COUNTRY REPORT

Malaysia Brunei At a glance: 2001-02

OVERVIEW ’s ruling coalition, the (BN), suffered a defeat in a by-election in late November in state, which was directly attributable to the unpopularity of the prime minister, Dr Mahathir. The leadership of the United Malays National Organisation (UMNO), the dominant party in the BN, continues to resist grassroots pressure for reform, which could weaken the position of the prime minister. Key changes from last month Political outlook • The by-election defeat of the BN in late November in Kedah, while having no serious immediate impact on national politics, shows the deep unpopularity of Dr Mahathir. The leadership of UMNO has rejected mounting popular pressure for greater democracy both within and beyond the party. Such inflexibility could weaken the position of the prime minister. Economic policy outlook • The Bank Negara Malaysia, Malaysia’s central bank, is likely to raise interest rates in the second half of next year as inflation gets close to the 3% limit set by policy makers. Economic forecast • US economic slowdown and South-east Asia’s reduced attractiveness to foreign investors because of political uncertainty are likely to affect Malaysia’s growth by the second half of 2001 and even more so in 2002. While have kept our expectations for GDP growth in 2001 unchanged at 7.3%, we have lowered our forecast for growth in 2002 from 7.9% to 6.7%.

December 2000

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ISSN 0269-6703

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Printed and distributed by Redhouse Press Ltd, Unit 151, Dartford Trade Park, Dartford, Kent DA1 1QB, UK 1

Contents

3 Summary

Malaysia

5 Political structure

6 Economic structure 6 Economic indicators 7 Quarterly indicators

8 Outlook for 2001-02 8 Political outlook 9 Economic policy outlook 11 Economic forecast

13 The political scene

18 Economic policy

23 The domestic economy 23 Economic trends 25 Oil and gas 27 Manufacturing 32 Agriculture 33 Infrastructure 35 Financial and other services

38 Foreign trade and payments

Brunei

40 Political structure

41 Economic structure 41 Annual indicators 41 Quarterly indicators

42 Outlook for 2001-02

43 The political scene

45 Economic policy and the economy

EIU Country Report December 2000 © The Economist Intelligence Unit Limited 2000 2

List of tables

11 Malaysia: international assumptions summary 12 Malaysia: forecast summary 19 Malaysia: federal government budgetary position 23 Malaysia: real gross domestic product 39 Malaysia: current account

List of figures

10 Malaysia: money supply, M2 13 Malaysia: gross domestic product 13 Malaysia: Malaysian dollar real exchange rate 24 Malaysia: quarterly gross domestic product 25 Malaysia: consumer and producer prices 27 Malaysia: output of the construction industry 28 Malaysia: industrial and manufacturing production 31 Malaysia: sales of passenger cars 36 Malaysia: non-performing loans

EIU Country Report 4th quarter 2000 © The Economist Intelligence Unit Limited 2000 3

Summary

December 2000

Malaysia

Outlook for 2001-02 Malaysia’s political crisis looks likely to get worse during the next two years as the prime minister, , continues to resist pressure for greater democracy from within and beyond the ruling Barisan nasional (BN) coalition. The opposition Parti Islam sa-Malaysia (PAS) has continued to gain popularity. There are signs of growing divisions within Dr Mahathir’s party, the United Malays National Organisation (UMNO), and the BN, but the opposition is probably only united in their desire to see Dr Mahathir ousted. Since the previous Country Report, we have kept our real GDP forecast for 2000 and 2001 unchanged at 8.6% and 7.3% respectively but, aware that slower US growth and political uncertainty will have a growing impact, lowered the forecast for 2002 from 7.9% to 6.7%.

The political scene A November by-election defeat in Kedah state was a major setback for Dr Mahathir. Reform proposals from the UMNO grassroots have been rejected by the UMNO leadership. UMNO has stressed the defence of ethnic Malay rights and pushed for a more Islamic agenda, while trying to cast the opposition PAS as intolerant. The government has cut the revenues of PAS-controlled state. The police have cracked down on opposition demonstrations and there has been public outrage over police brutality.

Economic policy The 2001 budget has reiterated the government’s faith in expansionary policies. A budget deficit of 4.9% of GNP is forecast for 2001. There has been no cut corporate income tax but many incentives to boost a “knowledge economy”. Proposals to revise the National Development Policy are proving highly controversial. Mahathir has stamped on calls to abolish Malay privileges.

The domestic economy Oil price rises have boosted export earnings. Petrol retail prices have been raised to check a surge in subsidies. Manufacturing production is set to growth by 17% this year. Electronics and electricals will retain a leading role in the economy. Output growth has slowed less than expected. The electronics industry is moving slowly upmarket. Malaysia’s relatively high labour costs have led to downsizing. Automation is keeping demand for labour down. Multinationals are playing a crucial role in the strong value-added growth in the electronics sector. Wafer-fabrication is to begin in Malaysia. Proton still has not found a strategic partner. Agricultural output will remain almost unchanged this year. Crude palm oil export tax has been temporarily lifted. Rubber production is likely to decline by 8.9% in 2000, while cocoa production is forecast to increase by 5.2% and sawn logs output to rise by 1.2%. Lending growth has remained slow. The bank merger programme continues to keep banks preoccupied. State-owned Bank of China has been allowed to re-open in Malaysia.

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Foreign trade and Substantial, but smaller, trade surpluses will continue as surging oil prices boost payments export values. Exports of electricals have grown faster than electronics. The services balance improved in the second quarter. The government is resisting another WTO round of negotiations.

Brunei

Outlook for 2001-02 Brunei politics will continue to be dominated by economic concerns. The official economic growth estimate for 2000 has been raised from 3% to 3.5%. Economic restructuring is to continue. The regulatory environment has been modernised, clearing a major hurdle on the path to becoming an international financial centre, with an emphasis on the provision of Islamic financial services.

The political scene Malay ethnic nationalism is on the rise in Brunei. The APEC summit meetings have brought mixed reviews for Brunei. The policing of morality and religion has been stepped up in the wake of the BIA scandal.

Economic policy and the Brunei’s oil and gas revenues have hit record highs. There has been no news of economy the promised civil service and welfare cuts. The private sector remains in a slump. Local confidence in the economy has waned. The APEC meetings have been a boost for Brunei tourism. Brunei signed new trade pacts at APEC meetings. The legislation to create an International Financial Centre has been passed. Brunei is upgrading its electronic infrastructure. A management contract for the Maura terminal has been signed. The governments is studying its options for downstream investments.

Editors: Frans Jonkers (editor); Graham Richardson (consulting editor) Editorial closing date December 6th 2000 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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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 (Dewan Negara) 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, , , and .

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 Mohd Effendi Norwawi 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

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Economic structure

Economic indicators

1996a 1997a 1998a 1999a 2000b GDP at market prices (M$ bn) 253.7 281.9 284.5 299.2 337.5 GDP (US$ bn) 100.8 100.2 72.5 78.7 88.8 Real GDP growth (%) 10.0 7.3 –7.4 5.6 8.6 Consumer price inflation (av; %) 3.5 2.7 5.3 2.7 1.8 Population (m) 21.2 21.7 22.2 22.7 23.1 Exports of goods fob (US$ m) 76,985.0 77,538.0 71,883.0 84,052.0 100,142.7 Imports of goods fob (US$ m) –73,137.0 –74,029.0 –54,378.0 –61,404.0 –82,216.0 Current-account balance (US$ m) –4,461.0 –5,936.0 9,529.0 12,607.0 8,296.7 Foreign-exchange reserves excl gold (US$ m) 27,009.0 20,788.0 25,559.0 30,588.0 36,200.0 Total external debt (US$ bn) 39.7 47.2 44.8 42.0 41.8 Debt-service ratio, paid (%) 8.9 7.4 7.4 6.9 6.5 Exchange rate (av) M$:US$ 2.52 2.81 3.92 3.80 3.80

December 6th 2000 M$3.80:US$1

Origins of gross domestic product 1999 % of total Components of gross domestic product 1999 % of total Agriculture 9.3 Private consumption 43.7 Mining 7.3 Public consumption 12.4 Manufacturing 30.0 Gross fixed capital formation 27.0 Construction 3.6 Stockbuilding 0.2 Electricity, gas & water supply 3.4 Exports of goods & services 110.2 Services 46.4 Imports of goods & services –93.4 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 4.1 South Korea 5.2 South Korea 3.0 Thailand 3.8 a Actual. b EIU estimates. c Customs basis, imports cif.

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Quarterly indicators

1998 1999 2000 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Federal government finance (M$ m) Revenue 14,414 11,138 15,498 13,997 17,861 11,219 16,682 15,421 Expenditure 14,770 9,198 10,058 12,158 15,285 7,805 12,760 14,662 Balance –356 2,120 5,440 1,839 2,577 3,413 3,922 759 Output GDP at constant 1987 prices (M$ m) 45,452 44,695 48,151 49,511 50,458 50,014 52,244 53,323 % change, year on year –11.2 –1.4 5.0 8.6 11.0 11.9 8.5 7.7 Industrial production index (1993=100) 144.9 142.1 155.0 164.1 170.9 175.5 186.2 193.9 % change, year on year –10.9 –2.4 6.6 14.2 17.9 23.5 20.1 18.2 Prices Consumer prices (1995=100) 113.1 114.6 114.8 114.9 115.4 116.3 116.4 116.6 % change, year on year 5.4 4.0 2.7 2.3 2.0 1.5 1.4 1.5 Producer prices (1990=100) 132.8 129.0 127.6 129.3 133.1 134.0 134.8 n/a % change, year on year 4.0 –4.1 –5.0 –4.2 0.3 3.9 5.6 n/a 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 5.9 5.6 3.8 3.8 3.3 3.3 3.3 n/a Lending 8.2 8.0 7.4 6.9 6.8 6.8 6.8 n/a Money market 5.9 5.3 3.1 2.6 2.6 2.6 2.5 n/a M1 (end-period; M$ m) 58,522 56,813 62,876 65,615 75,602 70,132 69,431 n/a % change, year on year –29.4 –17.3 –3.7 16.3 29.2 23.4 10.4 n/a M2 (end-period; M$ m) 271,066 274,103 298,968 309,999 316,851 324,716 334,515 n/a % change, year on year –1.4 3.6 13.2 17.1 16.9 18.5 11.9 n/a KLSE composite index (end-period; 1977=100) 586.1 502.8 811.1 675.5 812.3 974.4 833.4 713.5 % change, year on year –1.4 –30.1 78.0 80.8 38.6 93.8 2.7 5.6 Sectoral trends Electronic and electrical products index (1993=100) 167.2 163.8 189.9 203.4 218.5 237.8 269.8 n/a % change, year on year –12.6 –1.6 10.6 23.1 30.7 45.2 42.1 n/a Mining index (1993=100) 127.0 124.2 115.0 118.1 121.5 122.2 118.0 116.1 % change, year on year –0.2 –1.4 –4.9 –1.9 –4.3 –1.6 2.6 –1.7 Foreign trade (M$ m) Exports fob 75,946 69,261 77,864 83,649 90,408 84,758 90,968 101,641 Imports cif –56,166 –53,696 –59,702 –64,871 –70,601 –68,231 78,681 86,775 Trade balance 19,780 15,565 18,162 18,778 19,807 16,527 12,287 14,866 Foreign payments Current-account balance (M$ m) 13,153 10,798 12,340 14,056 10,708 10,710 7,879 n/a Reserves excl gold (end-period; US$ m) 25,559 27,140 30,571 31,134 30,588 33,626 33,666 n/a 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 simmering political crisis is likely to deteriorate during the next two years. The central problem remains the resistance of the prime minister, Mahathir Mohamad, to growing and seemingly irreversible pressure for greater democracy from within and beyond the ruling Barisan Nasional (BN) coalition. Disaffection within his United Malays National Organisation (UMNO) is deeper than ever—allied parties, particularly those representing the sizeable ethnic Chinese minority, seem set to become more assertive, and opposition groups, led by the resurgent Parti Islam sa-Malaysia (PAS), continue to gain popularity. Since Dr Mahathir’s autocratic and uncompromising leadership is the main issue, the longer he stays in place, the worse these problems will get, rendering their ultimate resolution all the more difficult.

We expect Dr Mahathir to see out the forecast period. He has made it abundantly clear he is unwilling to bow to pressure for renewal and reform in UMNO, apparently in the belief that significant concessions could hasten his departure. Intransigence should ensure his survival in the short-term. But the recent wholesale dilution by UMNO’s supreme council of changes to the party’s constitution advocated by a majority of ordinary members, suggests that grassroots discontent, already acute, will become even more pronounced. The upper echelons of the party are bound to feel more heat from the grassroots in the meantime, presaging potentially significant personnel changes. Indeed the pressure is already telling. Shahrir Samid, a member of the supreme council has openly blamed Dr Mahathir’s “character” for the BN’s defeat in a late November by-election in the prime minister’s native Kedah state.

Frictions within the BN also seem set to escalate. Dr Mahathir’s efforts to appease Muslim Malays—who traditionally voted for UMNO but now find PAS an attractive alternative—means he will be more inclined to neglect ethnic Chinese interests. Yet since solid Chinese backing in the November 1999 general election enabled the BN retain a two-thirds parliamentary majority, parties in the governing coalition which represent the main minority community are being urged by their constituents to press for greater recognition of their perceived rights. These include a paring down of the privileges enjoyed by Malays under a long-running affirmative action strategy. The prime minister’s recent strong condemnation of Chinese demands for more egalitarian policies appears to preclude much flexibility. It could also exacerbate racial tensions.

