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Malaysia After Mahathir

Successor Abdullah Badawi will try to boost stocks and improve education as foreign investment drops.

Abdullah Badawi can see two onion-domed buildings from his office in Malaysia’s Ministry of Home Affairs in Putrajaya, the country’s new administrative capital 25 kilometers (16 miles) south of Kuala Lumpur. One is the Putra mosque; the other, the prime minister’s office. “Allah and power,” says Ab- dullah with a smile, pointing first at the mosque, then at the prime minister’s office.

Come October, Abdullah, 63, will wield the power. That’s when he takes over from Mahathir Mohamad, 77, one of the world’s longest-serving leaders, who chose Abdullah to succeed him when he steps down after 22 years. Mahathir, who froze $10 billion of foreign investors’ funds when he imposed capital controls during the 1997–98 Asian economic crisis, will leave Abdullah a nation whose economy will grow more than 6 per- cent this year, according to government estimates, up from 4 percent in 2002. Malaysia has grown at an average of 6.9 per- cent a year for the past 15 years, with only one negative year— 1998, when it shrank by 7.4 percent following the crisis.

Unemployment is 3.2 percent; inflation, 1.8 percent, according to government figures. Members of a large urban middle class own houses, condominiums and cars. Malaysia, a country the size of New Mexico with a population of only 25 million, is the world’s 18th-largest exporting nation—just be- hind Russia and ahead of Sweden and Australia, according to World Trade Organization figures.

The biggest task facing Abdullah, who studied Islam in college and who’s spent his entire working life in politics and government, will be to maintain Malaysia’s prosperity. He says he plans to do that by investing in industries such as biotechnology, by upgrading the quality of education to include more teaching in English and by attempting to make Malaysia into a regional banking center and transportation hub.

The foreign investment on which Malaysia’s manufacturers rely is drying up. Last year, foreign direct investment in Malaysia fell 42 percent to $2.95 billion, International Trade and Industry Minister Rafidah Aziz announced in January. “I am feeling the heat of competition on the back of my neck,” says Koh Tsu Koon, 53, chief minister of Penang state, where foreign companies such as Dell Computer Corp., Intel Corp. and Motorola Inc. employ 90,000 of the labor force of 600,000. In the past two years, companies have eliminated 24,000 jobs, he says. Many foreign companies are building factories in countries in which there’s cheaper labor, such as China—where comparable salaries are 50–80 percent lower than in Malaysia, according to Koh.

To encourage investors, Abdullah wants to counter any impression that Malaysia, which is 60 percent Muslim, is a terrorist risk. U.S. Ambassador to Malaysia Marie Huhtala has praised Kuala Lumpur’s cooperation in the war on terror. Both Mahathir and Abdullah oppose an invasion of Iraq, in part because, they say, it will increase the number of recruits to terrorist organizations.

“A lot is riding on Abdullah,” says Surin Pitsuwan, a Harvard University–educated Muslim who was foreign minister of neighboring Thailand from 1997 to 2001. Malaysia has had no terrorist attacks, and its police have arrested more than 70 alleged Islamic terrorists since August 2001, a month before the attacks in the U.S. Malaysia says those arrested are members of Jemaah Islamiya, the al- Qaeda–linked group that’s been blamed for the Oct. 12 bombing in Bali in which 191 people were killed.

Timothy Garland, president of the American Malaysian Chamber of Commerce, says he’s detected some anti-Ameri- can sentiment. For example, a group called the Muslim Consumer Association said in December it would boycott Coca-Cola Co.’s soft drinks for three months. Coke’s local bot- tler, F&N Coca-Cola Malaysia Bhd., hasn’t detected any reduction in orders, says Kamal Harun, the company’s national corporate affairs manager. Still, few U.S. companies are looking at Malaysia, says Garland. “U.S. perceptions of Malaysia in the boardroom at this time are that it is not the first choice,” he says. The U.S. government has a travel warn- ing out on Malaysia, stating concern about possible height-ened risks to Americans and American interests in Malaysia. Such warnings anger Abdullah. “Various developed countries are giving the impression that Malaysia is somehow unsafe and cowering under the specter of imminent terror attacks,” Abdullah told foreign businesspeople and investors at a January lunch in Kuala Lumpur. “Of course, all this is untrue.” The same month, he told a conference of Asia-Pacific parliamentarians, “Malaysia is a safe place for everyone, and we will not allow outsiders to disorientate and destabilize us.”

Many analysts agree that the risks are exaggerated. “Western perception of Malaysia is, in our view, different from reality,” writes Stephen Hagger, director of Asian equity re- search at Credit Suisse First Boston in Kuala Lumpur, in a Jan. 10 report.

“We’re long on Malaysia,” says David Roche, president of Independent Strategy, a London- and Hong Kong–based consulting firm that advises fund managers. “I don’t think there will be an Islamic backlash. They are too rich and too smart.” Roche credits Mahathir’s policies with helping create the country’s middle class.

