Malaysia: real gross domestic product (M$ m unless otherwise indicated; at 1987 purchasers’ prices, not seasonally adjusted) 1999 2000 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Private consumption 21,002 22,026 23,589 23,219 23,535 24,116 % change, year on year 5.0 7.0 14.4 13.7 12.1 9.5 Public consumption 6,920 7,276 4,495 6,167 6,354 7,305 % change, year on year 23.9 19.6 5.1 13.5 –8.2 0.4 Gross fixed capital formation 12,926 14,095 14,205 16,778 17,291 16,141 % change, year on year 11.6 5.9 17.5 31.2 33.8 14.5 Change in stocks –788 –1,031 423 526 119 107 % of GDP –3.9 6.0 –1.1 –1.2 1.8 2.3 Net exports 9,432 8,093 7,254 5,512 6,064 6,079 % of GDP 4.4 –2.5 1.1 –6.0 –6.8 –4.0 Exports, goods & services 56,146 58,453 55,169 59,685 67,298 64,885 % change, year on year 19.5 18.4 19.9 15.1 19.9 11.0 Imports, goods & services 46,714 50,360 47,915 54,173 61,234 58,806 % change, year on year 18.1 25.6 22.1 24.6 31.1 16.8 GDP 49,491 50,458 49,966 52,201 53,355a 53,747 % change, year on year 8.6 11.0 11.8 8.4 7.8 6.5 a Total does not sum in source.

Source: Department of Statistics, Malaysia .

Sharp deceleration in Real aggregate domestic demand growth slowed to 9.6% year on year in the domestic demand fourth quarter, from 12.2% in the third and 17.1% in the second; quarter on quarter, the annualised increase during the final quarter of 2000 was only 3.2%. The expansion of private consumption moderated to 9.5%, from 12.1% and 13.7% in July-September and April-June respectively. Public consumption increased by 0.4%, having contracted by 8.2% in the third quarter. The growth of gross fixed investment slowed to 14.5%, from 33.8% in the third quarter and 31.2% in the second. No public/private sector breakdown was immediately available. But officials noted the sharp rise in government development spending and the positive trend in certain private investment indicators. The value of manufacturing investment proposals and approvals increased by 314%

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and 63.5% year on year in October-December, to M$10.5bn (US$2.76bn) and M$8.2bn respectively, while imports of capital goods rose by 35.1%.

Inflation remains subdued Despite several one-off cost-push factors (increases in the retail prices of petroleum products, in bus fares and in sales taxes on alcohol and tobacco), the annual inflation rate rose to only a modest 1.8% in October-December, and was only 1.5% in 2000 as a whole. The subdued nature of price pressures was partly attributable to the persistence of spare production capacity in certain sectors and the addition of capacity in others. The number of workers retrenched rose to 6,938 in the fourth quarter from 5,617 in the third, with manufacturing and services accounting for 55.8% and 30.5% respectively of the total. However, the Ministry of Human Resources said that many of those laid off were re-employed elsewhere, and noted that the number of registered job seekers fell to 27,820 at end-December from 36,067 at end-September.

Manufacturing

Manufactured goods sales While manufacturing production rose by 25.1% in 2000, almost double the slip in the fourth quarter 1999 growth rate of 13.5%, the pace of expansion slowed towards the close of the year, declining from 26.5% year on year in October to 15.1% in November before edging back up to 19.1% in December. Sales of manufactured goods followed a broadly similar pattern. They increased by 29.9% for the year as a whole, to M$333.7bn (US$87.8bn), with the year-on-year growth rate moderating progressively from 33.5% in September to 26.5% in October, 23% in November and 15.9% in December. Month on month, after expanding by 2.3% in September, sales contracted by 4.8%, 0.3% and 4.4% respectively in October, November and December. The growth of exports of manufactured goods slowed sharply in the fourth quarter, to 7% year on year, from 23.9% in the third. Exports rose by 8.5% in volume, while unit prices fell by an average of 2.1%. Having reached a historical monthly peak of M$30.1bn in September, manufactured exports slipped to M$28.1bn in October and M$27.8bn in November. Average manufacturing capacity utilisation declined to 81% in October-December, from 84% in July-September, according to Bank Negara.

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Electronics industry Similar trends were experienced by the key electronics industry. Its average growth weakens capacity utilisation is officially estimated to have fallen to 80% in the fourth quarter, from 89% in the third, and its export growth slowed to 7% year on year from 21.2%. Exports of electronic and electrical goods amounted to M$59.5bn in October-December, down from a record M$63.7bn in July- September. Foreign sales of semiconductors slipped to M$19.3bn, from M$19.4bn, and those of other electronic equipment and parts to M$23.8bn from M$25.8bn. Aggregate figures for January-November 2000 put production of semiconductors at 14.91bn units, compared with 9.96bn units in the whole of 1999, of integrated circuits at 19.53bn units, compared with 14.9bn units, and of electronic transistors at 16.24bn units, up from 13.32bn units.