Indeed all opposition parties are becoming increasingly frustrated with the government’s intolerance of supposed dissent, not least the systematically heavy-handed break-up of their rallies by police. Unless the authorities adopt a more benign approach to such demonstrations, violent retaliation, possibly on a large scale, could occur. Yet the four-party opposition (BA) is far from unified, and could fall apart. PAS’s pursuit of an Islamist

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agenda—whose ultimate objective is the transformation of Malaysia into a theocratic state—is constantly undermining its relationship with the avowedly secular and predominantly Chinese Democratic Action Party (DAP). The BN, which has long insisted that the two parties’ divergent ideologies make a sustainable alliance impossible, will extract as much political mileage as possible from their differences. Its claim that PAS is too extreme an option for moderate Malays, would gain valuable currency were the DAP to pull out of the BA.

International relations Concern about the vulnerability of their economies, especially in the face of China’s expected World Trade Organisation (WTO) membership, has led many ASEAN countries to pursue free trade agreements (FTAs), usually on a bilateral basis. Japan’s adoption of trade bilateralism could give Japan a much greater role in the region but could also undermine the broadly-based liberalisation process and further discourage FDI inflows from the US and Europe into ASEAN. ASEAN, suffering from political uncertainty and incomplete restructuring, is looking less attractive. The planned creation of an ASEAN Free Trade Area (AFTA) by 2003 has been harmed by Malaysia’s determination to delay the lowering of automotive tariffs, in order to protect the national car company, Proton.

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. Fiscal and monetary policy are expected to remain accommodative in the next 12 months as the government tries to consolidate and extend Malaysia’s impressive economic recovery. To put the country back onto its pre-crisis high-growth path is only possible if investment, which used to contribute two- thirds of GDP growth before the crisis, increases dramatically. Incentives to boost private and attract foreign direct investment (FDI) are being given a high priority. The 2001 budget stimulates public investment. The government will set out its economic strategy early next year in the Eighth Malaysia Plan (2001-05), a knowledge-economy masterplan, and the revision of the National Development Policy (NDP). Interventionist policies and exchange controls are likely to continue.

Fiscal policy The government continues its stimulative fiscal policy in the 2001 budget, which 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, as the government continues to boost development spending. The final budget deficit is likely to be smaller because the government tends to underestimate tax revenues. Fiscal consolidation may be delayed for several more years—the EIU forecasts a surplus by 2004—as the government continues a stimulative policy to achieve a high economic growth rate.

The 2001 budget gave a major boost to construction and infrastructure. The government is supporting those parts of the economy left behind in the recovery and is stepping up the development of new growth sectors such as

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knowledge-based industries, particularly the manufacturing and services sectors. The budget promotes investment in information communications technology, education and retraining of workers. In addition, the budget also aims to implement strategic initiatives to enhance the nation’s competitiveness. To stimulate domestic consumption, there are tax rebates for low and middle-income groups.

Monetary policy Money supply growth is picking up as bank lending increases—broad money growth M3 accelerated from 5.1% year on year in September to 6.6% in October. However, the increase in total loans outstanding, including loans sold to Cagamas and Danaharta, remained unimpressive at 4.3% year on year in October. Lending and money supply growth should accelerate in the course of 2001 as private investment picks up. While liquidity is still ample, there should be a gradual change in the accommodative policy of the Bank Negara Malaysia (BNM, the central bank) in the next 12 months, especially in the second half of 2001. By that time, inflation is likely to be getting close to the 3% limit targeted by the BNM, and average bank lending rates will have picked up, giving the central bank a reason to raise money market rates.

Signs of slower global growth abound, depressing Malaysia’s external outlook. The major risk remains the US, where growth is predicted to fall from 5.2% this year to 3.2% in 2001 and 2.6% in 2002, amid renewed speculation that a sharper, recessionary fall is possible. Malaysia’s economy is strongly influenced by the performance of the US—its largest export market— particularly for electronic and electrical goods which comprise 60% of Malaysia’s exports. In Europe as well, growth is forecast to slow but by less than in the US, from 3.5% this year to 3.1% in 2001 and 2.7% in 2002. However, the biggest change may come from the renewed signs of slower growth and political crisis in Asia—excluding Japan—which may make our forecast of only a very mild slowdown from 6.8% real GDP growth this year to 6.2% in each of the two consecutive years, look over-optimistic.

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Economic forecast

Malaysia: international assumptions summary (% unless otherwise indicated) 1999 2000 2001 2002 Real GDP growth World 3.5 4.9 4.2 4.1 OECD 2.9 4.1 3.1 2.7 EU 2.3 3.4 3.0 2.6 Exchange rates (av) ¥:US$ 113.9 107.3 104.0 102.0 US$:¤ 1.07 0.92 0.95 1.05 SDR:US$ 0.731 0.766 0.775 0.738 Financial indicators ¥ 2-month private bill rate 0.27 0.19 0.40 0.98 US$ 3-month commercial paper rate 5.18 6.32 6.38 5.25 Commodity prices Oil (Brent; US$/b) 17.9 28.8 23.5 18.8 Gold (US$/troy oz) 278.8 283.2 275.0 270.0 Food, feedstuffs & beverages (% change in US$ terms) –18.6 –7.1 4.7 11.5 Industrial raw materials (% change in US$ terms) –4.3 14.9 8.7 2.3

Note. Regional aggregate GDP growth rates weighted using purchasing power parity (PPP) exchange rates. Economic growth Real GDP increased by 7.7% year on year in the third quarter of 2000, suggesting some loss of momentum. Growth peaked in the first-quarter at 11.9% year on year and was followed by slower growth of 8.5% in the second quarter. Exports were remarkably strong in the third quarter, rising 13% from the preceding period—almost keeping pace with the 13.6% growth in imports. In year-on-year terms, however, the growth of imports continued to easily outstrip exports, with a 31.1% jump in imports and a 20.6% surge in exports. The year-on-year increase in gross domestic fixed capital formation remained high at 24.2%, after 25.3% in the second quarter, but spending levels were still well below pre-crisis levels.

In the next couple of years, net exports will remain a drag on GDP growth as imports surge and exports slow, while capital investment will continue to recover. The Malaysian economic expansion will gradually assume pre-crisis characteristics—the government is likely to push the economy hard, creating fast growth of domestic demand, with a gradual shift in emphasis from private consumption to capital spending, both public and private. It remains to be seen whether private capital spending will recover fully to pre-crisis levels, given ASEAN’s difficulty in attracting foreign direct investment (FDI). However, in the short term, higher private capital spending is likely as capacity utilisation increases and business confidence grows—total gross fixed capital formation (GFCF) is forecast to rise by 20.5% in 2000. Malaysia’s FDI applications have also risen strongly this year; together with higher infrastructural spending, it is expected to lead to another 16% rise in GFCF in 2001 and 15% in 2002. Demand for

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Malaysia’s exports—equivalent to 130% of GDP this year—is a crucial variable in the forecast. Export growth will decelerate from 19.8% this year to 14.3% in 2001 and 13.6% in 2002, with higher (but also slowing) growth in imports.

Malaysia: forecast summary (% unless otherwise indicated) 1999a 2000b 2001c 2002c Real GDP growth 5.6 8.6 7.3 6.7 Gross agricultural growth 3.3 2.4 1.0 3.3 Unemployment rate (av) 3.0 2.8 2.7 2.6 Consumer price inflation Average 2.7 1.8 2.6 3.2 Year-end –––– Short-term interbank rate 7.3 6.8 7.4 7.9 Government balance (% of GDP) –3.2 –3.5 –2.4 –1.9 Exports of goods fob (US$ bn) 84.1 100.1 116.3 136.6 Imports of goods fob (US$ bn) 61.4 82.2 102.9 124.9 Current-account balance (US$ bn) 12.6 8.3 3.3 1.5 % of GDP 16.0 9.3 3.4 1.5 External debt (year-end; US$ bn) 42.0 41.8 45.4 48.8 Exchange rates M$:US$ (av) 3.80 3.80 3.80 3.95 M$:¥100 (av) 3.34 3.54 3.65 3.87 M$:¤ (year-end) 3.82 3.33 3.86 4.36 M$:SDR (year-end) 5.22 4.73 5.09 5.51

a Actual. b EIU estimates. c EIU forecasts.

The forecast assumes that consumption growth, boosted by a sharp rise in disposable incomes from higher wages and increased tax allowances in the 2001 budget, will remain firm. Although unable to match the spending recovery which raised real consumption by 12.5% this year, the increase is expected to amount to 8.4% in 2001 and 8.3% in 2002.

Inflation Consumer price inflation jumped from 1.5% in September to 1.9% in October, as increases in the retail price of petrol, diesel, liquefied natural gas, and bus fares were implemented. Power tariffs may also be allowed to rise in the future. Inflation has bottomed out, but apart from oil, domestic cost pressures are still moderate. The increase in consumer prices during the first 10 months of 2000 amounted to only 1.5%. Encouragingly, producer price inflation has continued to slow in recent months. Producer price inflation declined from a peak of 7.3% year on year in June to 2.6% in September, largely because of lower prices for domestic products—the strong ringgit is also keeping imported inflation down. Consumer prices are expected to rise by an average 1.8% this year and by 2.6% in 2001. As capacity constraints become more evident, inflation will reach 3% by end-2001. The rise will continue into 2002, with average annual inflation of 3.2% and a year-end increase of 3.7%.

Exchange rates A weaker US dollar, to which the ringgit is fixed at a level of M$3.8:US$1, is likely to bring some relief to the squeeze on Malaysian competitiveness. Since

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the start of the year, the ringgit has appreciated moderately against the yen and Singapore dollar and more strongly against the euro and sterling. Much of the sizeable ringgit depreciation since the imposition of exchange controls on September 1st 1998 has therefore disappeared. The official belief in the benefits of stability against the US dollar is increasingly questioned and the disadvantages of an inflexible currency regime have been pointed out. However, there is still no reason to expect a change to the fixed currency regime this year or next, especially if the value of the US dollar continues to fall. The US dollar peg and the remaining capital controls are also considered symbols of Malaysia’s economic recovery and are therefore not easily discarded.

External sector Recent trade statistics suggest that Malaysia’s trade surplus will decline more slowly than previously expected. In October, Malaysia recorded a M$5.6bn trade surplus—the 36th in a row—as exports increased by 15.5% year on year and imports by 19.6%. It will probably not be until 2003 that the current- account surplus will turn into a deficit. A drop in foreign reserves this year, despite continued trade surpluses, and a rise in part-unrecorded capital outflows have raised concern about the effectiveness—and desirability—of capital controls. As yet, the outflows are not serious but this could alter if the political situation were to deteriorate. We forecast a fall in the current-account surplus from 9.3% of GDP this year to 3.4% in 2001 and 1.5% in 2002.

The political scene

A major setback for Dr Dr Mahathir Mohamad’s Barisan Nasional (BN) government was dealt a major Mahathir blow on November 29th when the opposition Parti Keadilan Nasional (PKN) won a key by-election in his native Kedah state. The PKN’s Saifuddin Nasution Ismail secured the state assembly seat for the constituency of Lunas, defeating S Anthonysamy of the Malaysian Indian Congress (MIC) by 10,511 votes to 9,981 after a brief but intense campaign. The ballot was caused by the mysterious November 4th killing of the MIC assembly member Joe Fernandez, who had won the seat during the nationwide elections exactly a year to the

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day earlier by a majority of 4,700. Both sides accused each other of using underhand tactics to sway voters. Mr Saifuddin described his victory as a clear indication that were disenchanted with the BN and wanted change. Many members of Dr Mahathir’s United Malays National Organisation (UMNO), the BN’s dominant component, agreed, although few were willing to say so publicly. Shahrir Samid, elected to UMNO’s Supreme Council last May, was less restrained. He attributed Mr Anthonysamy’s defeat to “the character of our leader, Dr Mahathir”, a widespread perception that the government is “full of corruption, self-serving and out of touch with the people", and UMNO’s resistance to change.

Demands from the UMNO Following UMNO’s big losses in the November 1999 elections—which saw its grassroots for reform share of the popular vote drop to 31.8%, from 39.4% in 1995—there was much internal debate about the causes, and the changes needed to arrest and reverse of the erosion of its support base. There was a general consensus among the middle and lower ranks that reforms to render the party more democratic and responsive to the needs of its ethnic Malay constituency had become an urgent necessity. The consensus was reflected in feedback received by a ten-member committee, set up to sound out the grassroots on the amendments it would like to see to UMNO’s constitution. , the committee’s chairman and UMNO vice-president, said in October that most members inter alia favoured: expanding the electorate that chooses the party’s leadership (president, deputy president, vice-presidents and supreme council) from 2,000 to about 30,000; scrapping the requirement that would-be contenders for the senior posts have a minimum number of nominations to be deemed eligible to contest; holding elections at all levels of the party every three years; and limiting to two the number of terms top office-holders can serve.

Proposals rejected by the Mr Muhyiddin initially said he did not think the adoption of such UMNO leadership recommendations would pose major “technical” problems. But he subsequently declared that the proposal seeking to restrict the number of terms served by top-flight leaders to have been rejected by the committee on the grounds that it was “undemocratic”. A meeting on October 30th of the supreme council chaired by Dr Mahathir—the next stage in the vetting process—effectively dismissed the reformists’ other key suggestions. The proposal that there be a bigger electorate for the top leaders was thrown out, ostensibly because of the logistical difficulties it would presage. The proposal that the presidential, supreme council and division-level polls all be held triennially was also scrapped. The council advocated that the terms of such office-holders should broadly follow that of the federal parliament—up to five years—but with the UMNO polls taking place as much as 12 months later than the general elections. This implied the postponement of the next UMNO leadership ballot from 2003 until possibly end-2005. The supreme council also recommended that the existing nomination criteria, which make it difficult to challenge incumbents, be retained. Despite protests by some UMNO members that the reformists’ agenda had been all but entirely discarded, the council’s stance was formally endorsed by 2,000 delegates to special assembly of the party on November 18th.

