Global Economics

Malaysia's Makeover Lures Investors


Malaysia is pulling in some serious foreign direct investment these days. At a construction site next to Malaysia's southern port of Tanjung Pelapas near Singapore, giant contract manufacturer Flextronics Intl. (FLEX) is spending $280 million on a 1.2 million-sq. ft. factory. This will include production lines relocated from China by the Singaporean concern.

Why? "Malaysia is one of the most cost-effective places for manufacturing in the world with overall costs about 20% lower than Shanghai," says Peter Tan, CEO of Flextronics Asia-Pacific, which has nearly 40% of its capacity in China.

In northern Penang, once dubbed Southeast Asia's Silicon Island, personal computer maker Dell (DELL) recently began work on a four-hectare (approximately 10 acres) facility next to an existing plant. Malaysia has long been a strategic manufacturing center for Dell. Some 90% of the company's global notebook PC production is now shipped from its Penang facility even as Dell continues to expand its footprint in China and India, the two fastest growing PC markets in the world.

BIG TURNAROUND. Intel (INTC), meanwhile, makes nearly a third of its global output of microprocessors at Penang. It is building a new state-of-the-art design center there, too. In 2007, Germany's Infineon (IFX) will open its $1.1 billion semiconductor wafer fab carved out of a paddy field an hour's drive away in Kedah state.

Infineon chose Kedah over Shanghai because overall costs were lower. Others are piling into Malaysia as well. Foreign direct investments totaled $4.2 billion last year, and third of that haul came from U.S. companies.

Wasn't Malaysia supposed to get smoked by China as an investment destination? Earlier in the decade, that seemed a real possibility. Under the rule of strongman leader Mahathir Mohamad, Malaysia had a problematic image among foreign investors.

NEW MANAGEMENT. After all, back in 1998 Mahathir slapped on stringent capital controls at the height of the Asia Financial Crisis, which created investor headaches for getting money in and out of the country. Malaysia's political climate was also nasty, what with Mahathir's jailing of his ambitious charismatic deputy, Anwar Ibrahim. Anwar, who was charged with sodomy and served six years behind bars, was released two years ago after his conviction was overturned by a court.

Malaysia wasn't exactly a no-go zone for foreign investment, but neither was it a preferred destination. That's all starting to change under Malaysian Prime Minister Abdullah Ahmad Badawi, who assumed leadership of this $140 billion economy three years ago from Mahathir. Investors are returning, capital controls were lifted years ago, and last year Malaysia removed its U.S. dollar peg, opting for a managed float for the ringgit.

Large global tech companies such as Seagate Technology (STX), Intel, and Dell that had sunk serious money in China are taking a hard look at Malaysia again. "It's a new, more confident Malaysia under a new leadership that is trying to reposition itself as China and India rise," says Dr. Michael Yeoh, director of the Asian Strategy and Leadership Institute, a think tank in Kuala Lumpur.

VOICES RESTORED. Many credit Badawi for the reassessment. "Malaysia today is more open, free, and democratic," says Musa Hitam, a former Malaysian deputy prime minister who rode to power with Mahathir 25 years ago only to fall out with his mentor. "There is freer public discussion of key issues, whereas in the past most people voiced their views only when Mahathir asked them to."

Moreover, the degradation of national institutions that marked the past two decades has been halted and their credibility is now being gradually restored. "Under Mahathir, judiciary, media, Parliament, police, civil service were all muzzled," adds Musa.

Indeed, the contrast between Mahathir and his successor couldn't be more marked. While Mahathir was a big-picture visionary, Badawi is a details man. Mahathir was a big spender who loved splurging on megaprojects like Kuala Lumpur's iconic Petronas Towers, the second-tallest building in the world, or the gigantic Bakun Dam. In contrast, Badawi is a fiscal conservative who has focused on education, training, and skills development of the country's population of 25.6 million mostly Malays, Chinese, and Indians.

YIN AND YANG. Mahathir could be by turns charming and absolutely autocratic. He surrounded himself with a close group of loyalists and cronies who were given lucrative government privatization contracts. Badawi is a somewhat shy and soft-spoken widower. However he has created more transparency in the government's bidding process. Big state contracts are now bid for in an open tender.

Mahathir brooked no dissent and was personally involved in all major decisions. Badawi is the ultimate consensus builder. Badawi has also been far tougher on corruption. He has sacked a Cabinet minister, put top businessmen on trial, and even dispatched the vice-president of his own political party, the ruling United Malays National Organization, for "money politics."