Manufacturing investment Figures released by the Malaysian Industrial Development Authority (MIDA) in plans may be overstated early February purported to show that proposed manufacturing investments amounted to M$45.9bn in 2000, a more than threefold increase on the M$14bn worth of applications registered in 1999. Applications from foreign investors were valued at M$29.7bn, up from M$9bn in 1999, while those from local firms rose to M$16.2bn, from M$5bn. Proposed investments in the electronic and electrical product industries surged to M$18.3bn, from less than M$3bn, with foreign companies accounting for M$16.5bn, according to MIDA. Data on the value of manufacturing investments approved in 2000 were not

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provided. Statistics for January-October put total approvals (foreign and local) at M$21.7bn, compared with M$16.9bn in the whole of 1999. Approved foreign investments were worth M$10.4bn, compared with M$12.3bn in the previous year, while endorsed local investments were worth M$11.2bn, compared with only M$4.6bn in January-December 1999. As usual, no data were available on the value of investments actually implemented, or on divestments. Despite the apparently positive MIDA figures, weakening external demand is obliging many electronics firms to cut production, lay off workers and shelve investment plans.

Agriculture

Measures to reduce the glut Malaysia is the dominant world producer of palm oil. Crude palm oil (CPO) of crude palm oil output reached a record 10.8m tonnes in 2000, up from 10.6m tonnes in 1999, according to official estimates; production could exceed 11.2m tonnes this year, traders said in February. The combination of a supply glut, subdued global demand and keen competition from rival edible oils producers continued to undermine prices and prompt more market-boosting and stockpile-reducing initiatives by the government. In late February the primary industries minister, Lim Keng Yaik, said that a plan was being considered to offer growers M$1,000 (US$263) for each hectare of ageing oil palm they replanted. He calculated that the replacement in 2001 of 200,000 ha of the estimated 340,000 ha of plantations which are more than 25 years old would cut the country’s oil output by some 600,000 tonnes. He also urged growers to trim production by cutting down on fertiliser usage.

New moves to boost Local press reports the same month claimed that the government had decided demand for palm oil that both crude and processed palm oil could be exported free of duty. During the latter months of 2000 it authorised the duty-free sale of 500,000 tonnes of CPO, and subsequently announced that up to 1m tonnes could be shipped on the same terms this year. In addition, moves were made to extend the scope of the Palm Oil Credit and Payment Arrangement, a loan and deferred payment facility for developing countries, to east European nations unable to offer sovereign guarantees. Officials also revealed that countertrade deals envisaging the exchange of Malaysian palm oil for other goods were being discussed with

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American, Chinese and Indian trading houses. Perhaps most interestingly, the state-controlled hydrocarbons concern, Petroliam Nasional, was reported to be drawing up plans for the construction of a pioneering M$500m (US$131.6m) facility to produce diesel from palm oil, with an initial throughput of 500,000 tonnes of raw material a year.

Government buys up excess Farmers in the northern peninsular states of Kedah, Perlis and Penang rice stocks complained at the turn of the year that they still had stocks of unsold rice amounting to more than 125,000 tonnes left over from the June-July harvesting season. With a new crop estimated at 700,000 tonnes due on the market within weeks, they variously urged the government to buy up the surplus, cut imports and take firm action against smugglers said to be spiriting large quantities of the staple grain across the border from Thailand. In late December the agriculture minister, Mohd Effendi, effectively pledged to meet most of their demands. Bernas, Malaysia’s main rice purchasing and marketing agency, was instructed to absorb a sizeable proportion of the excess supply and ship it to the deficit Borneo states of Sabah and Sarawak. Stricter surveillance of the Malaysian-Thai frontier led to the seizure of a number of illicit consignments, and an apparent reduction in smuggling. Malaysia consumes about 1.8m tonnes of rice annually, some 1.3m tonnes of it grown by subsidised local farmers.

Import ban on beef and On January 11th, following reports of fresh cases of so-called mad cow disease beef products in Europe, the government imposed a ban on imports of beef and beef products from all EU countries. The prohibition was extended to Brazil on February 6th, and to Thailand on February 10th. The affected countries have traditionally accounted for only a tiny fraction of the beef consumed in Malaysia. Major suppliers such as Australia, New Zealand and India were unaffected by the restriction.

Infrastructure

Kuala Lumpur’s light-rail In a move expected to presage a large-scale overhaul of the much-maligned companies bailed out transport system in and around Kuala Lumpur, the Ministry of Finance announced on December 22nd that the government was buying up the assets of two of the commercial capital’s loss-making light-rail companies. It said the developers of Projek Usahasanama Transit Ringan Automatik (PUTRA) and Sistem Transit Aliran Ringat (STAR) were to receive some M$6bn (US$1.6bn) from the sale of government bonds to help repay their debts and would continue operating the networks as leaseholders. Critics said the deals underscored the government’s willingness to bail out already overindulged but poorly run companies. Unable to attract nearly enough passengers to meet their investment and running costs, PUTRA—a unit of troubled infrastructure- based group Renong—and STAR had turned for help to the official Corporate Debt Restructuring Committee (CDRC) following the eruption of the regional economic crisis in mid-1997. Users complained fares were prohibitively high, stations were too far apart and lacking sufficient car-parking space, and that feeder bus services were inadequate. Local press reports subsequently claimed

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that PUTRA was seeking a further M$400m from the government for the purchase of new trains.