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UMNO stresses the defence While resisting pressure for a meaningful overhaul, UMNO leaders continued of ethnic Malay rights seeking to portray themselves as the most worthy and effective defenders of the rights of ethnic Malays, many of whom had switched allegiance to the opposition Parti Islam sa-Malaysia (PAS) in November 1999. Suggestions by ethnic Chinese individuals and lobby groups that policies supporting the long-running affirmative action strategy in favour of indigenous bumiputeras be watered down, triggered strong protests in August by UMNO’s youth wing. These in turn elicited a pledge from Dr Mahathir that the government would staunchly defend the rights of the majority community, and a denunciation of the umbrella grouping of Chinese lobbies as “extremist”. Voicing the feelings of many, PAS leaders accused UMNO of deliberately misinterpreting reasonable demands for salutary change to contrive a crisis and woo back disaffected Malays.

UMNO’s push for a more Some in UMNO sought to address PAS’s threat to their party’s hegemony Islamic agenda backfires by pushing a more Islamic agenda. But key initiatives in this direction back-fired. The disclosure in mid-September that the prime minister’s department was drafting a federal apostasy bill providing for the detention and rehabilitation of persons deemed to have renounced Islam or practised a deviant version of the religion sparked a major controversy. Critics claimed the adoption of such a law would contravene both constitutional and Koranic provisions guaranteeing freedom of religious practice. Women’s rights group, Sisters in Islam, said the proposed law contained no definition of apostasy and would therefore be open to abuse, with grave implications for a multiracial society. The group suggested the proposed law was the outcome of political expediency rather than designed to address any existing problem. PAS—some of whose leaders have advocated the death penalty for apostasy—also dismissed the government’s move as a “political ploy”. On September 29th Dr Mahathir suggested the draft bill had been shelved, acknowledging it had “many weaknesses” and would take some time to finalise.

Campaign to cast PAS as an UMNO’s campaign to cast PAS as an intolerant and discriminatory party, intolerant party inciting hatred against the government and causing disunity among Muslim Malays, has intensified. , a minister in the prime minister’s department responsible for legal matters, said in late July that the government would prove its claim that the Al Ma’unah sect, accused of a bizarre arms seizure and hostage-taking in northern state earlier that month, was associated with PAS. Yet by early December neither the authorities nor the treason trial of 29 members of the group, which began in September, had established such a link. In early August, Abdullah Badawi, the deputy premier, recalled an amanat (decree) supposedly issued in 1979 by —now PAS’s deputy president and the chief minister of Terengganu state—labelling UMNO members as kafirs (infidels), and demanded that he rescind it. Abdul Hamid Othman, the minister in the prime minister’s department in charge of religious affairs, went a step further, blaming the amanat for the alleged murder by Al Ma’unah members of two hostages seized in Perak, and warning it could lead to more killings.

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Revenues of PAS-controlled A September 5th announcement by the federal finance ministry that the Terengganu cut Terengganu state government—under PAS control since November 1999— would no longer receive a 5% royalty on offshore oil and gas production, was widely seen as a vindictive attempt to undermine the main opposition party. The royalty had been paid by Petroliam Nasional, the central government-run hydrocarbons corporation. The announcement said the royalty, which accounted for the bulk of the Terengganu administration’s budgetary revenue, was being replaced by special aid for poverty-eradication projects to be chosen by the ministry. The state’s assembly passed an emergency motion condemning the move as a breach of democracy. Mr Hadi, insisting Terengganu was legally entitled to the royalty, initially threatened to take the matter to court, but later said such a move would prove useless as the judiciary tended to defer to the wishes of the federal government in political cases.

Mosques have become a key In mid-October, Nik Aziz, the chief minister of PAS-governed state, battleground was threatened with legal action by his UMNO counterpart in , Mohamad Khir Toyo, for allegedly contravening a directive prohibiting the use of places of worship for political purposes. Mr Toyo said Mr Aziz had delivered a lecture at a mosque near Shah Alam, north of Kuala Lumpur, even though a request for him to do so had been turned down. The Kelantan chief minister, who chairs PAS’s council of scholars, claimed he only learned of the ban two days later, challenged Selangor’s religious affairs department to prove he had broken the law, and insisted he would accept future invitations to speak at mosques in the UMNO-controlled state. Mosques have become a key battleground in the intensifying war between UMNO and PAS for the hearts and minds of Muslim Malays. But Mr Aziz is regarded by many of the country’s Muslims as an exemplary religious and political leader, and the threat of legal action against him was widely condemned. Indeed some saw a late-October pledge by the Selangor government to phase out pig-farming in the state as an unconvincing attempt at damage-control.

PAS’ youth wing leader PAS supporters claimed another moral victory on November 9th when the goes to jail head of its youth wing, , opted to spend one month in jail rather than pay a M$1,500 (US$395) fine after being convicted by a Kuala Lumpur court of taking part in an illegal demonstration in April 1997. The demonstration had been organised by PAS to protest against the presence of an Israeli team at an international cricket tournament near the federal capital. The defence counsel, , declared that the conviction of Mr Mahfuz and his three co-defendants for participating in “an assembly to oppose the traitors of Islam” would “upset many Muslims here and overseas”. The verdict coincided with the acute escalation of hostilities between the Israeli army and Palestinians in the West Bank and Gaza Strip.

PKN accused of lobbying The trials of other opposition figures proceeded slowly. They included that of against Malaysia in US Mohamed Ezam Nor, the PKN youth wing chief and erstwhile political secretary to the former deputy prime minister, , charged last November with violating the Official Secrets Act by releasing classified documents which he alleged implicated close associates of Dr Mahathir in corrupt practices. Mr Ezam was embroiled in controversy again following an October 27th report in

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The Straits Times of Singapore that supporters of Mr Anwar had recruited a Washington-based lobbying firm to ensure the ousted deputy premier remain an issue internationally. Mr Anwar is serving jail terms totalling 15 years after being controversially convicted on corruption and sodomy charges. During a press conference the following day Mr Ezam declined to refute the report, but insisted the PKN had not engaged the firm identified, Janus Merritt Strategies, or any such organisation. However, he expressed the hope that any economic pressure from overseas, including a slowdown in inward investment, would encourage greater democracy in Malaysia. He also admitted having criticised Dr Mahathir during a recent visit to the US.

Wan Azizah Ismail, who is Mr Anwar’s wife and PKN president, subsequently conceded that Janus Merritt may have been recruited by the so-called Free Anwar Campaign, which is headed by the party’s media co-ordinator, Raja Petra Kamaruddin. Dr Mahathir accused the PKN of seeking to discredit the government and impoverish ordinary Malaysians by discouraging foreign investment, while Abdullah Badawi, the deputy premier, said the police would investigate Mr Ezam’s admission he had “smeared” the prime minister while abroad. The controversy was all the more bitter because it erupted shortly after seven member of US House of Representatives tabled a draft resolution demanding that all charges against Mr Anwar be dropped or that he be tried afresh.

Police crack down on A heavy-handed police crackdown on opposition supporters gathering for a opposition demonstration rally organised by the PKN north of Kuala Lumpur on November 5th, reinforced the widespread belief that Dr Mahathir was prepared to give little ground to his critics. While official permission to hold the rally was predictably denied and the police tried to prevent would-be participants reaching the site, thousands turned out for what the PKN later described as the biggest anti- government demonstration since Mr Anwar’s arrest in September 1998. Most people, cut off by police roadblocks, were unable to hear speeches delivered by Wan Azizah, Fadzil Noor (the PAS president), (the Democratic Action Party (DAP) chairman) and other opposition leaders, many of them calling on the prime minister to resign. Organisers claimed police began firing tear-gas and spraying chemical-laced water into the crowd as it was about to disperse. They also alleged that police indiscriminately beat both rally participants and others unwittingly caught up in the melee. Lawyers claimed that some two dozen of the more than 120 people arrested were assaulted in custody. Wan Azizah described the crackdown as a “shameless abuse of police power and government institutions to crush legitimate dissent and deny the people their political rights”. Dr Mahathir characteristically countered that opposition parties had provoked the repression by staging an illegal demonstration, and Norian Mai, the national police chief, said he was “satisfied” with the way the operation was handled.

Public outrage over police But the intensity of public outrage obliged Zainal Abidin Zin, the deputy home brutality minister, to promise that action would be taken against any police personnel deemed to have used excessive force. The Malaysian Human Rights Commission, set up by the government earlier in the year and widely decried as

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less than independent, said it would investigate complaints of police brutality. Mr Abdullah, who is home minister as well as deputy premier, said he had instructed Mr Norian to co-operate fully with the commission. However, one of its members subsequently claimed that the police had refused to provide it with the names and addresses of those arrested, a vital first step in the enquiry process. The police chief insisted his force was legally bound to withhold the information because court proceedings against the detainees were still pending.

Tensions within the Relations between members of the opposition Barisan Alternatif (BA), which opposition comprises PAS, the DAP, PKN and Parti Rakyat Malaysia, have been severely strained. In early August, Kerk Kim Hock, the DAP secretary-general, acknowledged there was mounting pressure from within his party to quit the coalition formed in the run-up to the 1999 elections, attributing it largely to concern over the implementation of PAS’s Islamic agenda. He said the Terengganu state government’s requirements that female workers wear a tudung (headscarf) and the sexes be segregated at supermarket check-outs, as well as calls by PAS leaders for pop concerts be banned and women prohibited from participating in Koran-reading competitions had dismayed many of the DAP’s mainly Chinese members. Lim Kit Siang, the party chairman, said such moves raised questions about PAS’s commitment to the empowerment of women and minorities, to human rights and cultural pluralism. PAS officials defended the controversial moves, arguing they were essentially targeted at Muslims and did not infringe on the fundamental rights of non-Muslims.

Alliance with PAS causes Noting that many grassroots DAP members had long been uneasy over their unease party’s alliance with PAS, pro-government newspapers gleefully predicted an imminent divorce. Prominent BA figures sought to downplay the tensions. Chandra Muzzafar, the PKN deputy president, insisted the DAP and PAS had an “excellent” working relationship, and that their differences arose from the “complex challenge of addressing issues pertaining to religion, culture, gender and morality in an ethnically divided society”. Following a meeting between leaders of the four parties, Mr Lim said PAS had agreed to consult its allies in future before implementing measures that might alienate non-Muslims, and maintained the DAP would not withdraw from the coalition. Fadzil Noor, the PAS president, also sought to repair some of the damage by stating that Malaysia’s pluralistic nature made it impossible for any one race to govern the country alone. The fragility of the BA was also underscored by a bitter dispute over the selection of a candidate to represent the opposition in the November 29th Lunas by-election. The DAP leadership claimed it had been “betrayed” when the PKN’s Mr Saifuddin was chosen, and initially threatened not to campaign on his behalf. It later relented.

Economic policy

Budget reiterates faith in In the 2001 budget the government again reiterated its faith in the expansionary policies pursuit of expansionary fiscal and monetary policies and the maintenance of the pegged exchange rate at M$3.8:US$1. The government intends to

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consolidate the recovery process in the short term and remains determined to engineer a transition from a production- to a knowledge-based economy over the long term. It has done little of late to revive sluggish investment or boost private consumption, seemingly in the belief that there is already sufficient short-term growth momentum and that much more stimulation could cause overheating. This, in essence, was the strategy outlined by the finance minister, Daim Zainuddin, when presenting the draft 2001 budget to parliament on October 27th. Mr Daim declared himself more than satisfied with the economy’s V-shaped recovery, which saw GDP grow by 5.8% last year after contracting by 7.4% in 1998. He predicted it would expand by 7.5% this year—well up on his previous forecast of 5.8%—and by 7% in 2001.

Budget deficit of 4.9% of Malaysia’s chief policymaker forecast a budget deficit of M$16.1bn GNP forecast for 2001 (US$4.25bn) or 4.9% of GNP for 2001, marginally down on the M$18bn (5.9% of GNP) shortfall officially expected this year. Total expenditure was scheduled to rise by 11.7% above the government estimate for 2000, to M$91.1bn, with operational spending up by 6.9% to M$62.2bn and development outlays 23.8% higher at M$28.8bn. Revenue was projected to rise by 9.6% to M$69.6bn. Officials said the deficit would be mainly financed from non-inflationary domestic sources, such as the bond market, so as not to deprive the private sector of funding. While the 2000 deficit derives essentially from the perceived need a year ago to pump-prime an economy emerging from recession—by, among other means, hefty spending on physical infrastructure and tax breaks to boost consumption and investment—the 2001 shortfall will have somewhat different origins. A substantial proportion of the capital budget is earmarked for the construction of low-cost housing, schools, hospitals and clinics, and to spur development in poorer rural areas. Many tax breaks likewise favour low- income earners, foremost among them a proposed increase in the annual rebate payable to individual taxpayers from M$110 to M$350 and the raising of the eligibility threshold from M$10,000 to M$35,000. The budget’s only tax increases are on alcohol and cigarettes. The populist nature of the package reflects the government’s concern about the strength of support for opposition parties.

Malaysia: federal government budgetary position (M$ m) 1995 1996 1997 1998 1999 2000a 2001a Revenue 50,954 58,280 65,736 56,710 58,677 63,500 69,610 Operating expenditure 36,573 43,865 44,665 44,584 46,699 58,206 60,710 Current-account balance 14,381 14,415 21,071 12,126 11,978 5,294 8,900 Development expenditure (net) 12,520 12,600 14,445 17,128 21,462 23,286 25,036 Overall balance 1,861 1,815 6,626 –5,002 –9,484 –17,992 –16,136 % of GDP 0.8 0.7 2.4 –1.8 –3.2 –5.3 –4.4 a The figures for 2000 and 2001 are from the 2001 Budget; 2000 is an estimate; 2001 a forecast. Share of GDP is an EIU calculation.