Badawi insists he isn't completely rejecting every policy of his outspoken predecessor. "People make too much of the differences but the main difference is style," Badawi told BusinessWeek.com in a recent interview.

NOTHING TO CUT. Malaysia's economy grew by 5.3% last year and is forecast to grow 5.5% this year. It is Asia's largest oil and gas exporter and is getting a nice bounce from the spike in global energy prices. Still, Badawi has tried to rein in the build-and-spend mentality common during the Mahathir era. And even resource-rich Malaysia can no longer live beyond its means, Badawi contends.

"When I took office there was a very high budget deficit, and one of the main policies of my government has been to cut this deficit," he explains. "We can't do that anymore because we don't have the money." What about more privatizations? "There really is not much left to sell," he adds.

Under Badawi, Malaysia is moving to reduce reliance on manufacturing from about one-third of gross domestic product, where it was three years ago, to around 25% in five years. Malaysia has Asia's heaviest manufacturing reliance—even higher than chip-foundry-intensive Taiwan. "We need new engines of growth," says Badawi.

ROLLER COASTERS. Now, as it emphasizes services such as tourism, Malaysia has emerged as the biggest Asian destination for high-spending Arab tourists who have had difficulty obtaining visas to Europe and the U.S. in the aftermath of September 11.

It is also developing new niches such as Islamic finance. Malaysia has more than half of the total global Islamic bond market. It has emerged as one of three key centers for the recycling of Middle East's petrodollars alongside Dubai and London. Negotiations are now underway to bring Disney (DIS), Universal Studios (GE), or another large theme-park operation to Johore Bahru, the border town near Singapore that caters to Southeast East Asian and Arab tourists.

In July, Badawi announced the government had earmarked $ 3.4 billion for development of a Johore growth corridor. "We look at Johore and Singapore as Shenzen and Hong Kong," Badawi says. YTL, a Malaysian construction group, has proposed a $2.5 billion high-speed express train that would travel from Singapore to Kuala Lumpur in 90 minutes. "These are all privately funded initiatives that government is looking at," says Badawi.

OUTSIDE INVESTMENT. Yet as he tries to rebrand Malaysia, Badawi is taking heavy incoming fire from his former boss and mentor, Mahathir. He has cut Mahathir-era megaprojects and reined in the former strongman's cronies. Three months ago, Badawi cancelled the new and so-called "crooked bridge" project that was to have replaced the current one connecting Singapore and Malaysia. (Because Singapore had refused to dismantle its part of the old bridge, the new one had to be crooked.)

Badawi has also take a hard look at government subsidies for government-linked companies such as auto maker Proton, Malaysia Airlines, and the utility firm Tenaga. He has folded state enterprises under the umbrella of state investment arm Khazanah Holdings. Khazanah is remaking itself into the mold of its Singapore counterpart Temasek Holdings, the city state's investment arm.

Rather than funneling subsidies to local companies, Khazanah is looking outside Malaysia. It has invested in Indian hospitals, Indonesian banks, a cellular phone company in Singapore, and retailing ventures in China.

WRESTLING MATCH. Mahathir doesn't like what he sees. He has called Badawi a "traitor" and accused him of "selling out" and "kowtowing" to Singapore over the bridge flap and other matters. He has also blasted Badawi for refusing to help Proton, the national car project. Under its trade commitments to other Southeast Asian neighbors, Malaysia is obligated to open its protected auto market to foreign competition, and Badawi has been cutting tariffs in preparations for that eventual opening.

Mahathir has criticized that move and said Badawi had "no guts" when it comes to protecting national icons and national interests. Last week, Mahathir called for Badawi to step down immediately. "I am not losing sleep over this," Badawi says. The stakes are high in the Mahathir-Badawi battle. A protracted wrestling match could undermine business confidence and rattle the financial markets.

THE QUIET MAN. Other challenges loom. Badawi is nudging Malaysian companies into alternative fuels as a hedge if energy prices tumble and to position state oil company Petronas for a profitable future. Others would like to see Badawi do more to reform the long-standing affirmative-action programs designed to help underprivileged Malays but hurt the prospects for talented Chinese and Indian citizens.

That is a much more long-range goal for Badawi. "Rome was not built in a day. We need to keep growing the pie to be able to distribute it evenly and fairly," he says.

Badawi may not attract the global headlines Mahathir used to with his outbursts against the West and severe criticism of Israel. However, in his quiet and determined way he is making his imprint on a Malaysia that looks like it's making a comeback.


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