The Economist Intelligence Report on Malaysia August 2010

There has been speculation in the past month that a general election will be called by early 2011. This would be considerably before its due date, which falls in March 2013. If an early election is called, it may be because the BN wants to make the most of a possible conviction against Anwar Ibrahim, the leader of the opposition Pakatan Rakyat alliance, who is in court fighting sodomy charges.

THE CORRIDORS OF POWER

Economist Intelligence Unit, London

Country Report - Main report: August 1st 2010

Highlights

Outlook for 2010-11

The Economist Intelligence Unit expects the Barisan Nasional (BN) coalition to remain in power in 2010-11. The BN still has a sufficiently large parliamentary majority to pass the bulk of new legislation unchallenged. Speculation has grown about the likelihood that the government will call a snap election, but we do not believe that the prime minister, Najib Razak, is preparing to go the polls before 2012.

Policy will be tightened in 2010-11 following a recent period of fiscal stimulus and loose monetary policy. The government aims to cut its fiscal deficit through an efficiency drive and a reduction in the subsidy bill.
The economy is expected to stage a strong recovery in 2010, growing by 6.8%. However, as this relatively rapid acceleration mostly reflects the rebound from the contraction in 2009, the annual average rate of growth will slow in 2011.

Price pressures will remain subdued in 2010, when we expect consumer price inflation to average 1.7%. Inflation will then accelerate to 2.6% in 2011, owing in part to continued growth in domestic demand. Despite the relatively fast pace of growth of imports compared with that of exports, Malaysia will continue to post substantial trade and current-account surpluses in 2010-11.

Monthly review

There has been speculation in the past month that a general election will be called by early 2011. This would be considerably before its due date, which falls in March 2013. If an early election is called, it may be because the BN wants to make the most of a possible conviction against Anwar Ibrahim, the leader of the opposition Pakatan Rakyat alliance, who is in court fighting sodomy charges.

Relations between Malaysia and Singapore are improving, with the two sides co-operating on land ownership and tourism deals.

On July 8th Bank Negara Malaysia (the central bank) took another step towards returning its main policy rate, the overnight policy rate, to a more neutral level. BNM raised the rate by 25 basis points to 2.75%.

In a surprise move on July 15th the government has reduced the size of the subsidies for five important items. It raised the regulated prices of petrol (RON95 grade) by 2.8%, diesel by 2.9%, cooking gas by 5.7% and sugar by 15.2%.

Data on industrial production and external trade for May showed a continuation of the recent strong growth, but a degree of caution is becoming evident, as reflected by changes in a business conditions index.

Outlook for 2010-11: Domestic politics

In 2010-11 fierce political tussles will continue between the ruling Barisan Nasional (BN) coalition and the main opposition Pakatan Rakyat (PR, People’s Alliance) as both groups strive to increase their representation in national and state parliaments. At present the BN governs with a simple parliamentary majority, which allows it to pass the bulk of legislation unchallenged. However, a two-thirds majority is needed to amend the constitution. The prime minister, Najib Razak, will continue to pursue a strategy aimed at restoring public confidence in the BN and winning back the seats in state assemblies and the national parliament that the coalition lost at the general election in March 2008. To date, there have been 11 state and parliamentary by-elections since the 2008 general election. The scorecard is eight wins to the PR and three to the BN. Despite these results, Mr Najib's approval ratings have been climbing steadily, from 44% in April 2009 to 72% in May 2010.

In the light of this higher approval rating and recent signs of a strong recovery in the economy, speculation has grown about the likelihood that the government will call a snap election. (The next general election is not due until early 2013.) Although a recent increase in parliamentary allocations for BN members of parliament (MPs) for help with their constituency expenses and a renewed focus on registering new voters has contributed to this speculation, the Economist Intelligence Unit does not believe that Mr Najib is preparing to go the polls before 2012. Although a strong election performance would bolster his mandate, the results of recent by-elections suggest that the electorate has become much more volatile, especially non-Malay voters, and there is no guarantee that the government's plans to reform policies that favour bumiputera (ethnic Malays and other indigenous peoples, who make up around 60% of the population) has increased its appeal among ethnic minorities.

Mr Najib continues to enjoy general support among ethnic Malays, but he does face opposition from conservative groups to his plans to reduce special rights for Malays. He appears to be hoping that he still has sufficient latitude to make further changes to these policies, while also securing a greater understanding for the necessity for other unpopular policy decisions, such as pushing through a goods and services tax (GST). The prime minister is also aware that the promotion of racial harmony is vital to his plans to woo voters from the country’s ethnic minorities, many of whom abandoned the BN in favour of the multiracial opposition at the last election. Mr Najib attempted to encapsulate his political ambitions by coining a new slogan—“1Malaysia: People first, Performance now”—at the start of his premiership.