Source: Ministry of Finance, Malaysia, website; Economic Report, October 2000.

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10% exit levy lifted but not Local businesses, many of them still ailing from the recession, were offered scrapped little direct relief. The most generous such concession was the waiving of import duties and sales taxes on equipment and machinery used by certain manufacturing and service companies. Despite recent calls by foreign business lobbies for improved incentives to help reverse the slide in inward investment, and Mr Daim’s admission during his budget speech that higher inflows are a prerequisite for sustained growth, incentives here too were modest. The most notable was the abolition of a 10% exit levy on stockmarket profits retained in the country for one year. Foreign portfolio investors had been hoping the levy—a product of the capital controls regime controversially imposed in September 1998—would be scrapped outright, with no retention proviso.

No cut in corporate income A widely-expected cut in the corporate income tax rate did not materialise. It is tax to remain at 28%, above those prevailing in many other Asian countries, including neighbouring Singapore. Proposing a modest enhancement of existing reinvestment allowances, Mr Daim urged foreign companies planning to expand production capacity to invest more in human capital and be more generous in the area of technology transfer. Acknowledging that the trend towards liberalisation and globalisation is irreversible, he hinted that limits on overseas equity holdings in key industries, including those deemed to be strategic, could be relaxed.

Budget incentives for a A primary objective of the budget is to spur the development of a “knowledge “knowledge economy” economy”, Dr Mahathir’s answer to the declining competitiveness of the manufacturing sector and the speed of the technology revolution. To this end, the draft budget promised: generous tax and other incentives to lure home Malaysian experts working overseas; the establishment of a M$500m venture capital fund and the outsourcing of its management; tax deductions for “angel” investors; the relaxation of requirements for listing on the MESDAQ, the country’s nascent stock exchange for high-tech companies; and a range of initiatives to boost computer usage and literacy.

Economy’s downside risks The government-run National Economic Advisory Council said the budget had acknowledged been formulated “with full recognition of the downside risks” to the economy, especially to external demand. The budget did not envisage “excessive pump- priming”, it said, as that would raise public debt much further. Moreover, the “long-term expectation” was that private sector spending would become more of a growth driver than that of the public sector.

National Development On November 2nd the 155-member National Economic Consultative Council Policy under revision (NECC) submitted to Dr Mahathir a 227-page report containing proposals to revise the National Development Policy (NDP)—the current incarnation of the 30 year-old positive discrimination programme in favour of bumiputeras (ethnic Malays and other indigenous groups) which is due to expire at the end of the year. While the report’s contents were not disclosed, it was believed to recommend paring down privileges that give bumiputeras preferential access to education, housing, jobs, business licences, public sector contracts, government grants, bank credit and share capital. Receiving the document, one of scores being solicited or offered for consideration in the drafting of the

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Eighth Malaysia Plan (2001-05), Dr Mahathir acknowledged it had been difficult for the multiracial NECC to reach a consensus. Pointing out that there were still great disparities in achievement between the country’s races— primarily a reference to the relative prosperity of the minority Chinese community in relation to the Malays—he insisted the government reserved the right to accept or reject the report’s proposals.

Proposals prove highly That warning, and the fact that the report was delivered three months late, controversial stemmed partly from a fierce controversy that erupted in August after press reports that cited NECC vice-chairman David Chua as suggesting the decade- old NDP was doing little good and advocating a merit-based liberalisation of affirmative action. Mr Chua, a prominent figure in the Chinese business community, said the NECC was examining several options to eliminate the discrimination programme’s central objective of helping bumiputeras acquire at least 30% of the nation’s wealth, as measured by outstanding share capital at par value. The options included scrapping the target completely in the case of high-technology businesses and phasing it out in other sectors. The bumiputera holdings rose from 2% in 1970, when the strategy was launched, to 20.6% in 1995, thanks largely to the government’s divestment of stakes in state-owned enterprises to hand-picked executives at substantial discounts and a requirement that big chunks of new share issues be reserved for bumiputeras. However, when the recent recession struck, the bumiputera holdings fell back again.

NDP breeds inefficiencies The affirmative action programme was prompted by bloody race riots in Kuala and abuse Lumpur in 1969. While it is in many respects an interesting experiment in social engineering, aimed at eradicating poverty and assuring racial harmony, it has always had its critics. These argue that pervasive and prolonged official patronage will inevitably engender a culture of complacency and an aversion to risk-taking. Another complaint is that the system is prone to abuse and corruption. The NDP has been especially controversial because its encouragement of the emergence of a critical mass of Malay entrepreneurs was considered by many to be too narrowly focused. It became even more controversial with the onset of the 1997-99 downturn, which exposed many beneficiary companies as hugely indebted and poorly managed. The rash of officially-orchestrated bailouts that ensued stoked even stronger condemnation of the process.

Mahathir stamps on calls to The proposed changes mentioned by Mr Chua are thus symptomatic of a abolish Malay privileges widely-held view that the NDP, by favouring a pro-government elite of doubtful entrepreneurial ability, is stifling initiative elsewhere in the economy and constraining growth. They also reflect increased assertiveness on the part of the ethnic Chinese community, whose solid backing gave the BN a two- thirds parliamentary majority in the November 1999 general election despite a large-scale switch in Malay allegiance from UMNO to the opposition Parti Islam sa-Malaysia (PAS). Claims by a Malay-language newspaper that the wholesale abolition of Malay privileges was being advocated sparked a storm of protest, spearheaded by UMNO’s youth wing, against both Mr Chua and an umbrella grouping of Chinese lobbies pressing for wide-ranging economic and

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social reforms, including the scrapping “in all respects of the bumiputera/non- bumiputera distinction”. Dr Mahathir told one group of demonstrators the government would not retreat “even one step” in its defence of Malay rights. He also dismayed many ethnic Chinese by slamming the respected umbrella grouping as “extremist”.

Both the Chinese lobby and Mr Chua countered they were not questioning the “special position” of Malays as enshrined in the constitution—a treasonable offence—but the implementation of policies supporting it. PAS leaders accused UMNO of deliberately misinterpreting legitimate demands for change in order to stoke racial tensions and stem the slide in its popularity among Malays. Somewhat ironically, Dr Mahathir regularly berates Malays for wasting the opportunities afforded by affirmative action. Would-be entrepreneurs given training, business premises, financial assistance, technical advice and marketing support, often opt to become sleeping partners in their companies, ceding operational control to others—usually ethnic Chinese. Firms that land projects on the strength of their bumiputera status routinely sub-contract the work to more aggressive or capable competitors. Abdullah Badawi, the prime minister’s deputy and possible successor, has said on numerous occasions recently that Malays must shake off their begging mentality, warning that the government is no longer willing to rescue poorly-run businesses.

Major changes unlikely in Yet it may be an idle threat. UMNO’s travails and the weakness of Malay-run affirmative action policy businesses suggests the government has little choice but to remain indulgent. The re-worked version of the NDP and the forthcoming five-year plan are bound to tinker with affirmative action. There is likely to be a broader dispersal of its benefits to temper allegations of favouritism and cronyism. Privatisation, hitherto synonymous with the hiving off of state assets to often less than efficient local companies, will proceed more cautiously, and involve greater consultation with the public and with interested firms. But policymakers will also take steps aimed at expanding the Malay business class and facilitating its involvement in more sophisticated activities.

Only grudging exceptions That implies more pressure on foreign companies to “Malaysianise” their are likely to the 30% rule operations and accommodate Malay-controlled firms as joint venture partners and suppliers. Exceptions to the stipulation, that bumiputeras hold 30% of the equity in Malaysia-based businesses, seem set to be made only grudgingly. The provision has been relaxed in the case of companies investing in the Multimedia Super Corridor and manufacturing concerns that export the bulk of their output. The government has authorised national flag-carrier Malaysian Airline Systems (MAS) to raise the ceiling on its foreign shareholding to 45%. Yet talks with potential overseas strategic partners conducted by MAS and other troubled big groups in recent months have thus far yielded little of substance, largely owing to Dr Mahathir’s reluctance to see “strategic” assets surrendered to supposedly predatory foreigners.

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The domestic economy

Economic trends

Third-quarter GDP expands Real GDP increased by 7.7% year on year in the third quarter of 2000—the by 7.7% sixth consecutive quarter of growth—according to data released at the end of November by the Department of Statistics. The figures were in line with earlier suggestions by officials, including Dr Mahathir, but disappointed some private forecasters. On a quarter-on-quarter (not seasonally-adjusted) basis, activity during the July-September period grew less rapidly than in the preceding three months, slowing also compared with the same period a year ago. Real GDP increased by 2% quarter on quarter after 4.5% in the April- May period and 2.8% in July-September of 1999. The general slowing of the pace of expansion from a peak of 11.9% year on year in the first three months of this year is evidence of the gradual loss of momentum and maturing of the economic recovery. The most striking features of the third- quarter numbers were the extraordinary strength of exports, which rose 13% from the second quarter and almost kept pace with the 13.6% growth in imports, and the relative weakness of gross domestic fixed capital formation, which increased by only 0.2% from the preceding period. In year-on-year terms, however, the economy shows remarkable vigour—a 20.6% surge in exports, easily exceeded by a 31.1% jump in imports, and 24.2% growth in gross domestic fixed capital formation, only slightly down from 25.3% in the second quarter.

Malaysia: real gross domestic product (at 1987 purchasers’ prices, M$m) 1999 2000 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Private consumption 20,427 21,002 22,026 23,589 23,219 23,535 % change year on year 2.7 5.0 7.1 14.4 13.7 12.1 Public consumption 5,433 6,920 7,276 4,350 6,006 6,265 % change year on year 4.7 23.9 19.6 1.7 10.5 –9.5 Gross fixed capital formation 12,783 12,926 14,095 13,770 16,017 16,048 % change year on year –10.5 11.5 5.7 13.9 25.3 24.2 Change in stocks 1,106 –788 –1,031 742 987 994 % of GDP a year ago 1.2 –3.9 6.0 –0.4 –0.2 3.6 Net exports 8,402 9,432 8,093 7,554 6,012 6,465 % of GDP a year ago 5.3 4.4 –2.5 1.7 –5.0 –6.0 Exports, goods and services 51,876 56,146 58,453 55,319 59,935 67,698 % change year on year 13.0 19.5 18.4 20.2 15.5 20.6 Imports, goods and services 43,474 46,714 50,360 47,765 53,923 61,233 % change year on year 8.8 18.1 25.6 21.8 24.0 31.1 GDP 48,151 49,491 50,458 50,004 52,241 53,308 % change year on year 5.0 8.6 11.0 11.9 8.5 7.7 Source: Department of Statistics, Malaysia

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Government raises 2000 The annual Economic Report released by the finance ministry in late October real GDP forecast in conjunction with the draft 2001 budget, forecast real GDP growth in 2000 at 7.5%, a significant improvement on the previous official projection of 5.8%. The upward revision, based on data for the first eight months of the year, was still lower than the EIU’s current estimate of 8.6%. The report attributed the strong growth momentum to the regime of capital controls and export- boosting pegged exchange rate of M$3.8:US$1, the continuing buoyancy of external demand, and improving domestic demand being fuelled by expansionary fiscal and monetary policies.

Public investment growth Public investment was officially projected to rise by 15.7% in 2000, compared in 2000 put at 15.7% to growth of 7.9% the previous year, reflecting the stronger fiscal stimulus, particularly higher outlays on physical and social infrastructure. Private investment was forecast to increase by 27.2%, a surge that reflects the sharpness of the declines experienced in 1998 and 1999 (50.9% and 27.3% respectively), heavier capital spending in the services sector (especially by the rapidly-expanding communications industry) and the addition of manufacturing capacity following the reactivation of facilities put on hold during the downturn.

Investment applications Investment proposals received by the Malaysian Industrial Development bounce back Authority (MIDA) in January-July 2000 were valued at M$17.48bn, 67.6% higher than in the first seven months of 1999. Applications from local investors were worth M$8.8bn, a year-on-year increase of 161.2%, while those from foreign investors rose by 23.1% to M$8.7bn. Proposals approved by MIDA during the same period were valued at M$12.14bn, an increase of 29.3% on January-July 1999, with endorsements of applications from local investors jumping by 270.8% to M$8.1bn and those of proposals from foreign investors dropping by 43.5% to M$4.1bn. Imports of capital goods rose by 49.7% in January-August 2000, having contracted by 20.5% in the corresponding period of the previous year.

Inflation pressures to Despite the strengthening of economic growth the annual inflation rate, as remain subdued measured by the consumer price index (CPI), has continued to moderate. It rose by 1.4% in January-September, against 3% in the first nine months of

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1999. The Economic Report attributed the slowdown to the stable exchange rate and the continuing low-inflation environment in major industrial countries, which rendered imported inflation “insignificant”. Domestic price pressures also remained subdued, given the persistence of excess capacity in certain areas.

Labour market expected to Upward pressure on wages is likewise generally moderate, although tightening tighten further labour supply in some areas of manufacturing industry resulted in relatively high pay increases. The Economic Report forecast that despite an expected 2% increase in the size of the labour force to almost 9.2m in 2000, the unemployment rate would decline to 2.9%, from 3% in 1999, owing to a projected 2.1% rise in total employment to nearly 8.93m. The number of job vacancies reported to the human resources ministry’s Manpower Department in January-July totalled 69,769, up 21.9% on the first seven months of 1999. The number of active job-seekers registered declined by 2.5% to 36,380, while the number of retrenched workers fell by 39.2% to 14,617.