Government assists KL In mid-January the transport minister, Ling Liong Sik, said that the state- monorail project owned Bank Pembangunan dan Infrastruktur had agreed to lend an additional M$610m to KL Monorail System, which is building a third elevated train service in the commercial capital. Work on the project began in 1996 but ground to a halt the following year owing to crisis-induced cost increases and related financing problems. It resumed in mid-1999 on the strength of a M$300m soft loan from the government, having been scaled back to 8.6 km from 16 km. It is now due to be commissioned in July 2002, four years later than originally planned. Its cost has likewise been revised down to M$1.2bn, from M$2.1bn, partly because the rolling stock is being manufactured locally. CDRC sources said that as part of its strategy to devise an efficient, integrated and affordable transport network for Kuala Lumpur and its hinterland, the government was also planning to take over some 20 bus companies. Other measures under consideration include taxing single-occupant motor vehicles entering the city, and raising parking fees.

Concern about future With electricity consumption having expanded by 12.8% in 2000 and electricity supply shortages expected to continue growing strongly, but with little additional generating capacity due on stream in the immediate future, there are concerns in official circles about possible short-term supply constraints. In mid-January installed capacity amounted to 12,045 mw, compared with peak demand of 9,712 mw, yielding a so-called reserve margin of 24%, which falls below the internationally recommended minimum of 33%. Executives at predominantly state-owned Tenaga Nasional, peninsular Malaysia’s main utility, warned that the margin would slip to 10-15% by early 2002, and urged the government to expedite the approval of planned projects. As a stop-gap measure, Tenaga concluded deals to buy surplus output generated by a number of existing independent power producers (IPPs), albeit offering them less favourable terms than in previous agreements. YTL Power, for example, accepted 10.9 sen per kwh (2.9 US cents per kwh), down from 15.1 sen per kwh earlier. Having opted in the late 1990s to focus primarily on transmission and distribution activities, Tenaga’s management nonetheless maintained that to ensure the construction of adequate generating capacity in future, IPPs had to be promised sufficient returns, ideally by guaranteeing to absorb a sizeable proportion of their output. The concept of “managed” liberalisation also found expression in Tenaga’s late December decision to suspend its programme of divesting equity in its thermal plants. Defending the reversal, company executives argued that a wholesale deregulation of the local industry could ultimately expose Malaysia to the sort of chaos—high tariffs and blackouts—then afflicting the US state of California.

Electricity tariff hike may Yet a hike in electricity tariffs soon—the first since 1997—is a distinct prove a hot political issue possibility. The size of the increase largely depends on the outcome of ongoing negotiations between Tenaga and Petronas on the price the latter should charge the former for the gas feedstock accounting for some two-thirds of the utility’s fuel costs. A three-year agreement under which Tenaga paid M$6.40 (US$1.68) per million metric British thermal units formally expired at the end

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of December, and Petronas has demanded that the price be raised to M$7.68, still well below the prevailing international market rate. The final decision, expected by the end of March, rests with the government, which owns 100% of Petronas and some 78% of Tenaga but is deeply concerned about the potentially adverse impact of a power price hike on consumers, businesses, the inflation rate and economic growth.

Water tariffs still heavily Business and consumer lobbies protested against the 20-75% increase in water subsidised after rate jump tariffs—the first in more than a decade—announced on February 21st by the Selangor state government, which oversees supplies to Kuala Lumpur and the surrounding areas. Hikes of 50-60% were imposed on industrial and commercial users. State officials argued that the increases were more justified by a steady and substantial rise in costs over the years, and the failure of many consumers to pay their bills. Moreover, tariffs would continue to be heavily subsidised, they added.

Financial and other services

Year-end spurt in loan Total loans outstanding rose by 5.4% in 2000 to M$454.2bn (US$119.5bn), disbursements according to official data. Loans outstanding to commercial banks increased by 6.4% to M$315bn. New loan approvals averaged M$12bn a month, compared with M$8.7bn in 1999 and M$5.6bn in 1998. However, the value of approvals declined from M$12.6bn in November to M$10.5bn in December and M$9.6bn in January. Disbursements averaged M$30.1bn a month in 2000, up from M$26.5bn in 1999 and M$20.9bn in 1998. On a quarterly basis, they rose steadily from M$84.1bn in January-March to M$98.8bn in October-December. Loan repayments averaged M$28.9bn a month last year, up from M$27.7bn in 1999. Quarterly repayments increased from M$75.8bn in April-June to M$91.5bn in October-December. Partly as a result the net non-performing loan (NPL) ratio, on a three-month arrears basis, declined to 9.6% at end-December from 10.5% at end-August. It had peaked at 14.9% in November 1998. On a six-month arrears basis—the more lax measure preferred by the government— the net NPL ratio fell to 6.3% at end-December from 6.9% at end-August.

Foreign investors remain Sentiment on the Kuala Lumpur Stock Exchange (KLSE) remained bearish. sellers of Malaysian equities Market capitalisation fell by 9.1% in the fourth quarter of 2000 to M$444bn. The bourse’s benchmark composite index, the KLCI, declined by 4.7% to 680 points. After sinking to a 20-month low of 653 points on January 2nd, the index subsequently staged a modest rebound, reaching 736 points at the end of business on February 2nd, largely due to buying support from government- controlled institutional funds. It closed at 696 points on March 7th. Overseas investors, whose activities tend to dictate those of local retail players, continued to be heavy sellers. They withdrew some M$10bn from the KLSE between May and December 2000, to account for little more than 5% of the shares held by the end of the year.