Mr Najib may be looking for the opposition to fall further into disarray before going to the polls. The opposition leader, Anwar Ibrahim, is facing the possibility of a 20-year prison term if found guilty of sodomy, a charge for which he is currently on trial. Mr Anwar continues to claim that the case against him is politically motivated and has been fabricated to remove him from the political scene. A guilty verdict and a custodial sentence for Mr Anwar could destabilise the PR, as he is widely believed to be the glue that holds the alliance together. The PR received a confidence boost from its electoral success in May 2010 when it won the Sibu parliamentary seat, but morale among members of the one of the parties in the PR, the Parti Keadilan Rakyat (PKR) led by Mr Anwar, remains low, undermined by the recent decision by a handful of its MPs to leave the PKR and stand as independents.

Outlook for 2010-11: International relations

Mr Najib is expected to strengthen economic ties with Singapore and China, Malaysia’s largest trade partners in Asia. To this end, he will continue to promote to Singaporean investors the Iskandar project, a 2,217 sq-km develop-ment zone in the state of Johor, which borders Singapore. In addition, state tourism agencies of both countries have recently launched a feasibility study to look into ways to replicate the success of Singapore's Sungei Buloh Wetland Reserve in Kranji at similar sites in Johor. Through its membership of the Association of South-East Asian Nations (ASEAN), Malaysia’s economic ties with China, Australia, New Zealand and India have been strengthened by the signing of free-trade agreements, all of which came into full effect in January.

Outlook for 2010-11: Policy trends

During the next decade the policy agenda will be guided by a host of initiatives aimed at raising per-head income and meeting the goal of becoming a high-income nation by 2020. Improvements will be made to six national key result areas, outlined in a Government Transformation Programme, which includes raising the quality of human capital and improving basic rural infrastructure. The Tenth Malaysia Plan (10MP), a medium-term spending plan covering 201115, will promote 12 national key economic areas, such as tourism, palm oil and private healthcare, which are thought to have the greatest potential to boost overall economic growth. In the forecast period the government will also be implementing eight strategic reform initiatives, which have been outlined in an Economic Transformation Programme. One of the initiatives is the phasing out of price controls and subsidies, which has been deemed necessary to create a competitive domestic economy. Another is to reform bumiputera affirmative-action policies. The government has already relaxed a requirement obliging firms to offer a minority equity stake to bumiputera. It hopes that further reforms will attract greater inflows of foreign direct investment, which will be one of the main drivers of growth in the next five years. However, the government is unlikely to dismantle affirmative action altogether for fear of losing its Malay support base.

Outlook for 2010-11: Fiscal policy

The government appears determined to address the country’s poor fiscal position, having run up a budget deficit equivalent to 7% of GDP in 2009 owing in part to its economic stimulus measures. The government will have broad success in its aim to cut the deficit to 5.3% this year through an efficiency drive and a reduction in the subsidy bill. The Economist Intelligence Unit expects the government to have further success in reining in the budget deficit in 2011, but there will not be a marked narrowing. Plans to widen the tax base have encountered strong resistance from businesses as well as consumers. The government has already announced changes to a new property tax, which will reduce the amount collected from this particular source. However, it remains non-committal on the implementation of the GST, a crucial part of tax reform. The proposed GST will make the government less dependent on payments by the national oil company, Petronas, which currently supplies over 40% of the government's revenue. According to the second finance minister, Ahmad Husni Hanadzlah, in early July 2010 the government still had not set a definite timeframe for the implementation of the new tax. Under its original plan, the government had sought to introduce the tax in the third quarter of 2011.

Outlook for 2010-11: Monetary policy

Bank Negara Malaysia (BNM, the central bank) is expected to tighten monetary policy further in the forecast period. It has already raised the overnight policy rate (OPR) three times since March 2010, by a total of 75 basis points, pushing the OPR up to 2.75%. It is expected to make incremental changes to the OPR in a process that it regards as a normalisation of this interest rate, after it was cut to a record low in response to a dramatic downturn in the Malaysian economy in 2009. However, BMN does not foresee inflation rising to problematic levels, believing that it will remain moderate going into 2011, with the forecast of a strengthening in domestic demand being accompanied by only a gradual acceleration in inflation. As such we do not see the OPR rising above the high of 3.5% that was in place during 2007 and much of 2008.