Oil and gas

Oil price rise boosts export Crude oil production, including condensates, averaged 695,823 barrels a day earnings (b/d) in January-August, up 2.3% on the 680,210 b/d pumped in the same period of 1999, according to the finance ministry’s annual Economic Report. It forecast output for the full year at 695,718 b/d, only 0.4% higher than in the whole of 1999. Export earnings from crude soared by 74% to M$8.8bn (US$2.3bn) in the first eight months, thanks to an 85.1% surge in unit value to over M$810 a tonne, the report said. The average export price of Malaysian crude rose by 83.5% to US$28.76 a barrel. The continued rise in prices thereafter, while boosting earnings still further, also sparked fears of a slowdown in global growth that would have serious repercussions for Malaysia’s export-oriented economy.

Higher retail prices to On September 30th, with key benchmark crudes around US$36 a barrel, the check surge in subsidies finance ministry announced increases in the retail prices of refined products— petrol, diesel and liquefied petroleum gas—of between 7.7% and 9.4%.

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Premium unleaded petrol, for example, went up to M$1.20 a litre, from M$1.10. Officials said the price hikes, the first since 1984, were justified by the ever more onerous burden controlled-pump prices imposed on the government in the form of subsidy payments and tax revenue foregone. The cost of unleaded petrol had almost tripled to M$0.91 a litre in five years, according to the official National Economic Advisory Council (NEAC). As a result, product subsidy payments had risen from M$180m in 1996 to M$1.2bn in 1999, and would have reached M$3.1bn in 2000 without the retail price increases. With the hikes, the NEAC estimated subsidy payments would still amount to a substantial M$2.9bn this year. Similarly, product tax revenue foregone had increased from M$1.2bn in 1996 to M$2.7bn in 1999, and would have totalled M$4.6bn this year in the absence of the pump price rises. Officials also noted that the subsidy regime benefited well-off consumers most, encouraged smuggling to neighbouring Thailand and Singapore where retail prices are significantly higher, and discouraged greater utilisation of public transport, a key government objective. Some opposition politicians argued that the retail price increases were unjustified because the state-run hydrocarbons corporation, Petroliam Nasional (Petronas) was reaping huge windfalls from crude sales.

Terengganu royalty On September 5th the federal government controversially announced that payments cut to spite PAS cash payments from Petronas to the Terengganu state administration relating to offshore oil and gas production, would be replaced by special assistance from the finance ministry for poverty eradication projects chosen by Kuala Lumpur. Since 1978 Terengganu had been receiving a royalty equivalent to 5% of the value of the hydrocarbons produced off its shores, but UMNO luminaries led by Dr Mahathir began disputing the allocation after PAS won control of the state in November 1999 elections. They claimed in essence that the relevant fields, being more than 100 km offshore, fell under central rather than state government jurisdiction. Opposition politicians denounced the change as an illegal, unjust and vindictive attempt to sabotage the state government. Terengganu is one of Malaysia’s poorest states and the royalty payments have long accounted for the bulk of its budgetary revenue. Thanks to surging crude oil prices they reached a record M$810m in the 12 months to end-March 2000, according to Petronas—almost double the previous year’s outlay. The September 5th statement, which claimed the PAS government could not be trusted to spend the royalty payments wisely, made no mention of how much development assistance would be disbursed.

LNG production forecast to The Economic Report forecast that natural gas production would average 3.9bn rise by 4.6% this year standard cu feet a day (scf/d) in 2000, 4.6% higher than in 1999. It attributed the expected improvement largely to stronger demand for liquefied natural gas (LNG) from traditional overseas buyers, particularly Japan and South Korea. Export earnings from LNG were projected to rise by 52.8% to M$9.7bn owing to an anticipated 52.1% increase in unit value to M$640 a tonne.

In early October Petronas formally committed itself to purchasing up to 250m scf/d of gas from Indonesia’s West Natuna field in the South China Sea. The deal, with Indonesia’s state-owned hydrocarbons concern Pertamina,

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envisages the gas being pumped via pipeline from West Natuna to the nearby Duyong field currently being developed by Petronas off Terengganu, and thence into the national grid. Delivery is to begin mid-2002.

Manufacturing

Manufacturing production The finance ministry’s end-October Economic Report forecast that to growth by 17% manufacturing production would expand by 17% in 2000, up from 13.5% in 1999, with strong global demand for electronic products, economic recovery in Asia and improving domestic consumption as the main drivers. The report said that output growth, having measured 24.5% in January-June, would moderate in July-December owing to the base effect of a stronger second half of 1999, capacity constraints in some industries and a possible slowdown in exports to the US. Exports of manufactured goods were projected to rise by 15.9% to M$316.3bn (US$83.2bn), accounting for over 85% of total foreign sales in 2000 and increasing slightly faster than the 14.7% growth rate achieved the previous year.

Electronics and electricals In January-August 2000 output of electronic and electrical products surged by retain leading role 44% year on year, with production of semiconductors up by 48.6%, according to the report. A number of other sectors also recorded significant increases in output in the first eight months. Production of basic metals rose by 31.6%, buoyed by an upturn in external demand and the accelerated implementation of infrastructure and housing projects. The transport equipment industry expanded by 24.5% thanks to increased domestic demand for passenger cars and commercial vehicles, a trend in turn attributable to the recovery-induced improvement in disposable incomes in an environment of low interest rates. Output of non-metallic minerals rose by 22.8%, largely on account of stronger demand for cement and concrete products as construction activity picked up. The chemicals, food and textiles industries grew by 18.9%, 18.2% and 9.4% respectively.

Output growth slows less Subsequent data derived from the official industrial production index indicated than expected that output growth was not slowing as much in the second half of 2000 as the authorities had feared. Year on year, manufacturing production expanded by

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24%, 25.1% and 21% in July, August and September respectively. Month on month, output rose by 4.2% in July, declined by 2.5% in August and rose by 4.7% in September. As a result, manufacturing production increased by 26.9% year-on-year in the first nine months of 2000.

Electronics industry moves The electronics industry, while still clustered towards the lower end of the slowly upmarket value chain, has continued to move slowly upmarket, an ascent dictated by rising domestic costs, labour shortages and the dizzying pace of technological progress. By some measures the sector—dominated by big-name multinationals that have spawned a rash of smaller local players—is still thriving. Output and exports are buoyant thanks to the speed of the global transition to the “new economy”, spurring capacity expansion. Spending on R&D is on the increase. Automation and diversification are boosting productivity and the value-added in production. But experts argue that such trends have to become much more pronounced if Malaysia is to extricate itself from the no-man’s-land it now occupies between emerging low-cost producers such as the Philippines, Thailand and China on one side and high-tech giants like Taiwan, South Korea and Singapore on the other.

Malaysia’s higher labour Market forces have been encouraging movement in this direction for some costs leads to downsizing time. Surging pay rates and rampant job-hopping induced by Malaysia’s prolonged pre-crisis manufacturing boom prompted a number of labour- intensive electronics companies to relocate to lower-cost countries in 1997-98. With wage pressures now reasserting themselves, downsizing has again become the order of the day. In late October Seagate Technology, the world’s biggest disk-drive maker, announced it was combining the operations of two of its five local plants, and had offered voluntary redundancy packages to 6,000 workers at recording heads factories in Ipoh and . Executives attributed the consolidation to technological advances—rising disk capacity requiring fewer heads per drive—and Malaysia’s rising labour costs. In a recent report the Malaysian American Electronics Industry (MAEI)—a lobby representing the local operations of 18 multinationals including Dell, Intel, Western Digital and Motorola—predicted that employment in the electronics sector would grow

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only marginally over the next few years. It also noted that some members were having trouble recruiting engineers, IT professionals and technicians.

Automation keeps demand One reason for the modest employment growth forecast is automation—a for labour down consequence of both the tightening labour market and the scramble for cost effectiveness generally amid intensifying price competition forced by technological advances. The MAEI report estimated that increased automation helped boost worker productivity in member companies by 39% last year. The introduction of more capital-intensive product lines is also contributing to greater efficiency. Memory chips have long constituted the bulk of the Malaysian industry’s output, but more value-added items such as disk-drives, magnetic disks, computers, telecommunications equipment and consumer electronics are assuming ever greater importance. The MAEI expects members’ exports of non-semiconductor products to overtake those of semiconductors by 2002.

Crucial role of Multinationals are driving the change. Many of them are undertaking or multinationals planning investments that involve more sophisticated manufacturing locally. For some, inward consolidation is a vital part of the process. Loss-making San Jose-based Komag, the world’s largest supplier of thin-film media—the main component of hard disk-drives—shut down its US production facilities last year, concentrating all such activity in Penang. It is now considering diversification into fibre-optic communications components, where margins are substantially higher than in the cut-throat disk-drive business. In June Agilent Technologies (formerly Hewlett-Packard) unveiled plans to transfer the production of proprietary state-of-the-art electronic instrumentation systems from eight offshore locations to Penang, part of a strategy that will double its investment to M$3bn over five years. Motorola, which has manufacturing plants in Penang and Kuala Lumpur, plans to invest up to M$2bn over the same period in a range of new communications technologies. Japanese consumer electronics powerhouses Sony, Sharp and Matsushita are likewise shifting core activities to their Malaysian plants.

Electronics sector expects Diversification into new product lines and investments in capacity expansion strong value-added growth saw the value-added in production by MAEI members rise by 40.6% in 1999, according to the group’s report, which forecast it would increase by 34% annually over the next three years. Value-added in the semiconductor sector is projected to expand by 19% a year, and that of the non-semiconductor sector by 47%. The move towards more capital-intensive manufacturing means foreign companies are undertaking more R&D in Malaysia. R&D spending by MAEI members is projected to rise from M$146m last year to M$250m in 2002. But that is still small money, and more than four-fifths of it is destined for the semiconductor sector.

Sharp rise in outsourcing With multinationals increasingly focusing on core competencies like design by multinationals and marketing, they are relying more heavily on smaller companies, many of them Malaysian-owned, for raw materials and services. Spending by MAEI members on such products and services almost doubled to M$8.7bn last year. Outsourcing not only reduces the industry’s dependence on imports and saves

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foreign exchange, but also pushes suppliers in what is an intensely competitive business to perform to the highest international standards. Product vendors must deliver at low cost, promptly and to specification. Semiconductor assemblers, particularly those serving the high-growth telecommunications market, are among the main beneficiaries of increasing local procurement. Unisem, Malaysian Pacific Industries and AIC are investing heavily in capacity expansion, while streamlining their production processes to keep ever more exacting customers satisfied.

Wafer-fabrication to begin After a few false starts, Malaysia’s moves to have its own wafer-fabrication in Malaysia facilities are finally taking shape. At present, the thin slices of polished silicon containing the semiconductors on which the country’s electronics industry is so heavily dependent, are almost entirely imported (Intel manufactures its own microprocessors locally). Two foundries, making chips to order for downstream users and scheduled to start commercial production during the next six months—both of them government initiatives—will change that. First Silicon, a M$6.5bn plant built by the Sarawak state government near Kuching on Borneo island and part-financed by a consortium of European banks, is now in the testing stage. It will start with a 0.25-micron fabrication line in the first quarter of 2001, and move to 0.18-micron—the scale required by the high- growth telecommunications market—within a year. It is expected to be fully operational by mid-2002, turning out 30,000 wafers a month. Japan’s Sharp is providing key technology and will be a major customer. The federal government industrial development bank and the finance ministry’s investment arm, Khazanah Nasional, provided most of the M$4.5bn for the second venture, Silterra, located at Kulim High Technology Park in peninsular Kedah state—within easy reach of the hundreds of electronics factories on Penang Island. It too is ultimately aiming to produce a similar volume of 0.18 micron circuits, having licensed the requisite technology from California-based chip-maker LSI Logic.

Investment incentives not While the recent MAEI report forecast that investment by members would sufficiently attractive reach M$3bn this year, up from M$1.9bn in 1999, industry executives say it could and should be higher. Established players account for almost all capital inflows to the electronics sector these days, because potential newcomers see Malaysia as a less than attractive destination. One reason is that the incentives on offer—foremost among them a five-year tax holiday and reinvestment allowances—are now considered inadequate, having been more than matched by other countries. While government officials insist the existing incentives package can be—and indeed has been—enhanced to meet the demands of individual investors, industry executives are discouraged by what they see as complex and protracted approval procedures. The Singaporean authorities, they say, are willing to part-finance R&D activities and employee training schemes, and are less obstructive when it comes to the recruitment of expatriate professionals.

Proton still has not found a On October 10th, the struggling national car manufacturer Perusahaan strategic partner Otomobil Nasional (Proton) denied reports it was close to striking a strategic alliance with a US giant. In a statement to the Kuala Lumpur Stock Exchange,

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Proton acknowledged it had held discussions with “several global automotive manufacturers to explore strategic alliances in technology and product development”, but insisted “no definite plans have been made in that respect with any party, including Ford Motor Company and DaimlerChrysler”. The statement followed local press reports claiming that the listed company had narrowed its search for a strategic partner to the two US car makers. Four days earlier Dr Mahathir—who launched Proton in 1983 as a key plank of the country’s industrialisation drive—declared that the government would not allow the company to sell more than 30% of its equity to foreign investors. At present, Japan’s Mitsubishi holds 16.06%, the finance ministry’s investment arm Khazanah Nasional 17.47%, local conglomerate Hicom Holdings 27.2%, and domestic and foreign portfolio investors the remaining 39.27%. The prime minister’s resistance to the idea of selling much more of Proton to foreign interests, reflects his frequently stated conviction that industries perceived as strategic should remain largely in the hands of Malaysians. He believes that were the company to be taken over, it would become a mere assembler of foreign vehicles. Yet as a small, high-cost producer, heavily dependent on imported components and the protection of huge tariffs on foreign vehicles, a stand-alone Proton can hardly hope to become competitive given the rapid consolidation of the industry globally and scheduled sharp cuts in regional tariffs.