Renewed concern over Dubious corporate governance continued to dismay foreign funds. The toll- corporate governance road operator, United Engineers Malaysia (UEM), a once much-admired blue- chip company, astounded the market in mid-November by unveiling a plan to

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pay M$6.7bn to acquire a clutch of mostly loss-making firms pledged as security for huge debts owed by Renong, its parent company and UMNO- linked infrastructure-based conglomerate. The move was widely seen as a bailout of the Renong chairman, Halim Saad. Three weeks later UEM was deemed to have added insult to injury by allowing Mr Halim to stagger over 17 months payments for almost M$3.2 billion of shares that he pledged to buy after a similarly shady deal between the two companies in 1997. The Renong chairman paid the first M$100m instalment on February 14th, but promptly asked UEM’s board to postpone the deadline for the second from July14th to October 1st. Investors’ wariness was also graphically underlined by the poor response to an initial public offering planned by another Renong unit, Time dotCom, to raise M$1.89bn. It emerged on February 13th that applications had been received for only 25% of the 572m shares up for sale, priced at M$3.30 each. The issue was fully underwritten by ten local banks.

Changes in MSCI indices are Bearish factors still abound. December’s announcement by Morgan Stanley likely to harm the KLSE Capital International (MSCI) of plans to weight companies on its widely tracked investment indices on the basis of the availability of their shares for open trading rather than market capitalisation—the current measure—also bodes ill for the KLSE. The transition to the new regime, due to begin in November and be completed six months later, presages significantly less foreign institutional investor interest in the government- and family-controlled Malaysian companies which presently dominate the blue-chip market.

Foreign trade and payments

Value of exports declines in Gross exports (fob basis) totalled M$373.3bn (US$98.2bn) in 2000, 16.1% the fourth quarter higher than the M$321.6bn registered the previous year. Sales slowed as the year drew to a close, with the growth rate moderating to 5.7% in October- December from 21.6% in July-September. Indeed exports fell to M$95.9bn in the fourth quarter from a record M$101.7bn in the third. The slowdown was progressive: from a peak of M$35bn in September to M$30.2bn in December. Sales of manufactured goods followed a similar pattern, declining to M$81.4bn in the fourth quarter from M$87.9bn in the third, and likewise eroding steadily month by month (see The domestic economy: Manufacturing). Buoyed by higher prices, the value of crude oil sales surged to a record M$14.2bn in 2000, from M$9.3bn the previous year. In volume terms, oil exports fell to 16.7m tonnes from 17.7m tonnes. Similarly, while the volume of liquefied natural gas exports edged up to 15.5m tonnes from 15.1m tonnes, the value of sales almost doubled to M$11.3bn from M$6.4bn. By contrast, earnings from palm oil dropped to M$10bn, from M$14.5bn in 1999, while volume sales, at 8.86m tonnes, were basically unchanged.

A corresponding drop in Gross imports (cif basis) rose by 25.7% in 2000, to M$312.4bn. But in line with fourth-quarter imports the slowdown in export growth, they too moderated during the latter months of the year: from M$86.8bn in July-September to M$78.8bn in October- December, and, on a monthly basis, from a record M$29.2bn in August to

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M$24.7bn in December. Trade surpluses of M$5.7bn in October, M$6bn in November and M$5.5bn in December yielded a fourth-quarter surplus of M$17.1bn—up from M$16.0bn in July-September but down from M$20.3bn in the final quarter of 1999—and a surplus for the year of M$60.9bn, down from M$73.1bn in 1999.

Little change in the The current-account surplus amounted to M$7.7bn in July-September 2000, current-account surplus fractionally down on the M$7.9bn surplus recorded in April-June, according to figures released by the Department of Statistics in mid-February. It put the third-quarter merchandise trade surplus (fob-fob basis) at M$19.7bn, up from M$17.9bn in the second quarter. The deficit on the services account widened from M$2bn in the second quarter to M$3.4bn in the third quarter, when there was a surge in services imports. On the income account, higher outflows of investment income and freight and insurance payments increased the third- quarter deficit to M$6.9bn from M$6.4bn in the second quarter. The surplus on the long-term capital account increased to M$2.8bn, from M$1.5bn. Government borrowing saw net inflows of official capital reach M$1.6bn, more than reversing the M$388m deficit registered in April-June, while inflows of private long-term capital declined to M$1.2bn, from M$1.8bn. Outflows of private short-term capital, however, surged to M$12.7bn, from M$8.6bn, reflecting the strength of the sell-down of shares by foreign portfolio investors.

Malaysia: current account (M$ m; not seasonally adjusted) 1998 1999 1999 2000 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Exports of goods 281,669 318,946 84,482 88,137 84,348 91,491 101,323 Imports of goods –212,453 –232,411 –60,133 –66,042 –64,060 –73,584 –81,591 Goods balance 69,216 86,535 24,349 22,095 20,288 17,907 19,732 Services: exports 46,247 46,865 12,380 13,877 11,382 12,007 14,009 Services: imports –53,669 –58,724 –15,507 –16,232 –13,675 –14,034 –17,458 Services balance –7,422 –11,859 –3,127 –2,355 –2,293 –2,027 –3,449 Income: credits 5,308 6,385 1,906 1,578 1,580 1,704 1,800 Income: debits –20,125 –26,660 –7,454 –7,949 –7,049 –8,054 –8,715 Income balance –14,817 –20,275 –5,548 –6,371 –5,469 –6,350 –6,915 Transfers: credits 2,975 3,148 761 1,122 724 654 724 Transfers: debits –12,558 –9,647 –2,379 –3,783 –2,540 –2,305 –2,528 Transfers balance –9,583 –6,499 –1,618 –2,661 –1,816 –1,651 –1,804 Current-account balance 37,394 47,902 14,056 10,708 10,710 7,879 7,564 Source: Department of Statistics, Malaysia .

