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Malaysia's Election Weakens Najib and Dims Prospects for Economic Reform

Prime minister courts his conservative base but electoral outcome fuels speculation of a leadership challenge later this year.

If investors were hoping that Malaysia’s fiercely contested election would provide clarity about the political outlook, they must be disappointed.

Although Prime Minister Najib Razak’s 13-party ruling Barisan Nasional (BN) — or National Front — coalition won a healthy majority of the seats in parliament in the May 5 election, his grip on power appears more tenuous. The BN lost the popular vote by a significant margin to the opposition Pakatan Rakyat, or People’s Alliance, whose leader, Anwar Ibrahim, has accused Najib’s coalition of electoral fraud and promised to challenge the outcome in court. The results also revealed a growing ethnic divide in the country, with Chinese voters swinging sharply to the opposition and away from the ruling coalition, which is dominated by Najib’s United Malays National Organization (UMNO).

Many analysts believe Najib is likely to face an early leadership challenge within the UMNO because of the weak showing. It doesn’t help that the party’s elder statesman, former prime minister Mahathir Mohamad, has started to question Najib’s authority.

“Najib’s days are clearly numbered,” says Bridget Welsh, an associate professor of Political Science at Singapore Management University. “He will have to pull something extraordinary out of the hat to get through the party elections in November.”

Anwar, a former deputy prime minister and finance minister who was ousted and jailed in the aftermath of the Asian financial crisis 15 years ago, has accused the ruling parties of a variety of poll irregularities, including vote buying in at least 30 constituencies where Najib’s coalition won with wafer-thin majorities. “They blatantly stole the elections,” Anwar told Institutional Investor in a short interview. “There was massive fraud.”

Nearly three weeks after the election results were announced, Anwar has yet to concede. Instead, he organized a series of political rallies in key cities to keep the pressure on Najib.

Even without the allegations of electoral fraud, Najib’s ruling coalition did poorly, polling just over 47 percent of the vote, while Anwar’s Pakatan Rakyat won about 51.5 percent. (Independents and minor parties not allied to either coalition took the remainder.) The regional and ethnic split was even greater.

In Peninsular Malaysia Anwar’s coalition took nearly 54 percent of the vote, and in most large cities it won nearly two thirds. Najib’s BN ran strongly in rural areas, particularly the Borneo states of Sabah and Sarawak. “It was clearly an urban tsunami for Pakatan,” says Ooi Kee-Beng, deputy director of the Institute of Southeast Asian Studies in Singapore and a prominent Malaysia watcher.

Najib blamed his party’s setback on what he called a “Chinese tsunami,” which saw nearly 90 percent of the country’s urban Chinese — who make up more than one quarter of the population — back Anwar’s coalition. The opposition coalition also gained ground in two of the most conservative states, Kelantan and Trengganu, where ethnic Malays, who make up over 60 percent of the country’s population, dominate the electorate. “Chinese votes were part of a larger multiracial swing against Najib and UMNO,” says Ooi. Moreover, he argues, the trend of urban middle-class ethnic Malays increasingly prepared to vote for change now seems irreversible. Malaysia’s current economic trajectory and urbanization are likely to reinforce the trend.

The loss of support could make it more difficult for Najib to govern and implement much-needed reforms, including the introduction of a so-called goods-and-services tax to help narrow a government budget deficit that’s running at an elevated rate of 4.5 percent of gross domestic product, analysts say.

“The election results mean policy making in Malaysia now becomes more challenging,” says Wei-Zheng Kit, an economist for Citigroup in Singapore. He contends that the government needs to stop dragging its feet and implement the tax.

It’s a sign of Najib’s weakness that his predecessor, Mahathir, is drawing attention to it. “Najib is not in a very strong position,” Mahathir was quoted as saying in Tokyo on Saturday, May 25, citing a risk that some politicians in the ruling coalition might defect to the opposition. “When you are concerned about that, the focus on development, economy and all that will be affected,” he said. “That is Najib’s problem.” In a bid to shore up his base, on May 15 Najib named a 57-member cabinet, one of the largest in the world, and packed it mostly with his own conservative supporters. He did add a few outsiders, including Paul Low, the former local head of Transparency International, an anticorruption organization, and Abdul Wahid Omar, chief executive of Maybank, one of Malaysia’s two big banks. Najib kept the key Finance Ministry portfolio for himself, in addition to his role as prime minister.