Government remains Government officials and Proton executives beg to differ. They claim the optimistic about Proton company’s latest model, the Waja—a four-door sedan on the market since late August—contains 80% domestically produced parts. This means substantial foreign exchange savings and less vulnerability to currency fluctuations, notably a rising yen, they argue. Domestic demand for the Waja has been brisk, they note, and predict that the popularity of the model will enable the company to make significant inroads into the hitherto difficult export market. Proton sold just 14,586 vehicles abroad in the financial year to end-March—its main markets being the UK, Australia and Germany—many of them presumably at a loss in the interests of establishing brand recognition. The company said in October that a new engine developed in just nine months for M$450m with British sports car maker Lotus, in which it has an 80% stake, will

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likewise help reduce costs and boost international exposure. The engine is to be manufactured locally and fitted in most Proton models from 2002.

Proton seen as a niche Yet at the same time, Dr Mahathir acknowledged that his hopes of building player, not a global giant Proton into a global giant cannot now be realised. The company needs to become a niche player, focusing on relatively small markets in Asia, the Middle East and North Africa, he said. Proton has indicated that it intends to open factories or enter joint-ventures in China, India, Egypt and Turkey which will assemble parts made in Malaysia. To that end, it is seeking additional technological expertise. Heavily-indebted Hicom’s stake in the company is expected to be assumed soon by the cash-rich, state-owned oil and gas corporation, Petroliam Nasional, which is developing an engine of its own. There is also talk of Proton acquiring a small US-based engineering firm.

Agriculture

Agricultural output to The finance ministry’s Economic Report projected a marginal 0.5% expansion remain almost unchanged in agricultural production in 2000. It forecast crude palm oil (CPO) production at 10.65m tonnes, up just 0.9% on 1999 owing to a downturn in the biological yield cycle of oil palm plantations. The area under oil palm cultivation was scheduled to increase by 4.5% to 3.5m ha. CPO production amounted to 6.4m tonnes in January-August, 1.9% down on the corresponding period last year. The report said that the country’s oil stocks were set to remain above 1m tonnes owing to the weakness of the export market. In January-August foreign sales declined by 1.5% in volume to 5.4m tonnes, and fell by 32.5% in value to M$6.6bn (US$1.7bn) on account of a 31.4% drop in the average export price to M$1,219 a tonne.

Crude palm oil export tax With output and stocks rising, prices and earnings falling, and low-cost temporarily lifted Indonesia selling aggressively, the government stepped up efforts to boost exports. On September 10th, the primary industries minister, Lim Keng Yaik, announced that seven local companies had been authorised to export up to 500,000 tonnes of CPO free of duty within six months (exports taxes are levied on a graduated basis, starting at 10% for cargoes priced at M$600 a tonne and rising to 30% for those above M$900 a tonne). On September 28th he revealed that half the permitted volume had been shipped, mainly to India and Europe. Dr Lim also said an additional US$135m was being made available under the Palm Oil Credit and Payment Arrangement—a loan and deferred payment facility—for five countries: Russia, Myanmar, Egypt, Bangladesh and North Korea. By mid-October CPO prices had dropped below M$800 a tonne, from a peak of nearly M$2,400 a tonne in 1998. Industry experts said growers should make the best of the price slump by replacing ageing trees and thereby positioning themselves to capitalise on an eventual upturn in the market.

Rubber production to The Economic Report forecast natural rubber production in 2000 falling by decline by 8.9% this year 8.9% to 700,000 tonnes, attributing the continuing downward trend to a further decline in yields and in the area under cultivation against the

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background of a weak market. In the first eight months output fell by 20.5% year on year to 421,254 tonnes. Exports stagnated in volume terms at 648,500 tonnes, but rose by 15.6% in value, to M$1.75bn, thanks to a 15.9% increase in average prices.

Part of INRO’s rubber Meetings in recent months between officials from Malaysia, Thailand and stockpile sold Indonesia—the three biggest producers of natural rubber, accounting for some 80% of global output—aimed at reaching agreement on measures to boost the flagging market made little apparent headway. Traders said the three countries were considering a minimum export price of up to US$1 a kilo and the retention of as much as 20% of their output. The all but defunct International Natural Rubber Organisation finally began offloading its 138,000 tonne stockpile in the third week of October, after member states agreed during a meeting in Kuala Lumpur that sales could be made at market prices. Previously, most had been insisting that any sale meet the organisation’s purchase and carrying costs of around US$0.71/kg. Traders estimated that up to 20,000 tonnes were sold by end-October at US$0.61-0.54/kg.

Cocoa production forecast Despite an anticipated 1.2% decline in the area under cultivation to 110,000 to increase by 5.2% ha, cocoa production in 2000 was expected to increase by 5.2% to 88,000 tonnes thanks to a 14.9% rise in the average yield, according to the Economic Report. Bean exports fell by 64.7% year on year in January-August to 6,700 tonnes. Earnings slumped by 77.8% to M$19.4m owing to a 37.3% drop in the average sales price to M$2,914 a tonne.

Sawn logs output to rise by The report forecast that output of sawn logs would edge up by 1.2% to 22.06m 1.2% in 2000 cubic metres in 2000, with domestic consumption rising by 12.3% to 17.05m cu metres. Production increased by 8% year on year in the first eight months to 15.72m cu metres. Exports rose by 4.8% in volume to 4.37m cu metres and by 2.3% in value to M$1.69bn.

Infrastructure

Growing role as a Substantial investment in port facilities over the years to boost Malaysia’s transshipment centre standing as a regional transshipment centre has yielded significant dividends of late. In August Denmark’s Maersk Sealand, the world’s largest container line, finalised the purchase of a 30% stake in recently-opened Tanjung Pelepas port in southern state for an undisclosed sum, and promptly pledged to make it the company’s Southeast Asian hub. To that end, Maersk promised to divert 2m 20-foot equivalent units there next year from Singapore port, its traditional hub 45 km to the south. Industry executives said the decision to migrate was motivated by cost and control factors, noting that while Singapore port boasts superior infrastructure and efficiency, persistent lobbying by Maersk for lower charges and dedicated or leased facilities had not succeeded. The company will operate its own terminal as part-owner of Tanjung Pelepas, and enjoy much cheaper fees. Its presence is also expected to attract other major shipping lines. Shortly after the conclusion of that deal, Hong Kong-based port operator

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Hutchinson International Terminals agreed to pay an estimated M$300m (US$79m) for a 30% interest in Westport, a container terminal at Port Klang, Malaysia’s premier port 50 km south-west of Kuala Lumpur.

Overseas buyer sought for A sizeable stake in troubled Malaysian Airline Systems (MAS) is likely to be stake in MAS sold soon to an overseas carrier. In late-October the finance minister, Daim Zainuddin, said that a number of potential strategic partners had been identified and discussions were underway with them. Dr Mahathir subsequently confirmed that the government was negotiating to buy the 29% interest in the national airline held by Naluri, a local company controlled by Daim protégé and MAS executive chairman Tajudin Ramli, that is seeking to dispose of assets to pay off debts of some M$1bn. It is understood that this stake, or part of it, would then be divested to a foreign airline. In late August MAS, which has debts of more than M$10bn, announced a net loss of M$128m for April-June, blaming sharply higher fuel costs. Much of the initial speculation focused on Qantas as the most likely overseas buyer, but in mid-September government officials claimed that talks with the Australian carrier had been all but abandoned. In late- November Malaysia’s Business Times reported that Swissair had become the front-runner, not least because it was offering to make Kuala Lumpur International Airport (KLIA) its regional hub.

British Airways abandons KLIA was dealt a major blow in mid-October when it emerged that British KLIA Airways (BA) had decided to suspend its London-Kuala Lumpur flights from March 31st 2001. Europe’s biggest carrier, which in April had increased the number of flights on the route from four a week to six and promised to add another from November, said it could not attract enough first- and business-class passengers to achieve profitability. The transport minister, Ling Liong Sik, who put BA’s losses on the route at £12m (US$17.4m) a year over the past six years, said the government would seek increased landing rights for MAS in London. MAS currently flies twice daily to the British capital. BA is the third foreign carrier to abandon KLIA since the airport opened in mid-1998. Germany’s Lufthansa did so in September 1999, citing poor profitability. Qantas followed suit last April after consolidating with BA.

Telekom Malaysia still Pressure on the government to find a strategic foreign partner for Telekom searching a foreign partner Malaysia, the dominant fixed-line provider that wants to significantly increase its share of the fast-growing cellular market, has intensified. Telekom’s share price took a battering following the mid-July disclosure that talks on a tie-up with Nippon Telegraph and Telephone had broken down, apparently over the issue of management control. A communications ministry announcement the same month, establishing licensing procedures for companies offering Voice Over Internet Protocol services, presages a possibly significant erosion of its main earnings base. Telekom suffered a 46% year-on-year drop in net profit in January-June, according to figures released in late August. Its cellular division posted yet another loss, even though the number of subscribers more than doubled to 461,000 during the six-month period. Local press reports in mid-November claimed that

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Telekom had three foreign suitors—France Telecom, Spain’s Telefonica and Hong Kong’s Hutchinson Whampoa—all of them particularly keen on the potential for rapid expansion of its cellular operations.

The cellular market is The cellular market is becoming much bigger, more competitive and developing rapidly sophisticated. All the major providers have achieved substantial increases in their subscriber bases this year, especially in the pre-paid segment of the market, and are forecasting the rapid growth to continue. Even before the early August revocation of a 1986 law regulating call and other charges, some had begun cutting tariffs and monthly access fees, launched aggressive marketing campaigns, and announced hefty capital expenditure programmes to upgrade networks, improve coverage and provide more services. Having already introduced Wireless Application Protocol facilities this year, most are planning to roll out General Packet Radio Services in the next few months. Some have indicated they plan to invest heavily in Third Generation (3G) technology, which provides signal transmission at broadband speeds. However, the communications ministry released a discussion paper in November which suggested it may award only two 3G licenses so as to prevent over-investment in the technology.

Financial and other services

Slow growth in lending Total loans outstanding at end-August 2000 amounted to M$443.9bn annoys Dr Mahathir (US$116.8bn), an increase of 3.2% on the end-December 1999 level, according to the finance ministry’s Economic Report. Loans outstanding to commercial banks were up 4.7%. The bulk of the increase was for the purchase of residential property, consumption spending and manufacturing activities. New loan approvals averaged M$10.9bn a month in January-August, compared to M$8.7bn a month in calendar year 1999. Disbursements averaged M$28.8bn a month, against M$26.5bn the previous year. The report said the continuing high level of repayments—which averaged M$28.2bn a month, up from M$27.7bn last year—largely accounted for the relatively modest increase in loans outstanding.

The explanation did not satisfy Dr Mahathir, who again expressed concern at the weakness of credit growth. In late August he accused banks of being excessively risk-averse, saying they were not doing enough to encourage economic recovery or development. Yet there were several factors at play. Demand for funds was still slack, even though the abundance of liquidity being generated by substantial monthly trade surpluses had pushed the average base lending rate of commercial banks—the rate applied to the most creditworthy borrowers—to an all-time low of 6.75% in May. Banks were also still worried about asset quality. Official data showed that the net non-performing loan (NPL) ratio, on a six-month arrears basis, rose to 6.9% at end-July, from 6.5% at end-June.

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Merger programme keeps Banks were also preoccupied with the on-going merger programme aimed at banks preoccupied forging a core group of resilient and dynamic domestic institutions ahead of the opening of the sector to foreign competition. The Economic Report said all the sales-and-purchase agreements needed to meld more than 50 banks and finance companies into 10 groups were successfully concluded by the extended deadline of end-August. Some of the pacts were signed at the last minute, and only after much arm-twisting by Bank Negara, the central bank. While the consolidation exercises are supposed to be completed by end-December, the integration process will in some cases be fraught with hazards. Some of the marriages may not even proceed. In early November Arab Malaysian Bank, one of the ten “anchor” institutions, said it was reviewing the terms of its proposed merger with Bank Utama, which has been problematic from the outset.

Maybank’s profit rebound Malayan Banking, the country’s biggest group, achieved a 40% increase in net profit, to M$1.4bn, for the year ended June 30th, according to figures released in late-August. Lower loan losses and provisions, and a recovery-induced increase in lending and deposits, were largely responsible for the improvement. Overall provisions for NPLs fell by 33% to M$1.5bn. Net specific provisions declined to M$1.2bn, from M$2bn in the previous financial year, while general provisions rose to M$307m from M$71m. Loans classified as non-performing amounted to M$6.9bn, down from M$7.9bn in 1998/99. Nevertheless, at end- June 2000 the group’s net NPL ratio, on a three-month arrears basis, was 5.6%, up from 5.3% a year earlier. Domestic lending expanded by 8.1%, compared to an industry average of 2% growth, boosting Maybank’s market share to 18.7% from 17.3%.

State-owned Bank of China After a 41-year break, the Bank of China recommenced operations in Malaysia re-opens in Malaysia in August, opening a branch in central Kuala Lumpur. The move followed the reinstatement of the Beijing government-owned institution’s banking licence, which it had surrendered in 1959 following the introduction of legislation prohibiting banks owned by foreign governments from operating in the country. That legislation was essentially aimed at curbing the flow of funds to ethnic Chinese communist insurgents. While Bank of China had been advised in the mid-1990s it would be allowed to reopen, not least to facilitate growing

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commercial and economic relations between the two countries, the prohibitive legislation remained in force, as did a freeze on the issuance of new licences. The concession to Bank of China was a “special arrangement”, officials insisted, adding that no other foreign-owned banks were likely to be licensed in the immediate future. Beijing made a reciprocal gesture, authorising Maybank to open a branch in Shanghai.