EIU Country Report March 2001 © The Economist Intelligence Unit Limited 2001 Brunei 33

Brunei

Political structure

Official name Negara Brunei Darussalam

Form of state Sultanate

The executive The sultan is advised on policy matters by four councils: the Religious Council, the Privy Council, the Council of Succession and the Council of Cabinet Ministers

Head of state HM Paduka Seri Baginda Sultan Haji Hassanal Bolkiah Mu’izzaddin Waddaulah

National legislature None

Legal system Courts of first instance exist on a local and religious basis; appeals go to the Religious Council in religious cases, and to the High Court and thence to the Court of Appeal in other cases. All major judicial posts are filled by the sultan’s appointees

National elections Last election 1968

National government The sultan, close family members and his appointees control all organs of state power, including the Council of Cabinet Ministers, under the state of emergency that has been in force since 1962

Main political organisations The Parti Perpaduan Kebangsaan Brunei (the Brunei National Solidarity Party, PPKB), which split from the Parti Kebangsaan Demokratik Brunei (Brunei National Democratic Party, PKDB) in early 1986, is now the country’s only legal party, the PKDB having been banned in early 1988. However, the PPKB is only intermittently active. The promotion of the national ideology of Melayu Islam Beraja (MIB), or Malay Islamic Monarchy, has been stepped up since 1990. The Parti Rakyat Brunei (Brunei People’s Party, PRB) has been banned since 1962 and operates in exile

Sultan, prime minister, minister of finance & defence Sultan Hassanal Bolkiah Mu’izzaddin

Key ministers Communications Zakaria Sulaiman Culture, youth & sports Hussain Mohamad Yusof Development Ismail Damit Education & health (acting) Abdul Aziz Umar Foreign affairs Prince Mohamed Bolkiah Home affairs & special adviser to the sultan Isa Awang Ibrahim Industry & primary resources Abdul Rahman Mohammad Taib Religious affairs Dr Mohamed Zain Serudin

EIU Country Report March 2001 © The Economist Intelligence Unit Limited 2001 34 Brunei

Economic structure

Annual indicatorsa

1996 1997 1998b 1999c 2000d GDP at market prices (Br$ m) 7.7 8.0 8.1 8.2 8.3 Real GDP growth (%) 3.5 4.0 1.0 2.5 3.5c Crude oil production (‘000 b/d) 165 165 155 180 175 Consumer price inflation (av; %) 2.0 2.0 –0.7e 1.0 n/a Population (‘000) 305.1 314.4 323.6 333.0d 342.0d Exports fob (US$ m) 6,670 3,973 1,979 2,552 n/a Imports cif (US$ m) –3,516 –3,154 –2.353 –1,328 n/a Reserves (US$ m) 5,937 3,656 4,011 n/a n/a Exchange rate (av; Br$:US$) 1.41 1.48 1.67e 1.69e 1.72e

March 9th 2001 Br$1.7562:US$1

Origins of gross domestic product 1998f % of total Oil & gas sector 32.5 Agriculture, forestry & fishing 2.8 Construction 6.6 Transport & communications 5.2 Wholesale & retail trade 11.2 Community, social & personal services 33.0 GDP at factor cost incl others 100.0

Principal exports 1999f Br$ m Principal imports 1998f Br$ m Natural gas 1,860 Machinery & transport equipment 981 Crude petroleum 1,650 Basic manufactures 854 Refined products 111 Food & live animals 396

Main destinations of exports 1999g % of total Main origins of imports 1999g % of total Japan 42.3 Singapore 34.2 US 17.0 UK 15.1 Korea 14.4 Malaysia 15.1 Thailand 8.9 US 4.9 a Source for most of the earlier data is IMF, Staff Country Report No. 99/19. b IMF estimates. c Brunei government estimates. d EIU estimates. e Actual. f Brunei Statistical Yearbook, 1999, estimates. g IMF, Direction of Trade Statistics.

Quarterly indicators 1999 2000 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Production (prodn/day) Crude petroleum ('000 barrels) 160 157 140 150 194 192 157 167 Foreign tradea (US$ m) Exports fob 425.2 557.2 630.5 738.9 840.5 688.4 n/a n/a Imports cif –310.9 –373.8 –331.6 –311.6 –366.5 –408.8 n/a n/a Trade balance 314.3 183.4 298.9 427.3 474.0 279.6 n/a n/a a DOTS estimates. Sources: Oil & Gas Journal; IMF, Direction of Trade Statistics.