Mahathir initiated megaprojects that gave Malaysia First World infrastructure: a new airport and a new seaport; expressways; the world’s tallest buildings, the 88-story Petronas Twin Towers; a national car, the Proton; and a vision of becoming a fully developed nation by 2020.

During the Asian economic crisis of 1997, when the ring- git tumbled 41 percent, Mahathir’s strategy was at odds with that of his neighbors. At first, Mahathir’s then finance minister and heir apparent, Anwar Ibrahim, followed the painful International Monetary Fund prescription of raising interest rates to 14 percent and slashing government spending. On Sept. 1, 1998, Mahathir changed tack by imposing capital controls. The following day, he pegged the ringgit at 3.8 to the U.S. dollar and reduced interest rates. While Indonesia, South Korea and Thailand adopted IMF policies in return for bailouts, Mahathir took nothing. His strategy worked. After contracting in 1998, Malaysia’s economy grew 6.1 percent the following year and 8.3 percent in 2000.

Mahathir famously blamed the currency crisis on hedge fund manager George Soros, whom he called a “moron.” Hours after pegging the ringgit to the dollar, Mahathir fired Anwar, accusing him of sodomy and corruption. Anwar, who says he was framed to thwart his political ambitions, failed to convince the court. He was found guilty of both charges and is serving a 15-year jail sentence.

Abdullah is less confrontational than Mahathir, those who work with him say. He’s also less likely to be planning Mahathir-style megaprojects, they say. “He’s not a physical builder; he’s a consensus builder,” says Penang Chief Minister Koh.

In an hourlong interview in late January, Abdullah stressed the need for better education if Malaysia is to become competitive. When Mahathir first came to power, the language of schooling was switched to Malay from English. Last year, the government decided mathematics and science would again be taught in English. It also withdrew grants to those Muslim religious schools it claimed were indoctrinating pupils, not educating them. “We have to ensure that anyone investing in Malaysia will know that we have a pool of workers, speaking good English, who are trained and trainable and further trainable,” says Abdullah.

Abdullah also says he wants to relax affirmative action quotas that Malaysia instituted 30 years ago to help the ethnic Malay majority. Muslim Malays, who account for 60 per- cent of the country, earn only a little more than half of what their ethnic Chinese counterparts earn. “A nation with half its people on crutches cannot survive in this highly competitive world for very long,” Abdullah, himself a Malay, said about the quotas in a recent speech. “They undermine the resilience of the recipients, sap competitive spirit and drive and encourage mediocrity and complacency.”

The son and grandson of religious teachers who ran a school in a poor kampung (Malay village) in a rural part of Penang state, Abdullah graduated from the University of Malaya in 1964 and then entered public service as an assistant secretary, rising to become director general of the Ministry of Youth and Sports in 1971. In 1978, he was elected to parliament as a representative of Mahathir’s United Malays National Organization (UMNO), the country’s dominant political party. Abdullah has been minister of education, of defense and of foreign affairs. In 1987, Abdullah backed one of Mahathir’s political rivals in a struggle for UMNO leader- ship. Mahathir won, and Abdullah left the cabinet. Abdullah remained active in politics as a vice president of UMNO and was on a committee to update the affirmative action pro- gram. Three years later, Mahathir recalled him to be foreign minister. Since 1999, Abdullah has been deputy prime minister and minister of home affairs.

Abdullah declines to say how long he aspires to lead Malaysia. An election is due by November 2004, though one could be called earlier. Still, Abdullah faces little opposition: The ruling coalition, which also includes parties represent- ing Malaysia’s Chinese and Indian minorities, has won every election since Malaysia gained its independence from Britain in 1957.

For the present, Abdullah promises to press ahead with Mahathir’s policies to spark the economy, including consolidating the banking sector, boosting the stock market and improving corporate governance. “I am a believer in continuing policies that work well,” Abdullah says.

One such initiative involves strengthening the country’s banks. In 1998, Mahathir set up a government-owned asset management company—Pengurusan Danaharta Nasional Bhd.—to acquire $13.7 billion worth of bad loans the banks had run up during the late 1990s. He then ordered the country’s 54 banks to merge into just 10. In 2007, the government plans to drop restrictions on foreign competition.

Abdullah says an area in which Malaysia can excel is Islamic finance. Many Muslims say Islam bans the paying or receiving of interest. Instead, banks and finance houses have developed products that incorporate fees into transactions.

Citigroup Inc., HSBC Holdings Plc and Standard Char- tered Plc all have Islamic banking divisions. Steve Martin, Dubai-based HSBC regional manager of corporate affairs, says HSBC estimates the global Islamic finance market is worth more than $200 billion. Malaysia already has an Islamic bond market. Last year, HSBC was lead arranger of a $600 million sovereign Islamic bond sale for the Malaysian government, Martin says.