Bearish trend continues at Sentiment on the Kuala Lumpur Stock Exchange (KLSE) has remained bearish, the KLSE with disappointing company earnings and concerns about corporate governance among the domestic factors contributing to a continued sell-down by foreign and local investors. In the first two trading days of September the benchmark composite index, the KLCI, tumbled 6.7% to 743 points following the controversial appointment of a prominent UMNO figure as chairman of the predominantly state-owned power utility Tenaga Nasional, the market’s largest-capitalisation stock, in place of a respected professional. It continued to trend downwards in the subsequent weeks, hitting a 10-month low of 720 on September 28th and a 12-month low of 703 on October 2nd. After recovering to 786 by October 24th amid expectations of a favourable 2001 budget, the KLCI began slipping again following Mr Daim’s less than encouraging October 27th presentation, and closed at 732 on November 29th.

Weak share prices affect The weakness of the stockmarket called into question the sustainability of corporate restructuring economic recovery, not least because it adversely affected key corporate restructuring plans that envisaged swapping debt for equity and were therefore premised on a prolonged post-recession upturn. The scheduled listing before the end of 2000 of telecoms concern Time dotCom and North-South Expressway operator Projek Lebuhraya Utara-Selatan—both units of troubled infrastructure group Renong—had to be postponed owing to the lack of liquidity in the market. Many listed companies took advantage of the depressed KLSE to buy back large blocs of their own shares, taking advantage of a concession made by the regulatory authorities in 1997 after the onset of the regional crisis. Some did so in an effort to persuade investors their stocks companies were unjustly undervalued.

Investors are demanding But others were perceived by increasingly suspicious investors as being greater transparency motivated by less noble considerations, such as a desire by company directors to manipulate prices for personal gain. Minority shareholders, local as well as foreign, are becoming much more vocal in defence of their own interests, demanding greater disclosure and transparency. Regulators are responding to the pressure by tightening rules and routinely punishing companies found to be breaking them. On September 22nd the KLSE warned it would impose stiffer penalties on firms that repeatedly fail to honour their obligations to shareholders, noting that of the 71 companies deemed to breached listing requirements in 2000, nine were repeat offenders. In mid-October, Hashim Ismail, the finance ministry parliamentary secretary, said the Securities Commission would contribute M$200,000 to help fund the launch of a permanent minority shareholders’ watchdog group, which is due to be in place before the end of the year. Yet the group will operate initially under the auspices of the finance ministry, and will have no legal powers.

EIU Country Report December 2000 © The Economist Intelligence Unit Limited 2000 38 Malaysia

Foreign trade and payments

Substantial, but smaller, Although imports are still growing faster than exports, Malaysia has continued trade surpluses continue to record substantial monthly trade surpluses. The September surplus reached M$6.1bn—the biggest in six months—thanks to a 23.8% increase in exports to a record M$34.9bn, and a 30.5% expansion in imports. By and large, exports and imports also grew on a month-on-month basis. Exports expanded by 2.8% in July, 4% in August and 2.6% in September. Imports rose by 6.7% in July and 1.7% in August, but edged down by 1.4% in September.

Surging oil prices boost The January-September trade surplus totalled M$43.7bn, down from M$52.5bn export values in the corresponding period of 1999. Imports were 31% higher at M$233.7bn, with purchases of intermediate, capital and consumption goods up by 32.2%, 48.2% and 18.3% respectively. Exports were 20.2% higher, suggesting the government’s forecast of 15% growth for the full year to be somewhat conservative. Clearly, its projection did not anticipate the strength of the recent surge in the prices of crude oil, refined petroleum products and liquefied natural gas (LNG).

Exports of electricals grow Exports of electronic and electrical goods rose by 21.9% year on year in faster than electronics January-September to M$162.5bn, accounting for 58.6% of total exports. Detailed data for January-August contained in the finance ministry’s Economic Report showed that while sales of electrical products expanded by 31.3%, rebounding from a contraction of 4.3% in the first eight months of 1999, the growth of electronics exports moderated to 17% from 29.6%. The strongest growth was in sales of petroleum products (124.1%), crude oil (74%) and LNG (52.8%), while exports of palm oil, textiles and clothing and non-metallic minerals expanded by 32.5%, 17.5% and 14.9% respectively.

Improving services balance Balance–of-payments figures for the second quarter of 2000 were published at in the second quarter the end of November. The data, which is not seasonally adjusted, shows that the decline in the current-account surplus, which started in the fourth quarter of 1999 on a year-on-year basis, is continuing and accelerating. The current-account surplus in April-June 2000 amounted to M$7,879m compared with M$12,340m in the same period a year earlier. The major reason for the decline of the current-account surplus was the drop in the trade surplus, mainly because of a very strong rise in imports. An unusual feature was the improvement in the services balance, due to a rise in services exports. It made up for part of the deterioration in the income balance, largely growing profits and dividends from the improving Malaysian economy, repatriated by foreign companies.

Government resists another The government continued to express reservations about plans for a new WTO round of negotiations round of multilateral negotiations under the auspices of the World Trade Organisation (WTO), which the United States wants to begin in 2001. Rafidah Aziz, the international trade and industry minister, was characteristically vocal on the matter. She insisted it would be “ridiculous” to launch a new round

EIU Country Report December 2000 © The Economist Intelligence Unit Limited 2000 Malaysia 39

without setting an agenda first, and reiterated 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. Ms Rafidah was instrumental in drafting the mid-November recommendation by ministers of the 21-member Asia Pacific Economic Cooperation (APEC) forum that an agenda be finalised in 2001, prior to the setting of a date for the start of a new round.

Malaysia: current account (M$m; not seasonally adjusted) 1999 2000 1998 1999 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Exports of goods 281,669 318,946 77,594 84,482 88,137 84,348 91,491 Imports of goods –212,453 –232,411 –56,296 –60,133 –66,042 –64,060 –73,584 Goods balance 69,216 86,535 21,298 24,349 22,095 20,288 17,907 Services exports 46,247 46,865 10,382 12,380 13,877 11,382 12,007 Services imports –53,669 –58,724 –13,525 –15,507 –16,232 –13,675 –14,034 Services balance –7,422 –11,859 –3,143 –3,127 –2,355 –2,293 –2,027 Income credits 5,308 6,385 1,344 1,906 1,578 1,580 1,704 Income debits –20,125 –26,660 –6,040 –7,454 –7,949 –7,049 –8,054 Income balance –14,817 –20,275 –4,696 –5,548 –6,371 –5,469 –6,350 Transfers credits 2,975 3,148 680 761 1,122 724 654 Transfers debits –12,558 –9,647 –1,799 –2,379 –3,783 –2,540 –2,305 Transfers balance –9,583 –6,499 –1,119 –1,618 –2,661 –1,816 –1,651 Current-account balance 37,394 47,902 12,340 14,056 10,708 10,710 7,879 Source: Department of Statistics, Malaysia

EIU Country Report December 2000 © The Economist Intelligence Unit Limited 2000 40 Brunei

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 elements 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 December 2000 © The Economist Intelligence Unit Limited 2000 Brunei 41

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 (%) 3.6 4.1 1.0 2.5 3.5c Consumer price inflation (av; %) 2.0 1.7 –0.4d 1.0 n/a Population (‘000) 305.1 314.4 323.6 333d 342d 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 1.72d

December 4th 2000 Br$1.7415: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 1997f Br$ m Natural gas 1,860 Machinery & transport equipment 1,229 Crude petroleum 1,650 Manufactured goods 804 Refined products 111 Food & live animals 352

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 data is IMF, Staff Country Report No. 99/19, drawing on Brunei’s Ministry of Finance, national development plans and Statistical Yearbook (various issues). b IMF estimates. c Brunei government estimates. d EIU estimate. e Actual. f Brunei Statistical Yearbook, 1998, estimates. g IMF, Direction of Trade Statistics.

Quarterly indicators 1997 1998 1999 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr Production (prodn/day) Crude petroleum '000 barrels 150 147 126 134 150 160 157 140 Foreign trade (annual totals) E x p o r t s f o b ( U S $ m ) 2 , 3 7 5 ( n / a ) ( n / a ) I m p o r t s c i f ( U S $ m ) 3 , 9 4 6 ( n / a ) ( n / a ) Note. Annual figures of most for the series shown above will be found in the Country Profile. Sources: Oil & Gas Journal; IMF, Direction of Trade Statistics, yearbook.

EIU Country Forecast ~quarter~ quarter ~year~ © The Economist Intelligence Unit ~year~ 42 Brunei

Outlook for 2001-02

Economic concerns may The economy will continue to dominate the political landscape in Brunei, with have political consequences the Sultanate coming under increasing pressure to prove its commitment to lead the country out of its economic difficulties. While the government is likely to maintain its firm control over its citizens, continuing its policies of censorship and suppression of potential dissidents, criticism of the government’s handling of economic affairs is likely to become louder. To attract foreign investment, Brunei will need to become more open toward the release of economic data, which may test the traditional complacency of its citizens. The loudest criticisms of government policy can be expected to come not from students or workers, as elsewhere in the region, but from businesspeople who feel their livelihoods threatened by the continuing crisis in the private sector.

Official economic growth Brunei has revised its year 2000 GDP predictions upwards from 3% to 3.5% on estimate raised the basis of higher oil prices and a 25% increase in petrochemical production. The Brunei Department of Economic Planning announced in mid-November that hydrocarbon revenues for the year are expected to reach an all-time high. Notwithstanding this much-needed boost of petroleum profits, Brunei’s economy is likely to falter again in 2001, when oil prices are likely to fall back again. The EIU predicts the price of oil will drop from US$32/b during the fourth quarter of 2000 to an average of US$23.50/b for the whole of 2001. Brunei has a number of ambitious plans on the table for revitalising the private sector—including an international financial centre and a diversified downstream oil and gas industry—but these projects are unlikely to bring substantial revenues for several more years.

Economic restructuring to Supported by record high oil and gas income in 2000, the government of continue Brunei will continue its efforts to restructure its economy to diversify its private sector and to expand its petrochemical activities. In 2001, Brunei will award contracts for a new 10,000 square kilometres of deepwater, which will double the area for oil exploration currently under concession. The Petroleum Unit has also promised to announce plans for new downstream projects that will utilise Brunei’s hydrocarbon reserves by mid-2001. A full slate of programmes to revitalise the private sector will be implemented, including human resources training, upgrading Internet services, and creating new financial and communications legislature. While these projects will not pay off immediately, they will send a clear signal that Brunei is serious about supporting sustainable economic growth.

Regulatory environment In late-August, Brunei overcame a major hurdle blocking its path to becoming modernised an international financial centre. Seven new pieces of legislation on money laundering, crime, international banking, companies, trusts, registered agents and limited partnerships were announced, while three new laws on insurance licensing and regulation, money markets, and securities will be published soon. An antiquated regulatory environment had been perceived by potential

EIU Country Report December 2000 © The Economist Intelligence Unit Limited 2000 Brunei 43

investors as one of Brunei’s biggest drawbacks. Brunei also promised to keep its legislation in tune with changes in international finance, and to offer overseas investors a streamlined government bureacracy. With its legislation modernised, Brunei now has to convince the world it has the infrastructure and expertise to support international finance. Its reputation as a haven of safety and social order in Asia should help draw business, as will the Sultanate’s ability and willingness to invest its oil funds in upgrading IT services and human resources. Brunei’s cultivation of closer ties with the wider Islamic world will also help it tap a potentially lucrative niche market for Islamic financial services.

The political scene

Brunei Investment Agency The saga of the missing billions from the Brunei Investment Agency (BIA) court case continues continued to play out under the public eye, with a number of new defendants ordered to appear in court. The scandal had seemed to be over when in August the state of Brunei and the BIA reached an out-of-court settlement with Prince Jefri. In February, the prince had been charged with misappropriating US$14.8b from the BIA during his tenure as BIA chairman and state finance minister. The terms of the settlement were not made public and Jefri was allowed to leave the country to reside overseas. The Sultanate seemed pleased to have him out of the picture but it had apparently not given up hope of recovering the government money he squandered. In early October, Brunei succeeding in having Awang bin Kassim deported from the Philippines to stand trial. Kassim was Deputy Managing Director of the BIA under Prince Jefri as well as the prince’s private secretary. He fled the country in 1998 following the collapse of Prince Jefri’s Amedeo conglomerate. Kassim is accused of having illegally received over US$90m of BIA funds. In February the court ordered him to make full disclosure of his personal assets and his knowledge of illegal BIA transfers. Kassim has been characterised in the local press as the “Prince’s Paymaster” and is rumoured to have had full knowledge of the prince’s financial dealings. He seems well positioned to become a non-royal scapegoat whose prosecution may help deflect attention away from corruption within the royal family, while aiding the state in tracing Jefri’s lavish expenditure.

In October, the High Court also ordered six former associates of the prince to file defence statements, after charging them with illegally receiving funds from the prince. Those accused include former BIA officers and executives in Jefri’s corporate empire, as well as a former director of Royal Brunei Airlines. The Borneo Bulletin reported that a number of other associates of Jefri’s, who were said to include high government officials and ministers, have received letters from state lawyers requesting them to return cash gifts from Jefri to the treasury.