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Outlook for 2001-02

Political outlook

Social control will increase Despite the government’s recent statements that Brunei must cultivate a new openness and transparency to increase its economic competitiveness, it appears that the level of social control and censorship is rising instead. In the wake of publicity generated by the scandal of Prince Jefri’s misappropriation of US$14.8bn in government funds and the release of a negative economic report by the Brunei Darussalam Economic Council (BDEC) in early 2000, the government seems to have decided to return to its former policy of secrecy and strict surveillance of its population. Economic data are becoming less forthcoming as little good news is available for release and crackdowns on perceived immorality and media freedoms are intensifying. As Brunei’s economy continues to falter, with complaints about high unemployment and a stagnant public sector becoming more vocal, the government has been trying to cultivate the support of its mainly Muslim population through a new stress on the Islamic foundations of the sultan’s rule. This trend is likely to intensify through 2001 as the sultan seeks to forestall criticism of the country’s economic performance by stressing his religious right to absolute power.

Economic forecast

Economic restructuring Brunei will continue to implement the recommendations laid out in the report will be limited in scope of the Brunei Darussalam Economic Council (BDEC) released in February, 2000. The government’s programme to inject liquidity into the economy is already under way in the form of B$200m (US$114m) worth of projects and loans to local enterprise, with modest results in the way of increased consumer spending expected in 2001. Brunei’s goal of moving away from its heavy reliance on oil and gas revenue and diversifying the private sector remains, however, a long-term prospect. Foreign investment will move only slowly into Brunei, drawn by the country’s political stability but wary of a lack of qualified personnel and business services.

Respectable growth will GDP is officially forecast to grow by 3-3.5% in 2001, bolstered by a 25% conceal economic problems increase in oil production rates. With the EIU forecasting oil prices to average US$23.85/barrel in 2001, it is likely that Brunei will reach this goal, a modest one compared with the 4.1% growth-rate forecast for the Association of South- East Asian Nations (ASEAN) overall. Weakness in the private sector will continue, however, to hamper full economic recovery. Despite the government’s attempts to stimulate the economy through a series of loans and grants to local businesses as well as a rise in available consumer credit, the private sector infrastructure remains too weak to sustain real growth. Brunei’s plans to develop its competitiveness in three key areas, tourism, international finance and information technology, while potentially feasible in the long term, will also continue to be plagued by a lack of business infrastructure and trained human resources.

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Non-oil external payments In December 2000 the Ministry of Economic Planning and Development position will worsen announced that the country’s trade and current-account balances had been deteriorating steadily over recent years, with imports rising sharply and exports stagnating. Although Brunei’s current account remained well in the black because of oil and gas revenue in 2000 (with a surplus equivalent to 39% of GDP), higher oil prices and output cannot conceal the downward trend indefinitely, with a marked deterioration possible in 2002. Little growth in private sector exports and a weakening of demand from Japan, Brunei’s major export market, are to be expected.

The political scene

Sultan’s hospital visit goes In keeping with increasing self-censorship about the affairs of the royal family, unreported Brunei’s media failed to report the fact that in March Sultan Hassanal Bolkiah checked into a US hospital for a five-day stay for undisclosed medical reasons. The 54-year-old ruler is reported to have a history of heart problems, which the government seems unwilling to discuss publicly for fear that it might weaken confidence in his absolute rule.

Other issues are not being openly discussed either. The scandal of Prince Jefri’s misappropriation of US$14.8bn in state funds has virtually disappeared from the Brunei press. With one of Jefri’s most high-profile assets, the Plaza Athenee Hotel in Paris, handed over to the government of Brunei in February in keeping with the out-of-court settlement reached in his case, the government seems reluctant to pursue the matter further.

Defamation ruling worries In other cases, press self-censorship is being encouraged not merely by the press deference to the ruling family, but by more straightforward legal threats. Brunei’s High Court ruled in December on a case brought by a local legal firm, Abrahams, Davidson & Co, along with two lawyers, Adrian Chan Choong Fatt and John Lee Boon Leng, against the publisher of the newspaper News Express. The law firm sued the publisher after the paper printed a series of reports about debt collectors repossessing the belongings of crisis-strapped debtors. The court ruled that the damages suffered to the law firm’s reputation by the paper’s use of “vitriolic language” outweighed any claim to freedom of the press. Brunei’s press has long struggled under government censorship, but over the past year had been cautiously pushing toward a new openness about political and economic problems. The ruling immediately placed a damper on media willingness to report on potentially controversial subjects.

Chief justice asks for end of In February Brunei’s chief justice, Sir Denys Roberts, criticised the government government’s immunity for continuing to insulate itself from legal prosecution. In a speech to mark the opening of Legal Year 2001, Sir Denys pointed out the difficulties of trying to to make Brunei an international investment centre, while the government was immune from the process of the law. He argued that the government’s immunity would discourage potential investors and urged the sultan to reconsider his stance and transform Brunei’s laws “in a revolutionary manner”. Sir Denys also called on the government to consider providing free or low-cost

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public defenders to those charged with crimes, and to adjust its system of punishment to include community service orders and special institutions for youth. The chief justice, who has gained a reputation as one of Brunei’s few reformist voices, is scheduled to retire from the court this year.