“Instead of a reconciliation or a reform cabinet, he has given Malaysia a crony cabinet,” says academic Welsh.

What does Najib need to do to get Malaysia back on the radar screens of the global portfolio investors who left in 1998 and still haven’t returned in a big way? “First, he has to allay concerns about growing political risks,” says Manu Bhaskaran, CEO of Centennial Asia Advisors, a Singapore-based consultancy. He notes how racial temperatures have risen as Najib and other BN leaders have blamed the ethnic Chinese minority for the party’s fortunes, calling them ungrateful for subsidies that the government has doled out to them.

“Secondly, Najib has to show that he still has the political will to implement a goods-and-services tax and move on rationalization of subsidies,” says Bhaskaran. Rating agencies have been calling on the government to introduce such a tax, equivalent to a value-added tax, to help reduce the budget deficit and diversify the government’s revenue sources. Fewer than 10 percent of Malaysians pay income tax and state oil giant Petronas accounts for 36 percent of government revenues. Since the elections, several ministers in the new cabinet have hinted that the government will introduce a 7 percent goods-and-services tax, which would generate $8.5 billion in annual revenues.

Bhaskaran says global investors also want “to see further moves to modernize the affirmative action program for Malays to make it more targeted and shorn of the distorted incentives, which encourage corruption and cronyism.”

Najib has vowed to continue to implement his $444 billion Economic Transformation Program, which includes big-ticket infrastructure projects like a new mass-transit network in Kuala Lumpur, a high-speed rail project linking Kuala Lumpur and Singapore, and a network of highways in the peninsula and in the two Borneo states. If the investment revival continues and big projects remain on track, Malaysia should have little problem chalking up growth of 4 to 6 percent a year over the next three to five years, says Bhaskaran.

Ooi says Najib’s coalition needs to broaden its appeal, not only to Chinese and Indian minorities but also to younger and middle-class ethnic Malays, particularly in urban areas. “Najib actually came in on a reform ticket, but that was washed out very quickly,” notes Sean Darby, a strategist for Jefferies & Co. in Hong Kong. “The reality is that there was very little reform, and despite enormous promises, his government just wasn’t able to deliver.”

The dilemma for Najib is that bolder reform efforts risk alienating the conservative base of the UMNO. Most political analysts expect Mahathir to encourage a challenge to Najib in UMNO’s party leadership election later this year. Mahathir is said to favor Muhyiddin Yassin, a conservative Malay nationalist who Najib kept on as deputy prime minister. Installing a less reform-minded leader like Muhyiddin will only increase the probability of BN losing power in the next general election as he will alienate more moderates and urban voters, says Ooi.

“Within UMNO, Najib, four years ago, decided to play the good cop and be the reformer, leaving the bad-cop role to Mahathir and right wing Malay nationalist groups like Perkasa, as well as Muhyiddin,” says Ooi. “The question is, will he now turn to play bad cop to save his own job or decide that he can actually move forward with his good cop role and go for broke, reining in those right-wing Malay nationalists.” The prominent Singapore-based political analyst says, “Najib’s best bet is to be the reformist prime minister the country needs.”

With a per capita GDP of just over $10,000, according to International Monetary Fund, Malaysia is caught in the middle-income trap, squeezed by rising giants like China, India and other emerging economies including Indonesia and Thailand. The government’s affirmative-action policies are driving talented ethnic Chinese and Indians to migrate to Hong Kong, Singapore and elsewhere in Asia. Citigroup’s Kit says even though the commodity super-cycle is over, resource-rich Malaysia can continue to develop its oil and gas industry as well as its electronics-manufacturing sector.

There are some long-term trends that are working in Malaysia’s favor, the economist notes. Those external factors will help revive foreign direct investments in Malaysia, Kit says, though not on the scale of Indonesia or Thailand, which are rising as investment destinations for other structural reasons. Manufacturing costs in China have risen significantly, he notes. “In early 2000 Malaysian manufacturing costs were four times that of China,” says Kit. Now they are just 1.5 times those of China and indeed many of the large Chinese manufacturing centers like Shanghai are Shenzhen are now more expensive than Malaysia.

Najib’s challenge is to make sure that the spoils of any manufacturing renaissance are more evenly spread out, which will allow his coalition to reclaim the lost ground.

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