Malay ethnic nationalism is The continuing economic stagnation has sparked a rise in Malay ethnic on the rise nationalist sentiment. While there has as yet been no violence directed at Brunei’s minority communities, ethnic Chinese have experienced increasing public resentment for what many Malays appear to perceive as their privileged

EIU Country Report December 2000 © The Economist Intelligence Unit Limited 2000 44 Brunei

economic position. Brunei’s government has indirectly supported such sentiment by announcing a programme to “uplift Malay entrepreneurs” and to research the reasons for Malay economic “backwardness”. Brunei’s government, long wary of the explosive political protests that have occurred in its neighbouring countries, even allowed Dr Mahathir Mohamad, the Malaysian Prime Minister, to speak at a gathering of Malaysian expatriates in October. Dr Mahathir called for increased Malay unity, claiming that Muslim Malays were still colonised by the West, and characterised those whose criticism of their governments had a negative impact on foreign investment as traitors. The fact that Brunei allowed Dr. Mahathir’s comments to be printed in the state-censored local press may be indicative of the Sultanate’s desire to deflect attention away from economic distress and use ethnic and religious sentiment to bolster its own claims to absolute rule.

With the unemployment rate estimated at 6-10% and with 25% of school leavers unable to find jobs, anti-foreigner sentiment is also on the rise. About 80% of private-sector jobs, especially in the service sector, are held by foreigners, mainly from Indonesia, Malaysia and the Philippines. Bruneians have been notoriously reluctant to accept such low-status jobs and prefer to rely on promises of government employment. They are now faced with a harsh new reality of the civil service cutting back on hiring and threatening to privatise some of its departments. Local newspapers have published a series of letters to the editor, calling for an end to work permits for foreigners and a concentrated effort by the government to provide more job training for Bruneians.

APEC meetings bring mixed In November, Brunei hosted the Asia-Pacific Economic Cooperation (APEC) reviews for Brunei summit meetings, which brought some 6,000 delegates and journalists to the country. Brunei’s $60m investment in preparing for the meetings seemed to have paid off in a smoothly run summit, putting to rest worries that the country’s infrastructure could not support a gathering of such magnitude—the largest Brunei has ever hosted. Brunei’s international press reviews were, overall, positive, with most coverage focusing on the country’s wealth and apparent calm rather than its economic problems. Brunei’s military and police, who had been preparing for months to counter terrorism and protests in a series of highly-publicised drills, also succeeded in demonstrating locally and internationally that dissent or disruption will not be tolerated in Brunei. But in the wake of APEC, some Bruneians were publicly questioning the benefits the meetings had brought to the country. A BruDirect Internet poll—one of the country’s few options for free speech—saw 50% of the respondants agreeing that “it was not worth it” for Brunei to host APEC. A heated online discussion then erupted between those who saw APEC as an investment in national pride and those who felt that few benefits had accrued to the average citizen still struggling with economic stagnation.

The policing of morality Brunei stepped up its campaign to police the morality of its citizens and and religion is stepped up increase its Islamic legitimacy. In a series of highly-publicised raids on hotels and nightspots, the Ministry of Religious Affairs and the police worked together to arrest people for adultery, homosexuality, and possession of

EIU Country Report December 2000 © The Economist Intelligence Unit Limited 2000 Brunei 45

pornographic materials and alcohol. The openness with which the operation was conducted represents a policy shift for the Sultanate, which previously preferred to hush up incidents deemed to be anti-social. But with the Sultanate’s own moral legitimacy questioned in the wake of the Prince Jefri scandal—which brought into the limelight the lavish lifestyle of the royal family—the state has become keen to reaffirm its moral authority. The Brunei authorities have also expressed concern over the recent appearance of religious groups whose teachings, they claim, contravene orthodox Islamic doctrine. Dyg Hajjah Sarimah, an official of the Ministry of Religious Affairs, claimed at a September seminar on “Islamic deviations and religious cults”, that the sects had been brought to Brunei by foreign nationals. However, the Sultanate has acted quickly to disband them in the interests of national harmony and stability. The Ministry of Religious Affairs announced it was continuing its investigation into the militant Malaysia-based Al-Ma’unah group. Brunei members of the organisation were detained in July after the news broke of a weapons raid on a military depot, the kidnapping and murder of two civilians, by members of the group in Malaysia. The Ministry dismissed the possibility that the Bruneians had been attracted to the group’s mission of creating an Islamic state, and claimed instead that they had been naively lured by the promise of miraculous medical cures.

Economic policy and the economy

Brunei’s oil and gas Taking advantage of spiralling petrochemical prices in the third quarter, Brunei revenues hit record highs stepped up its production of oil and Liquefied Natural Gas (LNG), bringing unprecedented revenues into its treasury. Hamdillah Wahab, the CEO of state- controlled Brunei LNG, announced in September that production of LNG was at the highest level in the company’s 28-year history. He predicted that Brunei LNG would export 197 shipments, or 14.8 million cubic metres, of natural gas in 2000, compared to an average of 155 shipments in recent years. Wahab also noted that oil exports were at a 10-year peak, with a 25% production hike bringing Brunei Shell’s output to 215 barrels per day. He stated that Brunei, which derives 90% of its income from oil and gas, was “expecting record government income” for year 2000.

No news of promised civil Despite recent oil price euphoria, Brunei seems to have stayed on course with service and welfare cuts its plan to restructure its economy away from over-reliance on oil and gas revenues, which was detailed in the February report of the Brunei Darussalam Economic Council (BDEC). The government has continued with its short-term economic stimulus plan, and pushed forward with proposals to create an offshore financial centre, boost manufacturing, and promote tourism. The government has, however, moved slowly with plans to trim a top-heavy civil service and reduce the social welfare burden. Earlier this year the government announced its intention to impose the first income tax in its history and to cut the benefits it provides to its citizens, including interest-free housing, car loans, free education and health care. However, no news has been forthcoming on how and when such measures might be implemented. Despite the criticism by

EIU Country Report December 2000 © The Economist Intelligence Unit Limited 2000 46 Brunei

the IMF in its 1999 report on Brunei, that civil servants’ high wage and bonus rates were hampering the country’s economic progress, the Sultanate has made no move to trim its payrolls.

The private sector remains Brunei’s recent oil windfall has not been able to compensate for the continuing in a slump weakness in the private sector. The construction industry, Brunei’s number two income generator, remains in a severe slump, with new construction virtually halted, the real estate market in a glut, and many construction-related firms reportedly on the verge of collapse. Brunei has kept its promise to award B$200m (US$120m) in contracts to small-to-medium sized enterprises (SMEs), but many local businessmen have complained publicly that the projects are not enough to rescue the economy from its troubles.

Local confidence in the Local confidence in Brunei’s economy appears to be at an all-time low. economy wanes Notwithstanding the booming oil business and the package of economic reform measures, Brunei’s citizens are bearing the brunt of shrinking incomes, high unemployment and a depressed private sector. One telling symptom of continuing economic woes is the dramatic rise in bankruptcy cases. The High Court is now reported to have over 300 cases registered, up from an average of less than half a dozen in previous years. Abas bin Mohamad, the deputy president of the National Chamber of Commerce and Industry, characterised the spirit of Brunei’s business community as “really low”. He said that “many have given up hope in our economic recovery process”. The Malay Chamber of Commerce, a newly-formed group composed of ethnic Malay businesspeople, stated its dissatisfaction with the slow pace of economic reforms, and announced its intention to form a watchdog body to monitor the government’s progress in implementing its promised programmes.

APEC brings a boost to APEC brought a much-needed boost to Brunei’s tourist industry, with all the Brunei tourism country’s hotels—a total of around 1,500 rooms—booked for the Leaders Summit, which took place on November 9th-16th. The media blitz surrounding APEC also drew some 2,000 Bruneians to register for job training in the hospitality industry, which has long been considered unattractive to Brunei’s citizens, who have preferred to rely on jobs in the government civil service. In the run-up to APEC, the BDEC announced it was tendering out 14 small-scale tourism infrastructure projects worth B$8.9m. These projects, which form part of the BDEC’s $200m short-term economic stimulus package, will focus on upgrading existing facilities as well as building new tourist information centres and cultural villages.

Brunei signs new trade APEC also provided an occasion for Brunei to sign several new trade pacts. pacts at APEC Brunei signed three memoranda of understanding with China, in a move to take advantage of China’s rapidly growing economy. The first is an agreement on the encouragement and reciprocal protection of investments. The second is an agreement to facilitate the flow of Chinese tourists to Brunei. The third, an agreement for Brunei Shell Petroleum (BSP) to provide 10,000 barrels of oil per day to China International United Petroleum and Chemical Company (UNIPEC), is the first ever accord signed between BSP and a Chinese buyer. Brunei, along with Chile, New Zealand, Singapore and the United States, also signed a multilateral agreement in principle on the liberalisation of

EIU Country Report December 2000 © The Economist Intelligence Unit Limited 2000 Brunei 47

international air transportation. The agreement was, according to the Brunei authorities, the world’s first multilateral “open skies” pact, which would allow the countries to operate without restrictions on flight frequencies, routes, or aircraft types.

International Financial In late August Brunei announced that it had implemented seven new laws, Centre legislation passed effective from July 1st 2000, that would lay the groundwork for the transformation of Brunei into an international financial centre. Robert Miller, the newly-appointed head of supervision of the Brunei International Financial Centre (BIFC), announced that the new laws covered international banking, companies, trusts, limited partnerships, registered agents, money laundering, and international crime. Miller stated that new legislation on insurance licensing and regulation, securities, and mutual funds would be forthcoming over the next few months. He explained that the legislation for the BIFC had been three years in the making, and was designed to appeal to potential foreign investors, who have long complained about Brunei’s antiquated and cumbersome regulatory system. He also promised that Brunei was committed to a regular review of its legislation, to keep it up to date with changes in the international financial community.

Islamic financial services Brunei reaffirmed its commitment to use its new international financial centre market targeted to capitalize on the growing demand for Islamic financial services. Selamat Munap, the deputy finance minister, speaking at a September news conference, expressed confidence that such an Islamic-focused centre could succeed, given that 22% of the world’s population are Muslims. “As Muslims become more and more devout, there is increased demand for Islamic papers and money market instruments,” he said. The Finance Ministry has stated that it would like to see Brunei become a lender to Islamic banks facing short-term liquidity shortages. In late August, Brunei hosted an international seminar on the Islamic money market, with banks from Saudi Arabia, Bahrain and Malaysia in attendance. But Robert Miller, head of supervision of the Brunei International Financial Centre (BIFC), explained that the BIFC would most likely concentrate its first efforts on more secular markets, including the—potentially large— Chinese demand for corporate insurance.

Brunei upgrades its Brunei continued to upgrade its electronic communications infrastructure, electronic infrastructure and announced its ambition to become a regional “cyber hub” for information technology and electronic commerce. In November, Brunei’s Telecoms Department launched its “e-speed” venture, a high-speed data transmission programme which expands the useable bandwidth of existing lines to deliver 512 kbps communications. The service premiered in urban areas and will eventually be available throughout the country. Brunei also announced the establishment of a national task force on e-commerce, which would focus on developing small-scale business Internet skills, addressing security concerns, and creating new legislation covering electronic transactions and computer crime. The Ministry of Communications announced a plan to build a Cyber Park, which would consist of offices, stores, research and development facilities, educational centres, and an exhibition hall. The ministry suggested that such a project could help develop

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an information technology industry in Brunei, bringing new job opportunities and improving the country’s human resources.

Management contract In late-October, Brunei signed an agreement with the Port of Singapore signed for Maura terminal Authority Corporation (PSAC) to manage the Muara container terminal. The 25-year contract is for the development, management, and operation of the facility. Since the Singapore company took over the management of the terminal in January, the productivity has almost doubled, rising from 15 to 27 containers per hour. The government has invested B$12m and PSAC B$2m in improving the facility, including the computerisation of the work flow, changes that Brunei hopes will make Muara a more competitive choice for regional shipping.

Brunei’s deepwater attracts The days of Brunei Shell Petroleum (BSP) dominance over Brunei’s oil industry investor attention appear to be ending. Brunei is opening up 10,000 square kilometers of deepwater for oil exploration, which will double the area currently under concession. Bidding for the new area opened in late-October and is to end on November 1st, 2001. According to Ahmad Ibrahim, the director of Brunei's Petroleum Unit, more than 30 companies attended a pre-launch session in October and 16 have already paid for the right to bid. Brunei has commissioned a three dimensional seismic survey on the deepwater area, and will begin to make the data available to potential investors in January, 2001. Brunei has expressed high hopes for the new site, with a government geologist calling it “the best piece of deepwater in Southeast Asia.” Brunei is confident that exploitation of the area will not only increase its current oil reserves— which it estimates will run dry in twenty years—but that it will raise profit margins and set the stage for the creation of a national oil company, as suggested in the February BDEC report. Brunei plans to award its deepwater blocks using a production sharing system, rather than the present concession and royalty/tax agreement it holds with Royal Dutch Shell.

Options for downstream In keeping with the February recommendations of the BDEC, that Brunei ease investments studied its economy away from overdependence on crude oil exports, the government announced in October that it has considered its options for investing in downstream industries. Pehin Yahya, the permanent secretary at the Prime Minister’s Office, stated that there were three possible projects currently under consideration: an export-oriented oil refinery; the production of natural-gas based petrochemicals such as ammonia, urea, and menthol; and an energy- intensive aluminium smelter. Brunei currently exports 95% of its oil as crude, while the rest is processed at the Brunei Shell Petroleum refinery for domestic use. About 90% of Brunei’s gas is converted to LNG for export, with the remainder used to generate electricity for domestic needs. Abdul Rahman, the head of Downstream Industry at Brunei’s Petroleum Unit, added that these downstream projects can spark additional spin-off industries that could revitalise the private sector. He suggested that local firms use a new downstream infrastructure to develop facilities for the manufacture of plastics, textiles, packaging materials, synthetic rubber, agricultural chemicals, and pharmaceuticals. Mr Yahya said that the government would be ready to announce its decisions on downstream projects by mid-2001.

EIU Country Report December 2000 © The Economist Intelligence Unit Limited 2000