New regulations to control The media may also suffer from further moves to discourage perceived anti- Internet content Islamic coverage. (The government is keen to boost its Islamic credentials, as a way of increasing its legitimacy.) In February the prime minister’s office announced the implementation of new laws to regulate Internet business and content, effective as of February 12th. The regulations liberalise entry into the Internet field by revoking the requirement that Internet Service Providers (ISPs) and Internet Access Resellers apply for a government broadcasting licence. ISPs must still, however, comply with licensing requirements under the State Telecommunications Act. This regulation was publicly hailed as a positive step toward increasing competition in the industry and improving community access to the Internet. The legislation also, however, included stricter controls over Internet content, requiring that “contents should not offend the Islamic religion or society and do not incite social disharmony and instability in the country.” In order to monitor Internet content, certain providers are now required to register with the Government Broadcasting Authority. Those affected include on-line newspapers, individuals or organisations publishing web pages to promote religious or political causes, or any individual providing a programme for the propagation or discussion of political, religious or social issues relating to Brunei. The government claimed that such regulations were necessary to control the “dark side” of the development of the Internet and to balance its economic benefits against the risks it posed to Brunei’s social and political order.

Public musical Such policies go beyond simple media control. Over the past months, Brunei performances are banned has been stepping up its policing of its citizens’ morality and increasing its commitment to “Islamicise” the country in keeping with its status as an Islamic sultanate. In February the Ministry of Home Affairs announced a ban on all public musical performances, arguing that singing is unlawful according to Islam. The ban immediately sparked controversy, with critics arguing that such a move would hamper Brunei’s efforts to develop itself as a tourism destination and to promote Visit Brunei Year 2001. The Ministry of Religious Affairs has also been pressing for an increasingly strict interpretation of Islamic law. While Brunei has long taken a harsh stand against cases of adultery, with convicted males receiving jail sentences of up to five years and females up to one year, the ministry has recently intensified its policing of khalwat, defined as a man and a woman who are not blood relatives being alone together in a private dwelling or in a quiet place away from public view. The ministry released statistics for 2000 showing a 77% rise in khalwat cases handled by its Investigation and Prosecution Unit, and warned that such incidents would continue to be dealt with harshly as they threaten the fabric of Bruneian society.

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Complaints about The effect of all this may be simply to channel public dissatisfaction and healthcare system increase criticism into other channels. Over the past months, the Brunei press has been filled with letters of complaint about the deterioration of public health services. (Free healthcare for Brunei citizens has long been a cornerstone of the Government’s generous social welfare programme.) Brunei’s system is heavily reliant on expatriate physicians, many of whom have left the country in the wake of the economic downturn, declining standards of living, and increasingly strict government regulation of social and religious affairs. Large numbers of Brunei medical students studying overseas have also, the Ministry of Health admitted, become reluctant to return to Brunei to seek employment. The Brunei public health system is now without specialist physicians in certain key fields such as cardiology and anaesthesiology, and Bruneians are being forced to leave the country or turn to private practitioners to access such services. While the ministry stressed its commitment to providing quality health care, it acknowledged that economic conditions were pushing the system toward privatisation, in keeping with the sultan’s recent decision to wean his subjects away from their reliance on an oil-funded “Shellfare” system of social services.

Economic policy and the economy

Brunei launches a private In keeping with the recommendations of the Brunei Darussalam Economic sector stimulus programme Council (BDEC) report released in February 2000, Brunei officially launched a Working Capital Credit Fund for small to medium-sized enterprises (SMEs) in January 2001. According to the BDEC, increasing SME competitiveness is crucial to improving Brunei’s stagnant private sector and easing Bruneians, 70% of whom are employed by the government, away from their reliance on oil-funded civil service jobs. Of the B$30m (US$17m) fund, 60% will be made available to businesses owned by ethnic Malay Brunei citizens, with the remaining 40% open to all locally based businesses, including joint ventures with foreign investors. While any business with assets not exceeding B$5m and with less than 100 employees may qualify, the government is encouraging potential applicants to focus on the public housing, information technology, tourism infrastructure and hospitality industries. Under the scheme, the minimum loan available is B$10,000 (US$5,700) and the maximum B$1.5m and interest rates are set at less than 4% per year. The fund is a joint venture between the government of Brunei and eight commercial banks, with the government assuming 75% of the loan risk and the lending bank the remaining 25%.

Some, however, have expressed concerns about the opportunities for corruption presented by the scheme. In the 1990s, Brunei’s Economic Development Board (EDB) suffered large losses after making loans to SMEs on a patronage basis, a situation which led to the privatisation of the loan section of the EDB under the Islamic Development Bank of Brunei. Even though the current credit fund is to be administered by local commercial banks, reports have been published in the local press that Bruneian businesses have been using funds obtained from the government through its economic stimulus

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program for the construction industry to make overseas investments. The Borneo Bulletin newspaper published a report alleging that some government officials were aware of the situation but had done nothing to stop it.

Consumer spending and Consumer spending appears to be on the rise, boosted by an increase in lending is on the rise available credit. Business is up slightly at Brunei’s shopping malls and commercial real estate occupancy rates have increased. Car dealerships–which comprise Brunei’s third-largest private sector industry after banking and construction–are reporting a rise in sales of new cars. But some critics are calling this a “shopping bubble”, claiming that Brunei’s banks have been capitalising on Bruneians’ reluctance to lower their standard of living even in the face of economic distress by offering easily available long-term personal loans. Several Brunei economists have warned the government that it must impose restrictions on consumer credit, arguing that the average Bruneian’s personal debt has become far too heavy a burden to handle and that banks’ extended payment terms could cause serious long-term damage to private sector recovery.