Abdullah says he’ll also try to attract more foreign investors to the Kuala Lumpur Stock Exchange, whose Composite Index fell 6.5 percent in the year to Feb. 7 compared with a decline of 25 percent for neighboring Singapore’s Straits Times Index. At the end of 2002, foreign investors accounted for only 18 percent of Malaysia’s stock market, down from 23 percent in 1998, according to KLSE figures. The market’s total capitalization is $130 billion, 55 percent of what it was in February 1997. In January, Mahathir launched a $2.6 billion investment fund called Value- Cap that buys shares in companies that are owned by two state investment companies and by the civil servants’ pen- sion fund. Once ValueCap began buying shares, the KLSE index rose 6.2 percent in three weeks.

Abdullah says he’s determined to improve public compa- nies’ disclosure—something officials of Malaysia’s Securities Commission say they’ve already started doing. Since 1999, companies have had to report quarterly instead of only twice a year, directors must take a day-and-a-half-long course to learn their responsibilities to shareholders and a minority shareholder watchdog committee has been set up by the gov- ernment. “We have to practice corporate governance as we practice religion,” says Zarinah Anwar, the Securities Com- mission’s deputy chief executive.

Not all investors are convinced. “Compared with Malaysia Inc. of two years ago, corporate governance has definitely im- proved,” says Kenny Tjan, Singapore-based vice president of Goldman Sachs Asset Management, who helps manage $3 billion in Asia excluding Japan, including $150 million in Malaysia. “But going forward, there’s room for improvement.”

Zarinah says securities laws are being enforced rigorously not only by jail terms but also with whippings. “They have scared the living daylights out of a lot of directors,” says Nik Mohamed Nik Yaacob, group chief executive of Sime Darby Bhd., Malaysia’s largest conglomerate. “They have cherry picked the best corporate governance practices from abroad and put them in place in Malaysia.”

Malaysia has also encouraged local entrepreneurs such as Tony Fernandes, 37, a British-educated Malaysian of Indian descent. Fernandes, a former managing director of Warner Bros. in Malaysia, decided he wanted to set up a low- cost airline modeled on EasyJet Plc and Ryanair Holdings Plc in competition with state-con- trolled national carrier Malaysian Airlines System Bhd.

Fernandes managed to get a meeting with Mahathir, who gave him the go-ahead. He sold his AOL Time Warner Inc. stock options for $70 a share and then bought a full-fare carrier, AirAsia, for 1 ringgit and the assumption of $18 million of debt. “It was amazing,” says Fernandes, who says he had no high-level connections. “Mahathir was familiar with the low-cost model.”

Barely a year later, AirAsia Sdn. is flying domestic routes in competition with Malaysian Airlines. It reported a prof- it of $3.1 million in the second half of 2002. “Much is said about cronyism, but I am a testament to how someone who didn’t know any politicians could be allowed to set up in competition with a national entity owned by the government,” says Fernandes.

Fernandes gives Abdullah high marks as well. “I am not at all worried,” he says. “The deputy prime minister is a steady guy. He’s very probusiness, and so are the people around him.”

When Malaysia has targeted a particular business goal in the past, it’s often succeeded. Four years ago, Mahathir decided to build from scratch a container port that would compete with that of the wealthy city-state of Singapore, the world’s second-busiest container port, after Hong Kong.

The port opened for business in 2000 in Tanjung Pelepas, a former fishing village about 200 miles from Kuala Lumpur and just 8 nautical miles from Singapore. A year later, Maersk Sealand, a unit of A.P. Møller Group, the world’s largest shipping line, moved its Southeast Asian transshipment hub to Tanjung Pelepas from Singapore, taking a 30 percent stake in the port. Maersk’s business alone amounted to 2 million container movements last year, says Jesper Praestensgaard, senior vice president of Maersk Sealand. “It’s a big thing to move a hub operation; it’s like open-heart surgery,” says Praestensgaard. He says Maersk improved its productivity 25 percent after the move. In April 2002, Tanjung Pelepas won Evergreen Marine Corp. as another customer

Stephen Taran, New York–based managing director and global head of sovereign credit research at Salomon Smith Barney, is betting Abdullah will have similar success. He says he’s advising Salomon clients to buy Malaysian bonds should spreads increase on fears of instability once Mahathir departs. “Such concerns are misplaced,” says Taran. “We have confidence that the transition will go smoothly and Badawi will do a good job.”

During the currency crisis, the spread on Malaysian government bonds over U.S. Treasuries rose to 1,000 basis points from 60 basis points, according to Bloomberg data. It’s now down to 140 basis points. (A basis point is 0.01 percentage point.) “Anyone who bought in 1998 would have done very well,” says Taran.

Not everyone is as upbeat. “I think Abdullah is in for a very tough time,” says Ngan Ching Wen, 70, managing di- rector of Unico-Desa Plantations Bhd. and president of the Malaysia China Chamber of Commerce. Ngan says he and many of his members have had to close electronics component factories because their multinational customers can now get parts more cheaply in China.

To succeed, Abdullah will not only have to win over foreign investors like Taran; he’ll have to get domestic bus- inesspeople like Ngan on board as well. For that, he may need all of his diplomatic skills.

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