Halal regulations raise Complaints about new regulations that all food, including imports, sold in prices and draw warnings Brunei must be halal—prepared in accordance with Islamic practice—are becoming more vocal. Many consumers are concerned that the additional expense of producing halal foods and obtaining the necessary certificates have resulted in much higher retail prices at a time when most Bruneians are still feeling the crunch of economic crisis. Despite stepped-up border patrols, rising prices have provoked an increase in smuggling of food products from neighboring Malaysia, and black-market meat is now being sold in Brunei for 25% of the price of domestic meat. Brunei has stated its intention of becoming a regional center for halal food production, but its goal is still far from feasible as there are currently no medium- or large-sized food production businesses operating in the country and 80% of Brunei’s consumer goods must be imported. Several Brunei economists have argued that the expense of obtaining halal certifications for products will impede the development of small and medium-sized enterprises (SMEs) and will pave the way for a return to monopolistic trading practices, which were dismantled several years ago in preparation for compliance with the Association of South-East Asian Nations (ASEAN) Free-Trade Area, to take effect in 2002.

A new job training Last year the Brunei government admitted for the first time that programme is promised unemployment was a serious and growing problem. The official unem– ployment rate stands at 6%, but more troublesome is the fact that at least 25% of school leavers are unable to find jobs. Brunei has traditionally cared for its workforce by providing them with well-paid jobs in the civil service, but recent economic conditions have made that impossible. In a televised speech to the nation in February, the sultan announced that Brunei would step up its campaign to tackle the unemployment problem. He said that the government was ready to implement a job training programme in which unemployed graduates would be offered apprenticeships in state-owned and private corporations and provided with an allowance paid by the government. The sultan stated that not only was such a measure necessary to forestall possible

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social problems arising from unemployment but that it was part of a plan to reduce Brunei’s “dependence on foreign manpower”. Brunei currently employs tens of thousands of workers from other Asian countries to fill its menial and service positions, while executive positions in the oil and gas industry are filled mainly by Western experts.

Brunei Shell Petroleum In November Brunei Shell Petroleum (BSP) announced the success of one of finds more oil and gas the two exploratory wells that it had drilled in 2000 in the offshore Bugan gasfield. Bugan-2 is expected to increase oil reserves by 65m barrels and gas reserves by 3.8 cu metres. BSP is optimistic about the potential of the Bugan field and announced that it was planning to drill three more exploratory wells there in the near future.

Pehin Yahya, the permanent secretary at the Prime Minister’s Office, lauded BSP’s progress, stating that in 2000 the company had increased average production by 25% while cutting production costs by an average of 15% per year over the past four years. He claimed that Brunei’s oil production outlook over the next 15 years was now approximately double the figure estimated in 1997. He said this would increase investor support of BSP’s plan to invest B$500m in modernising its offshore infrastructure.

Efforts to develop tourism The November 2000 Asia-Pacific Economic Co-operation (APEC) summit face major obstacles meetings, which drew some 7,000 delegates to Brunei, and the January 2001 ASEAN Tourism Forum (ATF), which hosted 2,000 visitors, lent momentum to the country’s efforts to develop itself as a tourism destination. Brunei is now investing heavily in Visit Brunei Year 2001, carrying out promotional campaigns and earmarking funds for tourism infrastructure development. Brunei has also expressed hopes that tourism can provide jobs for its unemployed school-leavers.

But all is not likely to go as smoothly as hoped. While the high-profile, well- planned APEC summit proceeded with few problems, the smaller ATF meetings, which generated less government support, were plagued by transportation and co-ordination problems. Attendees complained about Brunei’s lack of public transportation and public taxis and about the lacklustre service at its hotel and meeting facilities. Brunei’s hospitality industry still remains dominated by foreign guest-workers from other countries, with Bruneians themselves showing little enthusiasm for service industry jobs perceived to have little status. And while tourism in Brunei has always been hampered by the country’s lack of entertainment and its ban on alcohol consumption, a new ruling banning musical performances can only damage its image further. Plans to develop the country as an Islamic vacation destination are perhaps Brunei’s best bet, but its distance from the centre of the Islamic world in the Middle East and its lack of direct flights to most Muslim countries will continue to dissuade potential travellers.

Brunei sets its sights on Brunei’s highly publicised plan to develop itself as an Islamic financial services Islamic investment centre attracted its first participant, Emerging Markets Partnership (Bahrain), the general partner and manager for the Islamic Development Bank Infrastructure Fund, which opened a regional office in Brunei in early 2001.

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But the deputy minister of finance, Selamat Munap, has admitted that Brunei still faces a number of hurdles in attracting financial industry investors to Brunei. While Brunei recently announced a series of new laws to update its regulatory environment, Munap stated that the international business community was not yet thoroughly satisfied and was demanding a strengthened financial infrastructure, especially a stronger accounting and auditing industry and greater government transparency. Brunei will continue, however, to work to take economic advantage of its position as an Islamic Sultanate. An International Islamic Expo to be held in August is expected to draw 100,000 visitors, boosting the tourism industry and generating new business networks with Islamic banking, insurance, communications and manufacturing firms. By focusing on this niche market for Islamic business, Brunei could perhaps boost its rate of private sector growth.

EIU Country Report March 2001 © The Economist Intelligence Unit Limited 2001